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2015InternationalClientSeminarALFAINTERNATIONAL2015INTERNATIONALCLIENTSEMINARFIRSTWORLDCHALLENGES:FINDINGPRACTICALSOLUTIONSIN ASHRINKINGGLOBALECONOMYMarch5-8,2015FAIRMONTSCOTTSDALEPRINCESSScotsdale,ArizonaElaineMossBROWN &JAMES,P.C.St.Louis,MissouriCOURSEBOOKEDITEDBY:RobertPaschalYOUNG,MOORE&HENDERSONRaleigh,NorthCarolinaAGuidetoDoingBusinessAroundtheWorld

ALFA InternationalThe Premier Global Legal NetworkWhere You Need Us.When You Need Us.www.alfainternational.com

ALFA InternationalFACTSComplete NameBusinessLegal StatusHeadquartersALFA InternationalInternational Network of Law FirmsNon-Profit Delaware Corporation (501(c)(6))Chicago, Illinois# Staff 10WebsiteDate of Formationwww.alfainternational.com1980 (first legal network in the U.S.)# Member Law Firms 150# U.S. Member Firms 80# Countries with a Member Firm 65# Lawyers within Network 10,000# Support Staff 10,000# Offices 400U.S. CoverageAverage Member Firm Size95 of 100 largest metro areas75 lawyers# Members Per Metro Area One (Exclusivity)# Subject Matter Practice Areas 27# of Seminars/Events Per Year 15 –20# of Publications Per Year 30+

OVERVIEWBasics: ALFA International is the premier network of independent law firms. Founded in 1980, ALFA International wasthe first and continues to be one of the largest and strongest legal networks. We have 150 member firms throughoutthe world. Our 80 U.S. firms maintain offices in 95 of the 100 largest metropolitan areas. Our 70 international firms arelocated throughout Europe, Asia, Australia/New Zealand, Africa, Canada, Mexico and South America.Mission: ALFA International’s mission is to provide high quality, cost-efficient legal services wherever our clientsneed them. The ALFA model enables our members to use their local expertise to deliver highly effective legalsolutions, often drawing upon the collective wisdom and experience of other member firms. ALFA clients benefit froma geographically comprehensive network of exceptional law firms and accomplished trial and business counsel. Ourmember firms meet high standards to be part of the ALFA network and are well respected by their peers in the legaland business community.The ALFA International Difference: While ALFA International is an association of independent law firms,our members establish broad, deep relationships with each other by attending ALFA International CLE seminarsthroughout the year and working together on compendia, seminar programming, and most importantly, clientmatters. As a result, referrals among ALFA firms represent partnerships between trusted friends and colleagues ratherthan one-off engagements. Similarly, our many events provide corporate counsel with the opportunity to networkamong ALFA International lawyers and their peer in-house lawyers.Practice Areas: ALFA International attorneys have expertise across a full array of legal practice areas, a subset ofwhich are supported through our ALFA International Practice Groups. As part of our Practice Groups, the attorneyswork together to deliver excellent educational programming, including seminars, webinars, client site miniseminars,reference materials, speakers, newsletters and more. The ALFA International Practice Groups referredto above include:• Business Litigation• Construction• Health Care• Hospitality• Insurance• International Law• IP/Technology• Labor & Employment• Product Liability & Complex Torts• Professional Liability• Retail/Real Estate• Transportation• Women’s Initiative• Workers’ CompensationAdditionally, our member firms have expertise in:• Admiralty & Maritime• Alternative Dispute Resolution Services• Antitrust & Trade Regulation• Bankruptcy• Corporate & Securities• Environmental Law• Estate Planning & Wealth Transfer• Foreign Investment• Government Relations, Lobbying& Administrative Law• Immigration• Mergers & Acquisitions• Oil, Gas, & Energy• Tax• Venture Capital & Financingwww.alfainternational.com

For more information about upcoming seminars, webinarsor other educational opportunities, please contact:(312) 642-2532marketing@alfainternational.com980 N. Michigan Ave., Suite 1180Chicago, IL 60611Tel: (312) 642-ALFA (2532)Fax: (312) 642-5346Please join ALFA International onPlease follow ALFA International @ALFAIntLawwww.alfainternational.com

ALFA InternationalThe Global Legal NetworkLocal Relationships WorldwideDirectoryofMemberFirms2015www.alfainternational.com

ALFA InternationalThe Global Legal NetworkLocal Relationships Worldwide980 N. Michigan Avenue, Suite 1180Chicago, IL 60611Tel: (312) 642-ALFA (2532)Fax: (312) 642-5346www.alfainternational.comPocket Directoryof Member FirmsALFA International also publishes anelectronic version of this directory.Copies of these directories may be obtainedby contacting ALFA International’sChicago headquarters.REVISED 2015© COPYRIGHT 2015ALFA INTERNATIONAL GLOBAL LEGAL NETWORK, INC.ALL RIGHTS RESERVED.

ALFA INTERNATIONAL OVERVIEWBasics: ALFA International is the premier network ofindependent law firms. Founded in 1980, ALFA Internationalwas the first and continues to be one of the largest andstrongest legal networks. We have 150 member firmsthroughout the world. Our 80 U.S. firms maintain officesin 95 of the 100 largest metropolitan areas. Our 70international firms are located throughout Europe, Asia,Australia/New Zealand, Africa, Canada, Mexico, andSouth America.Mission: ALFA International’s mission is to provide highquality, cost-efficient legal services wherever our clientsneed them. The ALFA model enables our members touse their local expertise to deliver highly effective legalsolutions, often drawing upon the collective wisdom andexperience of other member firms. ALFA clients benefit froma geographically comprehensive network of exceptional lawfirms and accomplished trial and business counsel. Ourmember firms meet high standards to be part of the ALFAnetwork and are well respected by their peers in the legaland business community.The ALFA International Difference: While ALFA Internationalis an association of independent law firms, our membersestablish broad, deep relationships with each other byattending ALFA International CLE seminars throughoutthe year and working together on compendia, seminarprogramming, and most importantly, client matters. As aresult, referrals among ALFA firms represent partnershipsbetween trusted friends and colleagues rather than one-offengagements. Similarly, our many events provide corporatecounsel with the opportunity to network among ALFAInternational lawyers and their peer in-house lawyers.Carol B. Ervin, ChairYoung Clement Rivers, LLPCharleston, SCcervin@ycrlaw.com(843) 724-66634

ALFA INTERNATIONAL PRACTICE AREASALFA International attorneys practice in virtually everysubject matter area. The ALFA International “PracticeGroups” are the heart and soul of the organization, andeach attorney is a member of at least one Practice Group.Our Practice Groups enable our attorneys from acrossthe United States and around the world to leverage theircollective expertise to better serve their clients. ThesePractice Groups produce a wide range of best-in-classeducational programs and materials, including multi-dayseminars, one-day programs, webinars, and compendia.The Practice Groups currently supported are:• Business Litigation• Construction• Health Care• Hospitality• Insurance• International Law• Intellectual Property &Information Technology• Labor & Employment• Product Liability& Complex Torts• Professional Liability• Retail-Real Estate• Transportation• Women’s Initiative• Workers’ CompensationAdditionally, our member firms have expertise in:• Admiralty and Maritime• ADR• Antitrust & Trade Reg.• Bankruptcy• Corporate & Securities• Environmental Law• Estate Planning• Foreign Investment• Government Relations• Immigration• Mergers & Acquisitions• Oil, Gas, & Energy• Tax• Venture Capital &Financing5

ALFA BOARD OF DIRECTORSEXECUTIVE COMMITTEECarol B. ErvinChairYoung Clement Rivers, LLP25 Calhoun StreetSuite 400Charleston, SC 29401Tel: (843) 724-6663Fax: (843) 724-6600cervin@ycrlaw.comwww.ycrlaw.comPeter S. MarletteVice-ChairDamon Morey LLPThe Avant BuildingSuite 1200200 Delaware AvenueBuffalo, NY 14202Tel: (716) 856-5500Fax: (716) 856-5510pmarlette@damonmorey.comwww.damonmorey.comKathleen C. PeahlSecretaryWadleigh, Starr & Peters, P.L.L.C.95 Market StreetManchester, NH 03101Tel: (603) 669-4140Fax: (603) 626-4808kpeahl@wadleighlaw.comwww.wadleighlaw.comMichael J. MurphyChair EmeritusCarter, Conboy, Case, Blackmore,Maloney & Laird, P.C.20 Corporate Woods BoulevardAlbany, NY 12211-2350Tel: (518) 465-3484Fax: (518) 465-1843mmurphy@carterconboy.comwww.carterconboy.comGary A. BagueTreasurerHaight Brown & Bonesteel LLP555 South Flower StreetForty-Fifth FloorLos Angeles, CA 90071Tel: (213) 542-8000Fax: (213) 542-8100gbague@hbblaw.comwww.hbblaw.com6

MEMBERSBrett K. BaconFrantz Ward LLP2500 Key Center127 Public SquareCleveland, OH 44114-1230Tel: (216) 51 5-1660Fax: (216) 515-1650bbacon@frantzward.comwww.frantzward.comMelanie R. CheairsLorance & Thompson, P.C.2900 North Loop WestSuite 500Houston, TX 77092Tel: (713) 868-5560Fax: (713) 864-4671mrc@lorancethompson.comwww.lorancethompson.comMarc H. HarwellLeitner, Williams, Dooley &Napolitan, PLLCTallan Building200 W. Martin Luther King Blvd.Fifth FloorChattanooga, TN 37402Tel: (423) 265-0214Fax: (423) 267-6625marc.harwell@leitnerfirm.comwww.leitnerfirm.comJohn HutchingsCornwall StodartLevel 10114 William StreetMelbourne, Victoria 3000AustraliaTel: +613 9608 2245Fax: +613 9608 2222j.hutchings@cornwalls.com.auwww.cornwalls.com.auElizabeth P. JohnsonEspirito Santo PlazaFowler White Burnett P.A.1395 Brickell Avenue14th FloorMiami, FL 33131Tel: (305) 789-9200Fax: (305) 789-9201ejohnson@fowler-whte.comwww.fowler-white.comRichard W. KriegLewis, Thomason, King, Krieg &Waldrop, P.C.One Centre Square5th Floor620 Market StreetKnoxville, TN 37902Tel: (865) 546-4646Fax: (865) 523-6529dkrieg@lewisthomason.comwww.lewisthomason.comW. David PaxtonGentry Locke Rakes & Moore LLP10 Franklin Road, SoutheastSuite 800Roanoke, VA 24011Tel: (540) 983-9300Fax: (540) 983-9400paxton@gentrylocke.comwww.gentrylocke.comRonald G. Polly, Jr.Hawkins ParnellThackston & Young LLP4000 SunTrust Plaza303 Peachtree Street, NortheastAtlanta, GA 30308-3243Tel: (404) 614-7400Fax: (404) 614-7500rpolly@hptylaw.comwww.hptylaw.com7

ALFA BOARD OF DIRECTORSMarta RodriguesL.O. Baptista Schmidt ValoisMiranda Ferreira Agel AdvogadosAv. Paulista 12948° andar01310-100 São Paulo, SPBrazilTel: +55-11-3147-0800Fax: +55-11-3147-0811mar@lob-svmfa.com.brwww.lob-svmfa.com.brSelcuk SengulerSenguler & SengulerCumhuriyet Cad. No.25Cinar Apt. Kat. 434437, Taksim/IstanbulTurkeyTel: +90-212-361-50-66Fax: +90-212-361-50-67selcuk.senguler@senguler.av.trwww.senguler.av.trJohn SykesCharles Russell Speechlys LLP5 Fleet PlaceLondon EC4M 7RDEnglandTel: +44-20-7203-5000Fax: +44-20-7203-0200john.sykes@crsblaw.comwww.charlesrussellspeechlys.comINTERNATIONAL MEMBERSHIP SECRETARYLaurence WattCharles Russell Speechlys LLP5 Fleet PlaceLondon EC4A 7RDEnglandTel: +44-20-7203-5145Fax: +44-20-7203-0207laurie.watt@crsblaw.comlwatt@alfainternational.comwww.charlesrussellspeechlys.com8

U.S. MEMBER FIRMSALABAMABIRMINGHAMBradley Arant BoultCummings LLPOne Federal Place1819 Fifth Avenue NorthBirmingham, AL 35203David G. Hymer(dhymer@babc.com)Denson N. Franklin III(dfranklin@babc.com)John B. Grenier(bgrenier@babc.com)Jennifer McGahey(jmcgahey@babc.com)Tel: (205) 521-8000Fax: (205) 521-8800www.babc.comHUNTSVILLEBradley Arant BoultCummings LLP200 Clinton Avenue WestSuite 900Huntsville, AL 35801-4900G. Bartley Loftin III(bloftin@babc.com)Harold Stephens(hstephens@babc.com)Tel: (256) 517-5100Fax: (256) 517-5200www.babc.comMOBILEMcDowell Knight Roedder& Sledge, L.L.C.RSA Battle House Tower11 North Water Street, Suite 13290Mobile, AL 36602Archibald T. Reeves(areeves@mcdowellknight.com)Brian P. McCarthy(bmccarthy@mcdowellknight.com)Anne Laurie McClurkin(amcclurkin@mcdowellknight.com)Tel: (251) 432-5300Fax: (251) 432-5301www.mcdowellknight.comMONTGOMERYBradley Arant BoultCummings LLPRSA Dexter Avenue Building445 Dexter AvenueSuite 9075Montgomery, AL 36104Charles A. “Chuck” Stewart III(cstewart@babc.com)William C. “Bill” McGowin(wmcgowin@babc.com)Tel: (334) 956-7608Fax: (334) 956-7808www.babc.comALASKATo Be DeterminedCall ALFA Internationalat 312-642-ALFAARIZONAPHOENIXRenaud Cook DruryMesaros, PAOne North CentralSuite 900Phoenix, AZ 85004William W. Drury(wdrury@rcdmlaw.com)Steven G. Mesaros(smesaros@rcdmlaw.com)Tamara N. Cook(tcook@rcdmlaw.com)Margaret T. McCarthy(mmccarthy@rcdmlaw.com)Tel: (602) 307-9900Fax: (602) 307-5853www.rcdmlaw.com9

U.S. MEMBER FIRMSTUCSONRenaud Cook DruryMesaros, PA177 North Church AvenueSuite 815Tucson, AZ 85701William W. Drury(wdrury@rcdmlaw.com)Steven G. Mesaros(smesaros@rcdmlaw.com)Tamara N. Cook(tcook@rcdmlaw.com)Margaret T. McCarthy(mmccarthy@rcdmlaw.com)Tel: (520) 792-1554Fax: (602) 307-5853www.rcdmlaw.comARKANSASLITTLE ROCKWright, Lindsey& Jennings LLP200 West Capitol AvenueSuite 2300Little Rock, AR 72201-3699Ed Lowther(elowther@wlj.com)Kyle R. Wilson(kwilson@wlj.com)Jerry J. Sallings(jsallings@wlj.com)Tel: (501) 371-0808Fax: (501) 376-9442www.wlj.comCALIFORNIALOS ANGELESHaight Brown & Bonesteel LLP555 South Flower StreetForty-Fifth FloorLos Angeles, CA 90071William O. “Skip” Martin, Jr.(wmartin@hbblaw.com)Peter A. Dubrawski(pdubrawski@hbblaw.com)S. Christian Stouder(cstouder@hbblaw.com)Gary A. Bague(gbague@hbblaw.com)Tel: (213) 542-8000Fax: (213) 542-8100www.hbblaw.comSACRAMENTOMatheny Sears Linkert &Jaime LLP3638 American River DriveSacramento, CA 95864-5901Richard S. Linkert(rlinkert@mathenysears.com)Doug Sears(dsears@mathenysears.com)Matthew Jaime(mjaime@mathenysears.com)Tel: (916) 978-3434Fax: (916) 978-3430www.mathenysears.comNW ARKANSAS/FAYETTEVILLEEverett Wales & Comstock1944 E. Joyce BoulevardFayetteville, AR 72703Christy Comstock(christy@everettfirm.com)Tel: (479) 433-0292Fax: (479) 443-0564www.everettfirm.com10

SAN DIEGOHiggs Fletcher & Mack, LLP401 West A StreetSuite 2600San Diego, CA 92101-7913James M. Peterson(peterson@higgslaw.com)Peter S. Doody(doody@higgslaw.com)Tel: (619) 236-1551Fax: (619) 696-1410www.higgslaw.comSAN FRANCISCOManatt, Phelps & Phillips, LLPOne Embarcadero Center30th FloorSan Francisco, CA 94111Andrew A. “Drew” Bassak(abassak@manatt.com)Sharon B. Bauman(sbauman@manatt.com)Eric A. Newsom(enewsom@manatt.com)Tel: (415) 291-7400Fax: (415) 291-7474www.manatt.comCOLORADODENVERHall & Evans, LLC1001 17th StreetSuite 300Denver, CO 80202Kevin E. O’Brien(obrienk@hallevans.com)Benton J. Barton(bartonb@hallevans.com)Lisa F. Mickley(mickleyl@hallevans.com)Lance G. Eberhart(eberhartl@hallevans.com)Tel: (303) 628-3300Fax: (303) 628-3368www.hallevans.comCONNECTICUTHARTFORDHalloran & Sage LLPOne Goodwin Square225 Asylum StreetHartford, CT 06103Henry M. Beck, Jr.(beck@halloransage.com)Susan O’Donnell(odonnell@halloransage.com)Alfred A. DiVincentis(divincentis@halloransage.com)Brian D. Rich(rich@halloransage.com)Tel: (860) 522-6103Fax: (860) 548-0006www.halloransage.comWESTPORTHalloran & Sage LLP315 Post Road WestWestport, CT 06880Stephen P. Fogerty(fogerty@halloransage.com)Thomas P. Lambert(lambert@halloransage.com)Joshua M. Auxier(auxier@halloransage.com)Tel: (203) 227-2855Fax: (203) 227-6992www.halloransage.comDELAWAREWILMINGTONMorris James LLP500 Delaware AvenueSuite 1500Wilmington, DE 19801-1494James W. Semple(jsemple@morrisjames.com)John H. Newcomer, Jr.(jnewcomer@morrisjames.com)Tel: (302) 888-6800Fax: (302) 571-1750www.morrisjames.com11

U.S. MEMBER FIRMSDISTRICT OF COLUMBIADickstein Shapiro LLP1825 Eye Street NWWashington, DC 20006-5403Ira H. Polon(poloni@dicksteinshapiro.com)Deborah Kelly(kellyd@dicksteinshapiro.com)Tel: (202) 420-2200Fax: (202) 420-2201www.dicksteinshapiro.comFLORIDAFORT LAUDERDALEFowler White Burnett P.A.One Financial Plaza100 Southeast Third Avenue21st FloorFort Lauderdale, FL 33394Christopher E. Knight(cknight@fowler-white.com)Robert Bouchard(rbouchard@fowler-white.com)Rory E. Jurman(rjurman@fowler-white.com)Tel: (954) 377-8100Fax: (954) 377-8101www.fowler-white.comJACKSONVILLETaylor, Day, Grimm & Boyd50 N. Laura StreetSuite 3500Jacksonville, FL 32202Reed W. Grimm(rwg@taylordaylaw.com)John D. Osgathorpe(jdo@taylordaylaw.com)Tel: (904) 356-0700Fax: (904) 356-3224www.taylordaylaw.comMIAMIFowler White Burnett P.A.Espirito Santo Plaza1395 Brickell Avenue14th FloorMiami, FL 33131Christopher E. Knight(cknight@fowler-white.com)John C. Strickroot(jstrickroot@fowler-white.com)Elizabeth P. Johnson(ejohnson@fowler-white.com)Tel: (305) 789-9200Fax: (305) 789-9201www.fowler-white.comORLANDO / FT. PIERCE /MELBOURNE / GAINESVILLEDean, Mead, Egerton,Bloodworth, Capouano& Bozarth, P.A.800 North Magnolia AvenueSuite 1500Orlando, FL 32803Darryl M. Bloodworth(dbloodworth@deanmead.com)Michael D. Minton(mminton@deanmead.com)Kimberly Bonder Rezanka(krezanka@deanmead.com)Tel: (407) 841-1200Fax: (407) 423-1831www.deanmead.comTALLAHASSEEDean, Mead, Egerton,Bloodworth, Capouano& Bozarth, P.A.215 S. Monroe StreetSuite 815Tallahassee, FL 32301Peter Dunbar(pdunbar@deanmead.com)Tel: (850) 999-4100www.deanmead.com12

TAMPA / SARASOTA / FT. MYERS /ST. PETERSBURG / NAPLESDickinson & Gibbons, P.A.401 N. Cattlemen RoadSuite 300Sarasota, FL 34232A. James Rolfes(ajrolfes@dglawyers.com)Ralph L. Marchbank(rlmarchbank@dglawyers.com)Tel: (941) 366-4680Fax: (941) 365-2923www.dglawyers.comWEST PALM BEACHFowler White Burnett P.A.Northbridge Centre515 N. Flagler StreetSuite 2100West Palm Beach, FL 33401Christopher E. Knight(cknight@fowler-white.com)Michael J. Drahos(mdrahos@fowler-white.com)Tel: (561) 802-9044Tel: (305) 789-9210Fax: (561) 802-9976www.fowler-white.comGEORGIAATLANTAHawkins Parnell Thackston &Young LLP4000 SunTrust Plaza303 Peachtree Street, NortheastAtlanta, GA 30308-3243Warner Fox(wfox@hptylaw.com)Christine L. Mast(cmast@hptylaw.com)T. Ryan Mock(rmock@hptylaw.com)Ronald G. Polly, Jr.(rpolly@hptylaw.com)Tel: (404) 614-7400Fax: (404) 614-7500www.hptylaw.comSAVANNAHHunterMaclean200 East Saint Julian StreetP.O. Box 9848Savannah, GA 31412Sarah H. Lamar(slamar@huntermaclean.com)Shawn Kachmar(skachmar@huntermaclean.com)Tel: (912) 236-0261Fax: (912) 236-4936www.huntermaclean.comHAWAIIHONOLULUClay Chapman Iwamura Pulice& NervellTopa Financial Center700 Bishop StreetSuite 2100Honolulu, Hawaii 96813Anders G. O. Nervell(anervell@paclawteam.com)Tel: (808) 535-8400www.paclawteam.comwww.pacific-lawyers.comIDAHOBOISEGreener Burke ShoemakerOberrecht P.A.950 W. Bannock StreetSuite 950Boise, ID 83702Richard H. Greener(rgreener@greenerlaw.com)Fredric V. Shoemaker(fshoemaker@greenerlaw.com)Christopher C. Burke(cburke@greenerlaw.com)Phillip S. Oberrecht(poberrecht@greenerlaw.com)Tel: (208) 319-2600Fax: (208) 319-2601www.greenerlaw.com13

U.S. MEMBER FIRMSCOEUR D’ALENEPaine Hamblen LLP701 East Front AvenueSuite 101Coeur d’Alene, ID 83814-4914Donald G. Stone(don.stone@painehamblen.com)Scott C. Cifrese(scott.cifrese@painehamblen.com)Michael B. Hague(michael.hague@painehamblen.com)Tel: (208) 664-8115Fax: (208) 664-6338www.painehamblen.comILLINOISBELLEVILLEBrown & James, P.C.Richland Plaza 1525 West Main StreetSuite 200Belleville, IL 62220-1547Beth Kamp Veath(bveath@bjpc.com)Denise Baker-Seal(dseal@bjpc.com)Tel: (618) 235-5590Fax: (618) 235-5591www.brownjames.comCHICAGOJohnson & Bell, Ltd.33 West Monroe StreetSuite 2700Chicago, IL 60603John A. Childers(childersj@jbltd.com)William V. Johnson(johnsonw@jbltd.com)Joseph R. Marconi(marconij@jbltd.com)Marilyn M. Reidy(reidym@jbltd.com)Tel: (312) 372-0770Fax: (312) 372-9818www.johnsonandbell.comINDIANACROWN POINTJohnson & Bell, Ltd.11051 BroadwaySuite BCrown Point, IN 46307Edward Hearn(hearne@jbltd.com)Sharon L. Stanzione(stanziones@jbltd.com)Stephen A. Tyler(tylers@jbltd.com)Tel: (219) 791-1900Fax: (219) 791-1901www.johnsonandbell.comINDIANAPOLISLewis Wagner, LLP501 Indiana AvenueSuite 200Indianapolis, IN 46202A. Richard M. Blaiklock(rblaiklock@lewiswagner.com)Stephanie L. Cassman(scassman@lewiswagner.com)Dina M. Cox(dcox@lewiswagner.com)Robert R. Foos, Jr.(rfoos@lewiswagner.com)Tel: (317) 237-0500Fax: (317) 630-2790www.lewiswagner.com14

IOWADES MOINESWhitfield & Eddy, P.L.C.317 Sixth AvenueSuite 1200Des Moines, IA 50309-4195Bernard L. (Jerry) Spaeth(spaeth@whitfieldlaw.com)Matt Jacobson(jacobson@whitfieldlaw.com)Kimberly S. Bartosh(bartosh@whitfieldlaw.com)Jaki K. Samuelson(samuelson@whitfieldlaw.com)Tel: (515) 288-6041Fax: (515) 246-1474www.whitfieldlaw.comKANSASKANSAS CITY/OVERLAND PARKBaker Sterchi Cowden & Rice L.L.C.51 Corporate Woods9393 West 110th StreetSuite 500Overland Park, KS 66210Scott Kreamer(kreamer@bscr-law.com)Kara Trouslot Stubbs(stubbs@bscr-law.com)Shawn M. Rogers(rogers@bscr-law.com)Thomas E. Rice(rice@bscr-law.com)Tel: (913) 451-6752Fax: (816) 472-0288www.bscr-law.comWICHITAHinkle Law Firm LLC301 North Main StreetSuite 2000Wichita, KS 67202Kenneth R. Lang(klang@hinklaw.com)J. Philip Davidson(pdavidson@hinklaw.com)Mitchell L. Herren(mherren@hinklaw.com)Tel: (316) 267-2000Fax: (316) 264-1518www.hinklaw.comKENTUCKYBOWLING GREENHarlin Parker519 E. Tenth StreetBowling Green, KY 42101Marc A. Lovell(lovell@harlinparker.com)Mark D. Alcott(alcott@harlinparker.com)Tel: (270) 842-5611Fax: (270) 842-2607www.harlinparker.comLEXINGTONDinsmore & Shohl LLPLexington Financial Center250 W. Main Street, Suite 1400Lexington, KY 40507Mindy G. Barfield(mindy.barfield@dinsmore.com)Chauncey S.R. Curtz(chauncey.curtz@dinsmore.com)Colleen P. Lewis(colleen.lewis@dinsmore.com)D. Craig York(craig.york@dinsmore.com)Tel: (859) 425-1000Fax: (859) 425-1099www.dinsmore.com15

U.S. MEMBER FIRMSLOUISVILLEDinsmore & Shohl, LLP101 South Fifth Street, Suite 2500Louisville, KY 40202Kathryn A. Quesenberry(kathy.quesenberry@dinsmore.com)D. Craig York(craig.york@dinsmore.com)Patrick Michael(patrick.michael@dinsmore.com)Jill F. Endicott(jill.endicott@dinsmore.com)Tel: (502) 581-8000Fax: (502) 581-8111www.dinsmore.comLOUISIANANEW ORLEANSLeake & Andersson, L.L.P.1100 Poydras StreetSuite 1700New Orleans, LA 70163-1701W. Paul Andersson(pandersson@leakeandersson.com)George D. Fagan(gfagan@leakeandersson.com)Lou Bonnaffons(lbonnaffons@leakeandersson.com)Edward T. Hayes(ehayes@leakeandersson.com)Tel: (504) 585-7500Fax: (504) 585-7775www.leakeandersson.comLAFAYETTELeake & Andersson, L.L.P.600 Jefferson StreetSuite 603Lafayette, LA 70501-8920Patrick M. Wartelle(pwartelle@leakeandersson.com)Tel: (337) 233-7430Fax: (337) 233-8403www.leakeandersson.comMAINEPORTLANDNorman Hanson & DeTroy, LLCTwo Canal PlazaPortland, ME 04101Stephen Hessert(shessert@nhdlaw.com)Jonathan W. Brogan(jbrogan@nhdlaw.com)Adrian P. Kendall(akendall@nhdlaw.com)Doris V. Rygalski(drygalski@nhdlaw.com)Tel: (207) 774-7000Fax: (207) 775-0806www.nhdlaw.comMARYLANDBALTIMORESemmes, Bowen & Semmes25 South Charles StreetSuite 1400Baltimore, MD 21201James W. Bartlett(jbartlett@semmes.com)Mark Moore(mmoore@semmes.com)Heather H. Kraus(hkraus@semmes.com)Robert E. Scott, Jr.(rscott@semmes.com)Tel: (410) 539-5040Fax: (410) 539-5223www.semmes.com16

MASSACHUSETTSBOSTONMorrison Mahoney LLP250 Summer StreetBoston, MA 02210Mark P. Harty(mharty@morrisonmahoney.com)Sean F. McDonough(smcdonough@morrisonmahoney.com)Grace V. B. Garcia(ggarcia@morrisonmahoney.com)John P. Knight(jknight@morrisonmahoney.com)Tel: (617) 439-7500Fax: (617) 439-7590www.morrisonmahoney.comFALL RIVERMorrison Mahoney LLP10 North Main StreetFall River, MA 02720Mark P. Harty(mharty@morrisonmahoney.com)Sean F. McDonough(smcdonough@morrisonmahoney.com)Grace V. B. Garcia(ggarcia@morrisonmahoney.com)John P. Knight(jknight@morrisonmahoney.com)Tel: (508) 677-3100Fax: (508) 672-3840www.morrisonmahoney.comSPRINGFIELDMorrison Mahoney LLPTower Square1500 Main StreetSuite 2400Springfield, MA 01115Mark P. Harty(mharty@morrisonmahoney.com)Sean F. McDonough(smcdonough@morrisonmahoney.com)Grace V. B. Garcia(ggarcia@morrisonmahoney.com)John P. Knight(jknight@morrisonmahoney.com)Tel: (413) 737-4373Fax: (413) 739-3125www.morrisonmahoney.comWORCESTERMorrison Mahoney LLP446 Main StreetSuite 1010Worcester, MA 01608Mark P. Harty(mharty@morrisonmahoney.com)Sean F. McDonough(smcdonough@morrisonmahoney.com)Grace V. B. Garcia(ggarcia@morrisonmahoney.com)John P. Knight(jknight@morrisonmahoney.com)Tel: (508) 757-7777Fax: (508) 752-6224www.morrisonmahoney.com17

U.S. MEMBER FIRMSMICHIGANDETROITPlunkett Cooney535 Griswold StreetSuite 2400Detroit, MI 48226Henry B. Cooney(hcooney@plunkettcooney.com)Matthew J. Stanczyk(mstanczyk@plunkettcooney.com)Theresa Smith Lloyd(tlloyd@plunkettcooney.com)Tel: (313) 965-3900Fax: (313) 983-4350www.plunkettcooney.comGRAND RAPIDSPlunkett CooneyBridgewater Place333 Bridge N.W.Suite 530Grand Rapids, MI 49504Henry B. Cooney(hcooney@plunkettcooney.com)Timothy F. Sheridan(tsheridan@plunkettcooney.com)Tel: (616) 752-4600Fax: (616) 752-4607www.plunkettcooney.comMINNESOTAMINNEAPOLIS / ST.PAULNilan Johnson Lewis PA120 South Sixth StreetSuite 400Minneapolis, MN 55402-4501Stanley E. Siegel(ssiegel@nilanjohnson.com)Brian N. Johnson(bjohnson@nilanjohnson.com)Teresa J. Kimker(tkimker@nilanjohnson.com)Tel: (612) 305-7500Fax: (612) 305-7501www.nilanjohnson.comMISSISSIPPIGULFPORTDaniel Coker Horton & Bell, P.A.1712 15th StreetSuite 400Gulfport, MS 39501Edward C. Taylor(etaylor@danielcoker.com)John S. Gonzalez(jgonzalez@danielcoker.com)Brenda G. Long(blong@danielcoker.com)Tel: (228) 864-8117Fax: (228) 864-6331www.danielcoker.comJACKSONDaniel Coker Horton & Bell, P.A.4400 Old Canton RoadSuite 400Jackson, MS 39211Jackson H. Ables, III(jables@danielcoker.com)Michael Ellingburg(mellingburg@danielcoker.com)Jason H. Strong(jstrong@danielcoker.com)Tom R. Julian(tjulian@danielcoker.com)Tel: (601) 969-7607Fax: (601) 969-1116www.danielcoker.comOXFORDDaniel Coker Horton & Bell, P.A.265 North Lamar BoulevardSuite ROxford, MS 38655-1396Robert F. Stacy, Jr.(rstacy@danielcoker.com)Ginger Robey(grobey@danielcoker.com)Tel: (662) 232-8979Fax: (662) 232-8940www.danielcoker.com18

MISSOURIKANSAS CITYBaker Sterchi Cowden& Rice L.L.C.Crown Center2400 Pershing RoadSuite 500Kansas City, MO 64108-2533Kara Trouslot Stubbs(stubbs@bscr-law.com)Scott Kreamer(kreamer@bscr-law.com)John W. Cowden(cowden@bscr-law.com)James R. Jarrow(Jarrow@bscr-law.com)Tel: (816) 471-2121Fax: (816) 472-0288www.bscr-law.comST. LOUISBrown & James, P.C.800 Market StreetSuite 1100St. Louis, MO 63101-2506Steven H. Schwartz(sschwartz@bjpc.com)Joseph R. Swift(jswift@bjpc.com)Tel: (314) 421-3400Fax: (314) 421-3128www.brownjames.comMONTANABILLINGSAxilon Law Group, PLLCElectric Building, Suite 310115 North BroadwayBillings, MT 59101T. Thomas Singer(tsinger@axilonlaw.com)Michael J. Johnson(mjohnson@axilonlaw.com)Tel: (406) 294-9466Toll Free: (866) 294-9466Fax: (406) 294-9468www.axilonlaw.comBOZEMAN/BIG SKYAxilon Law Group, PLLC895 Technology DriveSuite 102Bozeman, MT 59718Gary D. Hermann(ghermann@axilonlaw.com)Frederick P. Landers, Jr.(rlanders@axilonlaw.com)Tel: (406) 922-4777Toll Free: (866) 294-9466Fax: (406) 294-9468www.axilonlaw.comMISSOULAAxilon Law Group, PLLC257 West Front St.Suite BMissoula, MT 59802Elizabeth L Griffing(bgriffing@axilonlaw.com)Jill M. Gerdrum(jgerdrum@axilonlaw.com)Tel: (406) 532-2635Toll Free: (866) 294-9466Fax: (406) 294-9468www.axilonlaw.com19

U.S. MEMBER FIRMSNEBRASKALINCOLNBaylor, Evnen, Curtiss,Grimit & Witt, L.L.P.1248 O StreetSuite 600Lincoln, NE 68508Dallas D. Jones(djones@baylorevnen.com)Gail S. Perry(gperry@baylorevnen.com)Randall L. Goyette(rgoyette@baylorevnen.com)Darla Ideus(dideus@baylorevnen.com)Tel: (402) 475-1075Fax: (402) 475-9515www.baylorevnen.comOMAHABaylor, Evnen, Curtiss,Grimit & Witt, L.L.P.One Pacific Place1125 S. 103rd StreetSuite 400Omaha, NE 68124Peter Katt(pkatt@baylorevnen.com)Andrew Loudon(aloudon@baylorevnen.com)Tel: (402) 934-5468Fax: (402) 475-9515www.baylorevnen.comNEVADALAS VEGASAlverson, Taylor,Mortensen & Sanders7401 West Charleston BoulevardLas Vegas, NV 89117-1401J. Bruce Alverson(balverson@alversontaylor.com)LeAnn Sanders(lsanders@alversontaylor.com)Kurt R. Bonds(kbonds@alversontaylor.com)Seetal Tejura(stejura@alversontaylor.com)Tel: (702) 384-7000Fax: (702) 385-7000www.alversontaylor.comNEW HAMPSHIREMANCHESTERWadleigh, Starr& Peters, P.L.L.C.95 Market StreetManchester, NH 03101Marc R. Scheer(mscheer@wadleighlaw.com)Kathleen C. Peahl(kpeahl@wadleighlaw.com)Stephen L. Boyd(sboyd@wadleighlaw.com)Tel: (603) 669-4140Fax: (603) 626-4808www.wadleighlaw.c omNEW JERSEYNEWARKSills Cummis & Gross P.C.One Riverfront PlazaNewark, NJ 07102Jeffrey H. Newman(jnewman@sillscummis.com)Tel: (973) 643-7000Fax: (973) 643-6500www.sillscummis.com20

NEW MEXICOALBUQUERQUEButt Thornton & Baehr PC4101 Indian School Road, NESuite 300 SouthAlbuquerque, NM 87110Alfred L. Green(algreen@btblaw.com)Agnes Fuentevilla Padilla(afpadilla@btblaw.com)Monica R. Garcia(mrgarcia@btblaw.com)Tel: (800) 322-6883Tel: (505) 884-0777Fax: (505) 889-8870www.btblaw.comNEW YORKALBANYCarter, Conboy, Case,Blackmore, Maloney& Laird, P.C.20 Corporate Woods BoulevardAlbany, NY 12211-2350Michael J. Murphy(mmurphy@carterconboy.com)Edward D. Laird, Jr.(elaird@carterconboy.com)Kathleen McCaffrey Baynes(kbaynes@carterconboy.com)William D. Yoquinto(wyoquinto@carterconboy.com)Tel: (518) 465-3484Fax: (518) 465-1843www.carterconboy.comBUFFALODamon Morey LLPThe Avant BuildingSuite 1200200 Delaware AvenueBuffalo, NY 14202-2150Peter S. Marlette(pmarlette@damonmorey.com)Thomas J. Drury(tdrury@damonmorey.com)Christopher T. Greene(cgreene@damonmorey.com)Kathleen M. Reilly(kreilly@damonmorey.com)Tel: (716) 856-5500Fax: (716) 856-5510www.damonmorey.comNEW YORK CITYLitigationLester Schwab Katz& Dwyer, LLP100 Wall StreetNew York, NY 10005Melvin Katz(mkatz@lskdnylaw.com)Felice Cotignola(fcotignola@lskdnylaw.com)Michael E. McDonagh(mmcdonagh@lskdnylaw.com)Tel: (212) 964-6611Fax: (212) 267-5916www.lskdnylaw.comTransactionsSills Cummis & Gross P.C.30 Rockefeller PlazaNew York, NY 10112Jeffrey H. Newman(jnewman@sillscummis.com)Tel: (212) 643-7000Fax: (212) 643-6500www.sillscummis.com21

CLEVELANDFrantz Ward LLP2500 Key Center127 Public SquareCleveland, OH 44114-1230Brett K. Bacon(bbacon@frantzward.com)Ian H. Frank(ifrank@frantzward.com)Joel R. Hlavaty(jhlavaty@frantzward.com)Colleen C. Murnane(cmurnane@frantzward.com)Tel: (216) 515-1660Fax: (216) 515-1650www.frantzward.comCOLUMBUSCrabbe, Brown & James500 South Front StreetSuite 1200Columbus, OH 43215-0014Vincent J. Lodico(vlodico@cbjlawyers.com)Richard D. Wetzel, Jr.(rwetzel@cbjlawyers.com)Tel: (614) 228-5511Fax: (614) 229-4559www.cbjlawyers.comDAYTONDinsmore & Shohl LLPFifth Third CenterOne South Main StreetSuite 1300Dayton, OH 45402Michael Hawkins(michael.hawkins@dinsmore.com)Harvey Jay Cohen(harvey.cohen@dinsmore.com)Colleen Lewis(colleen.lewis@dinsmore.com)Tel: (513) 977-8200Fax: (513) 977-8141www.dinsmore.comOKLAHOMAOKLAHOMA CITYPhillips Murrah P.C.Corporate Tower, 13th Floor101 N. RobinsonOklahoma City, OK 73102Thomas G. Wolfe(tgwolfe@phillipsmurrah.com)Lyndon W. Whitmire(lwwhitmire@phillipsmurrah.com)Dawn M. Rahme(dmrahme@phillipsmurrah.com)Tel: (405) 235-4100Fax: (405) 235-4133www.phillipsmurrah.comTULSAFranden, Woodard, Farris,Quillin and GoodnightWilliams Center Tower II9th FloorTwo West Second Street,Suite 900Tulsa, OK 74103Joseph R. Farris(jfarris@tulsalawyer.com)Jason Goodnight(jgoodnight@tulsalawyer.com)Paula J. Quillin(pquillin@tulsalawyer.com)Tel: (918) 583-7129Fax: (918) 584-3814www.tulsalawyer.com23

U.S. MEMBER FIRMSOREGONPORTLANDCosgrave Vergeer Kester LLP500 Pioneer Tower888 SW Fifth AvenuePortland, OR 97204Andrew Burns(aburns@cosgravelaw.com)Jill D. Laney(jlaney@cosgravelaw.com)David Morrison(morrison@cosgravelaw.com)Walter H. Sweek(wsweek@cosgravelaw.com)Tel: (503) 323-9000Fax: (503) 323-9019www.cosgravelaw.comPENNSYLVANIAHARRISBURGMcNees Wallace & Nurick LLC100 Pine StreetHarrisburg, PA 17101Kandice K. Hull(khull@mwn.com)Donald B. Kaufman(dkaufman@mwn.com)Schaun D. Henry(shenry@mwn.com)Barbara A. Darkes(bdarkes@mwn.com)Tel: (717) 232-8000Fax: (717) 237-5300www.mwn.comPHILADELPHIAGerman, Gallagher &Murtagh, P.C.The Bellevue200 S. Broad StreetSuite 500Philadelphia, PA 19102Gary H. Hunter(hunterg@ggmfirm.com)Dean F. Murtagh(murtaghd@ggmfirm.com)Robert P. Corbin(corbinr@ggmfirm.com)Kathryn A. Dux(duxk@ggmfirm.com)Tel: (215) 545-7700Fax: (215) 732-4182www.ggmfirm.comPITTSBURGHMeyer, Darragh, Buckler,Bebenek & Eck, P.L.L.C.U.S. Steel TowerSuite 4850600 Grant StreetPittsburgh, PA 15219Paul R. Robinson(probinson@mdbbe.com)Eric N. Anderson(eanderson@mdbbe.com)Mark A. Eck(meck@mdbbe.com)Tel: (412) 261-6600Fax: (412) 471-2754www.mdbbe.com24

RHODE ISLANDPROVIDENCEHiggins, Cavanagh& Cooney, LLPThe Hay Building123 Dyer StreetProvidence, RI 02903Stephen B. Lang(slang@hcc-law.com)James A. Ruggieri(jruggieri@hcc-law.com)John F. Kelleher(jkelleher@hcc-law.com)Tel: (401) 272-3500Tel: (800) 274-5299Fax: (401) 273-8780www.hcc-law.comSOUTH CAROLINACHARLESTON / NORTH CHARLESTONYoung Clement Rivers, LLP25 Calhoun St.Suite 400Charleston, SC 29401Carol B. Ervin(cervin@ycrlaw.com)Duke R. Highfield(dhighfield@ycrlaw.com)F. Drake Rogers(drogers@ycrlaw.com)Tel: (843) 577-4000Fax: (843) 724-6600www.ycrlaw.comCOLUMBIANelson Mullins Riley& Scarborough, LLP1320 Main St.Meridian Building, 17th FloorColumbia, SC 29201S. Keith Hutto(keith.hutto@nelsonmullins.com)Robert W. Foster, Jr.(robbie.foster@nelsonmullins.com)Timothy M. McKissock(tim.mckissock@nelsonmullins.com)Tel: (803) 799-2000Fax: (803) 256-7500www.nelsonmullins.comGREENVILLENelson Mullins Riley& Scarborough, LLPPoinsett PlazaSuite 900104 South Main StreetGreenville, SC 29601-2122A. Marvin Quattlebaum, Jr.(marvin.quattlebaum@nelsonmullins.com)William S. Brown(william.brown@nelsonmullins.com)Tel: (864) 250-2300Fax: (864) 232-2925www.nelsonmullins.comMYRTLE BEACHNelson Mullins Riley& Scarborough, LLPBeach First Center, 3rd Floor3751 Robert M. Grissom PkwyMyrtle Beach, SC 29577Susan P. MacDonald(susan.macdonald@nelsonmullins.com)Tel: (843) 448-3500Fax: (843) 448-3437www.nelsonmullins.com25

U.S. MEMBER FIRMSSOUTH DAKOTAFARGO (ND)Vogel Law Firm218 NP AvenueFargo, ND 58102M. Daniel Vogel(dvogel@vogellaw.com)W. Todd Haggart(thaggart@vogellaw.com)Robert B. Stock(rstock@vogellaw.com)Brenda L. Blazer(bblazer@vogellaw.com)Tel: (701) 237-6983(800) 677-5024Fax: (701) 356-6395www.vogellaw.comTENNESSEECHATTANOOGALeitner, Williams, Dooley& Napolitan, PLLCTallan Building200 W. Martin Luther King Blvd.Fifth FloorChattanooga, TN 37402Steven W. Keyt(steven.keyt@leitnerfirm.com)Alan B. Easterly(alan.easterly@leitnerfirm.com)Marc H. Harwell(marc.harwell@leitnerfirm.com)Tel: (423) 265-0214Fax: (423) 267-6625www.leitnerfirm.comKNOXVILLELewis, Thomason, King, Krieg& Waldrop, P.C.One Centre Square5th Floor620 Market StreetKnoxville, TN 37902Richard W. Krieg(dkrieg@lewisthomason.com)Janet S. Hayes(jhayes@lewisthomason.com)Benjamin W. Jones(bjones@lewisthomason.com)Tel: (865) 546-4646Fax: (865) 523-6529www.lewisthomason.comMEMPHISBurch, Porter & Johnson, PLLC130 North Court AvenueMemphis, TN 38103David J. Harris(dharris@bpjlaw.com)Doug Halijan(dhalijan@bpjlaw.com)Joshua B. Lawhead(jlawhead@bpjlaw.com)Tel: (901) 524-5000Fax: (901) 524-5024www.bpjlaw.comNASHVILLELewis, Thomason, King, Krieg& Waldrop, P.C.424 Church StreetSuite 2500Nashville, TN 37219John R. Tarpley(jtarpley@lewisthomason.com)Lisa Ramsay Cole(lcole@lewisthomason.com)Robert F. Chapski(rchapski@lewisthomason.com)Tel: (615) 259-1366Fax: (615) 259-1389www.lewisthomason.com26

Leitner, Williams, Dooley& Napolitan, PLLC414 Union StreetSuite 1900Bank of America PlazaNashville, TN 37219Richard C. Mangelsdorf, Jr.(chuck.mangelsdorf@leitnerfirm.com)D. Randall Mantooth(randy.mantooth@leitnerfirm.com)Tony Noel(tony.noel@leitnerfirm.com)Tel: (615) 255-7722Fax: (615) 780-2210www.leitnerfirm.comTEXASAMARILLOMullin Hoard & Brown, L.L.P.500 S. TaylorSuite 800, LB 213Amarillo, TX 79101Danny M. Needham(dmneedham@mhba.com)Chris Weber(cweber@mhba.com)Mark Logsdon(mlogsdon@mhba.com)Tel: (806) 372-5050Fax: (806) 372-5086www.mullinhoard.comAUSTINNaman Howell Smith & Lee, PLLC8310 Capital of Texas Hwy, NorthSuite 490Austin, TX 78731Clark Aspy(aspy@namanhowell.com)David LeBas(dlebas@namanhowell.com)Stephanie Potter(spotter@namanhowell.com)Tel: (512) 479-0300Fax: (512) 474-1901www.namanhowell.comDALLASStrasburger & Price, LLP901 Main StreetSuite 4400Dallas, TX 75202Mark E. Golman(mark.golman@strasburger.com)Kimberly Moore(kim.moore@strasburger.com)Mark S. Scudder(mark.scudder@strasburger.com)Kirk F. Sniff(kirk.sniff@strasburger.com)Tel: (214) 651-4300Fax: (214) 651-4330www.strasburger.comEL PASOMounce, Green, Myers, Safi,Paxson & Galatzan, P.C.100 N. StantonSuite 1000El Paso, TX 79901Carl H. Green(green@mgmsg.com)Darryl S. Vereen(vereen@mgmsg.com)Tel: (915) 532-2000Fax: (915) 541-1597www.mgmsg.comHOUSTONLorance & Thompson, P.C.2900 North Loop WestSuite 500Houston, TX 77092Larry D. Thompson(ldt@lorancethompson.com)Walter F. ‘Trey’ Williams III(wfw@lorancethompson.com)Eric R. Benton(erb@lorancethompson.com)Melanie R. Cheairs(mrc@lorancethompson.com)Tel: (713) 868-5560Fax: (713) 864-4671www.lorancethompson.com27

U.S. MEMBER FIRMSLUBBOCKMullin Hoard & Brown, L.L.P.1500 BroadwaySuite 700Lubbock, TX 79401Molly Manning(mmanning@mhba.com)David Langston(drl@mhba.com)Larry Doss(ldoss@mhba.com)Tel: (806) 765-7491Fax: (806) 765-0553www.mullinhoard.comSAN ANTONIONaman Howell Smith & Lee, PLLCUnion Square II10001 Reunion PlaceSuite 600San Antonio, TX 78216J.K. Leonard(jkleonard@namanhowell.com)Larry D. Warren(lwarren@namanhowell.com)David Ortega(dortega@namanhowell.com)Tel: (210) 731-6300Fax: (210) 785-2957www.namanhowell.comWACONaman Howell Smith & Lee, PLLC400 Austin AvenueSuite 800Waco, TX 76701Clark Aspy(aspy@namanhowell.com)Hayes Fuller(fuller@namanhowell.com)Jordan Mayfield(mayfield@namanhowell.com)Tel: (254) 755-4100Fax: (254) 754-6331www.namanhowell.comUTAHSALT LAKE CITYChristensen & Jensen, P.C.257 East 200 SouthSuite 1100Salt Lake City, Utah 84111Heidi G. Goebel(heidi.goebel@chrisjen.com)Barton Kunz(bart.kunz@chrisjen.com)Tel: (801) 323-5000Fax: (801) 355-3472www.chrisjen.comVERMONTRUTLANDRyan, Smith & Carbine, Ltd.Mead Building98 Merchants RowP.O. Box 310Rutland, VT 05702-0310John J. Zawistoski(jjz@rsclaw.com)Andrew H. Maass(ahm@rsclaw.com)Mark F. Werle(mfw@rsclaw.com)Tel: (802) 786-1000Fax: (802) 786-1100www.rsclaw.com28

VIRGINIARICHMONDMorris & Morris, P.C.11 South 12th Street5th FloorRichmond, VA 23219D. Cameron Beck, Jr.(cbeck@morrismorris.com)Matthew D. Green(mgreen@morrismorris.com)Lauren E. Hutcheson(lhutcheson@morrismorris.com)Philip B. Morris(pmorris@morrismorris.com)Tel: (804) 344-8300Fax: (804) 344-8359www.morrismorris.comROANOKEGentry Locke Rakes& Moore LLP10 Franklin Road, SoutheastSuite 800Roanoke, VA 24011W. David Paxton(paxton@gentrylocke.com)K. Brett Marston(marston@gentrylocke.com)Paul G. Klockenbrink(klockenbrink@gentrylocke.com)Monica T. Monday(monday@gentrylocke.com)Tel: (540) 983-9300Fax: (540) 983-9400www.gentrylocke.comWASHINGTONSEATTLEMerrick, Hofstedt & Lindsey, P.S.3101 Western AvenueSuite 200Seattle, WA 98121Andrew C. Gauen(agauen@mhlseattle.com)Thomas J. Collins(tcollins@mhlseattle.com)Thomas R. Merrick(tmerrick@mhlseattle.com)Tamara K. Nelson(tnelson@mhlseattle.com)Tel: (206) 682-0610Fax: (206) 467-2689www.mhlseattle.comSPOKANEPaine Hamblen LLPWashington TrustFinancial Center717 W. Sprague AvenueSuite 1200Spokane, WA 99201-3505Donald G. Stone(don.stone@painehamblen.com)Scott C. Cifrese(scott.cifrese@painehamblen.com)James Kalamon(james.kalamon@painehamblen.com)Tel: (509) 455-6000Fax: (509) 838-0007www.painehamblen.com29

U.S. MEMBER FIRMSWEST VIRGINIACHARLESTONRobinson & McElwee PLLC400 Fifth Third Center700 Virginia Street, EastCharleston, WV 25301Edward J. George(ejg@ramlaw.com)Kent J. George(kjg@ramlaw.com)David K. Higgins(dkh@ramlaw.com)Tel: (304) 344-5800Fax: (304) 344-9566www.ramlaw.comCLARKSBURGRobinson & McElwee PLLC140 West Main StreetSuite 300Clarksburg, WV 26301Richard W. Gallagher(rwg@ramlaw.com)Stephen F. Gandee(sfg@ramlaw.com)Jeffrey A. Kimble(jak@ramlaw.com)Tel: (304) 622-5022Fax: (304) 622-5065www.ramlaw.comWISCONSINMADISONWhyte Hirschboeck Dudek S.C.P.O. Box 137933 East Main StreetSuite 300Madison, WI 53701Eugenia (Gina) Carter(ecarter@whdlaw.com)Tel: (608) 255-4440Fax: (608) 258-7138www.whdlaw.comMILWAUKEEWhyte Hirschboeck Dudek S.C.555 East Wells StreetSuite 1900Milwaukee, WI 53202-3819Eugenia (Gina) Carter(ecarter@whdlaw.com)William E. Hughes(whughes@whdlaw.com)Karen Tidwall(ktidwall@whdlaw.com)Tel: (414) 273-2100Fax: (414) 223-5000www.whdlaw.comWHEELINGRobinson & McElwee PLLC2108 Lumber AvenueSuite 4Wheeling, WV 26003Lisa M. Schmitt(lms@ramlaw.com)Tel: (304) 905-9420Fax: (304) 344-9566www.ramlaw.com30

WYOMINGCASPERMurane & Bostwick, LLC201 North WolcottCasper, WY 82601W. Henry Combs III(whc@murane.com)James C. Worthen(jcw@murane.com)Tel: (307) 234-9345Fax: (307) 237-5110www.murane.comCHEYENNEMurane & Bostwick, LLC508 West 27th StreetCheyenne, WY 82001Loyd Smith(les@murane.com)Tel: (307) 634-7500Fax: (307) 638-7882www.murane.com31

INTERNATIONAL MEMBER FIRMSAMERICAN SAMOAPAGO PAGOLaw Offices of Marshall Ashley,P.C.2nd Floor,Aitulagi Building, TafunaP.O. Box 326Pago Pago, AS 96799Marshall Ashley(marshall_as@yahoo.com)Tel: (684) 699-5115www.ashleylaw.aswww.pacific-lawyers.comARGENTINABUENOS AIRESG. Breuer25 de mayo 460C1002ABJ Buenos Aires,ArgentinaJorge Otamendi(joo@gbreuer.com.ar)Alejandro López Tilli(alopeztilli@gbreuer.com.ar)Diego Fissore(dfissore@gbreuer.com.ar)Tel: +54-11-4313-8100Fax: +54-11-4313-8180www.gbreuer.com.arAUSTRALIAADELAIDE, SOUTH AUSTRALIACowell ClarkeLevel 563 Pirie StreetAdelaide, South Australia 5000AustraliaBrett M. Cowell(bcowell@cowellclarke.com.au)Jonathan C. Clarke(jclarke@cowellclarke.com.au)Natalie Abela(nabela@cowellclarke.com.au)Megan Jongebloed(mjongebloed@cowellclarke.com.au)Tel: 61-8-8228-1111Fax: 61-8-8228-1100www.cowellclarke.com.auBRISBANE, QUEENSLANDTressCox LawyersLevel 440 Creek StreetBrisbane, Queensland 4000AustraliaRobin Lonergan(robin_lonergan@tresscox.com.au)Tony Mylne(tony_mylne@tresscox.com.au)Tel: 61-7-3004-3500Fax: 61-7-3004-3599www.tresscox.com.au32

CANBERRA, AUSTRALIANCAPITAL TERRITORYMeyer VandenbergLevel 31 Farrell PlaceCanberra City, ACT 2601AustraliaArchie Tsirimokos(archie.tsirimokos@meyervandenberg.com.au)Alisa Taylor(alisa.taylor@meyervandenberg.com.au)Greg Brackenreg(greg.brackenreg@meyervandenberg.com.au)Tel: 61-2-6279-4444Fax: 61-2-6279-4455www.meyervandenberg.com.auMELBOURNE, VICTORIACornwall StodartLevel 10114 William StreetMelbourne, Victoria 3000AustraliaJohn Hutchings(j.hutchings@cornwalls.com.au)Levent Shevki(l.shevki@cornwalls.com.au)Michael Kohn(m.kohn@cornwalls.com.au)Michelle McLean(m.mclean@cornwalls.com.au)Tel: 61-3-9608-2000Fax: 61-3-9608-2222www.cornwalls.com.auPERTH, WESTERN AUSTRALIARockwell OlivierLevel 8, Wesfarmers House40 The EsplanadePerth, Western Australia 6000AustraliaBrendan Taylor(btaylor@ro.com.au)Tel: 61-8-9420-7100Fax: 61-8-9420-7101www.rockwellolivier.com.auSYDNEY, NEW SOUTH WALESTressCox LawyersLevel 16, MLC Centre19 Martin PlaceSydney, New South Wales 2000AustraliaAlistair Little(alistair_little@tresscox.com.au)Philip Mitchell(philip_mitchell@tresscox.com.au)Peta Tumpey(peta_tumpey@tresscox.com.au)Tel: 61-2-9228-9200Fax: 61-2-9228-9299www.tresscox.com.auAUSTRIAVIENNALaw Offices Dr. F. SchwankStock Exchange BuildingWipplingerstrasse 34A-1010 ViennaAustriaFriedrich Schwank(schwank@schwank.com)Merran Loewenthal(loewenthal@schwank.com)Sabine Straka(straka@schwank.com)Tel: +43-1-533-5704Fax: +43-1-533-5706www.schwank.com33

INTERNATIONAL MEMBER FIRMSBAHRAINMANAMACharles Russell Speechlys LLPFloor 24Bahrain World Trade CentreEast TowerIsa Al Kabeer AvenuePO Box 31249ManamaKingdom of BahrainPatrick Gearon(patrick.gearon@crsblaw.com)Tel: +973 17 133200Fax: +973 17 133201www.charlesrussellspeechlys.comBARBADOSST. MICHAELDelany & AssociatesAttorney at LawThe BungalowSavannah DriveThe GarrisonSt. Michael, BarbadosWest IndiesDustin D.P. Delany(dd@delanylaw.com)Tel: (246) 228-2260Fax: (246) 228-2264www.delanylaw.comBELGIUMBRUSSELSMarx Van RanstVermeersch & PartnersAvenue de Tervueren 270B-1150 BrusselsBelgiumJan Ravelingien(jan.ravelingien@mvvp.be)Kristoffel Vermeersch(kristoffel.vermeersch@mvvp.be)Tel: 32-2-285-01-00Fax: 32-2-230-33-39www.mvvp.beBRAZILSÃO PAULOL.O. Baptista Schmidt ValoisMiranda Ferreira Agel AdvogadosAv. Paulista 12948° andar01310-100 São Paulo, SPBrazilMarta Rodrigues(mar@lob-svmfa.com.br)Tel: 55-11-3147-0800Tel: 55-11-3147-0808Fax: 55-11-3147-0811www.lob-svmfa.com.brCANADACALGARY, ALBERTABorden Ladner Gervais LLPCentennial PlaceEast Tower1900, 520 - 3rd Ave SWCalgary, Alberta T2P 0R3CanadaBruce Churchill-Smith Q.C.(bchurchillsmith@blg.com)Brad J. Pierce(bpierce@blg.com)Tel: (403) 232-9669Fax: (403) 266-1395www.blg.comCHARLOTTETOWN,PRINCE EDWARD ISLANDStewart McKelvey65 Grafton St.Charlottetown, P.E.I.C1A 1K8CanadaScott Norton Q.C.(snorton@stewartmckelvey.com)Tel: 902-420-3200Fax: 902-420-1417www.stewartmckelvey.com34

FREDERICTON, NEW BRUNSWICKStewart McKelveySuite 600, Frederick Square77 Westmorland St.Fredericton, N.B.E3B 6Z3CanadaScott Norton Q.C.(snorton@stewartmckelvey.com)Tel: 902-420-3200Fax: 902-420-1417www.stewartmckelvey.comHALIFAX, NOVA SCOTIAStewart McKelveySuite 900Purdy’s Wharf Tower One1959 Upper Water St.Halifax, N.S.B3J 3N2CanadaScott Norton Q.C.(snorton@stewartmckelvey.com)Tel: 902-420-3200Fax: 902-420-1417www.stewartmckelvey.comMONCTON, NEW BRUNSWICKStewart McKelveySuite 601, Blue Cross Centre644 Main St.Moncton, N.B.E1C 1E2CanadaScott Norton Q.C.(snorton@stewartmckelvey.com)Tel: 902-420-3200Fax: 902-420-1417www.stewartmckelvey.comMONTREAL, QUEBECFasken Martineau DuMoulin LLPStock Exchange TowerSuite 3700800 Place VictoriaP.O. Box 242Montreal, Quebec H4Z 1E9CanadaEnrico Forlini(eforlini@fasken.com)Diane Bertrand(dbertrand@fasken.com)Tel: (514) 397-7400Fax: (514) 397-7600www.fasken.comSAINT JOHN, NEW BRUNSWICKStewart McKelveySuite 1000, Brunswick House44 Chipman HillSaint John, N.B.E2L 2A9CanadaScott Norton Q.C.(snorton@stewartmckelvey.com)Tel: 902-420-3200Fax: 902-420-1417www.stewartmckelvey.comST. JOHN’S, NEWFOUNDLAND ANDLABRADORStewart McKelveySuite 1100, Cabot Place100 New Gower St.St. John’s, N.L.A1C 6K3CanadaScott Norton Q.C.(snorton@stewartmckelvey.com)Tel: 902-420-3200Fax: 902-420-1417www.stewartmckelvey.com35

INTERNATIONAL MEMBER FIRMSTORONTO, ONTARIOFasken Martineau DuMoulin LLP333 Bay StreetSuite 2400Bay Adelaide Centre, Box 20Toronto, OntarioM5H 2T6CanadaRobert W. Cosman(rcosman@fasken.com)Tel: (416) 865-4364Peter J. Pliszka(ppliszka@fasken.comTel: (416) 868-3336Jennifer L. McAleer(jmcaleer@fasken.com)Tel: (416) 865-4413Fax: (416) 364-7813www.fasken.comVANCOUVER, BRITISH COLUMBIAFasken Martineau DuMoulin LLP2900-550 Burrard StreetVancouverBritish Columbia V6C 0A3CanadaWilliam Westeringh(wwesteringh@fasken.com)Tel: (604) 631-3155Fax: (604) 631-3232www.fasken.comCHILESANTIAGOAlessandriEl Regidor 66, 10th floorP.O. Box 136-34 - Las CondesSantiago, ChileArturo Alessandri(arturo@alessandri.cl)Fernando Jamarne(fjamarne@alessandri.cl)Tel: +562 27876000Fax: +562 27876062www.alessandri.clCHINABEIJINGGrandall Law Firm9th Floor,Taikang Financial TowerNo. 38 North RoadEast Third RingChaoyang District,Beijing 100026 ChinaGregory Sy(gregsy@grandall.com.cn)Wenjie Sun(sunwenjie@grandall.com.cn)Tel: (+86)(10) 6589 0699Fax: (+86)(10) 6589 0799www.grandall-law.comSHANGHAIGrandall Law Firm45-46/F, Nanzheng Building580 Nanjing West RoadShanghai 200041 ChinaGregory Sy(gregsy@grandall.com.cn)Wenjie Sun(sunwenjie@grandall.com.cn)Tel: (+86)(21) 5234 1668Fax: (+86)(21) 5234 1670www.grandall-law.comSHENZHENGrandall Law Firm24/F, Tequbaoye Building6008 Shennan AvenueShenzhen 518009 ChinaGregory Sy(gregsy@grandall.com.cn)Wenjie Sun(sunwenjie@grandall.com.cn)Tel: (+86)(755) 8351 5666Fax: (+86)(755) 8351 5333www.grandall-law.com36

COLOMBIABOGOTATriana, Uribe & MichelsenCalle 93b No. 12-48 P.4BogotaColombiaJuan Pablo Triana Soto(jpt@tumnet.com)Juan Carlos Uribe(jcu@tumnet.com)Tel: (571) 6019660Fax: (571) 6114209www.tumnet.comCOSTA RICASAN JOSEARA LAW ABOGADOSEdificio Ara Law125 meters North Torre“La Sabana”Sabana NorteSan José, Costa RicaAlejandro Rodríguez Castro(arc@aralaw.cr )Tel: (506) 2291-8844Fax: (506) 2291-8839www.aralaw.crCYPRUSNICOSIALC Law Stylianou & Drakou LLC12 Zenonos Sozou StreetCY-1075 NicosiaP.O. Box 25319CY-1308 NicosiaCyprusLora Stylianou(lora.stylianou@lclaw.com.cy)Tel: +(357) 22 44 74 40Fax: +(357) 22 44 74 50www.lclaw.com.cyDENMARKCOPENHAGENELMANNStockholmsgade 41Copenhagen DK-2100DenmarkSoren Ingerslev(sei@elmann.dk)Tel: +45 33 37 63 30Fax: +45 33 37 63 31www.elmann.dkECUADORGUAYAQUILOrtega Abogados & AsociadosS.A. EjomotAv. Fco. De Orellana yMiguel H. AlcívarEdificio Centro EmpresarialLas Cámaras, Oficina 1 MezzanineGuayaquil, EcuadorGustavo Ortega Trujillo(drgot@ortegaabogados-ec.com)Ma. Alexandra Maridueña Vargas(mmariduena@ortegaabogados-ec.com)Tel: (59-34) 268-1123Fax: (59-34) 268-1224www.ortegaabogados-ec.com37

INTERNATIONAL MEMBER FIRMSEGYPTCAIROSarie-Eldin & PartnersLegal AdvisorsKM 28 CairoAlex Desert Road,B-19 Smart Village6th of October / EgyptDr. Hani SalahMohamed Sarie-Eldin(hsarie@sarieldin.com)Tel: (+2 02) 35 35 24 24Fax: (+2 02) 35 35 24 25www.sarieldin.comENGLANDLONDONCharles Russell Speechlys LLP5 Fleet PlaceLondon EC4M 7RDEnglandJohn Sykes(john.sykes@crsblaw.com)Patrick Russell(patrick.russell@crsblaw.com)Tel: 44-20-7203-5000Fax: 44-20-7203-0200www.charlesrussellspeechlys.comFEDERATED STATES OFMICRONESIAPOHNPEILaw Office ofMichael J. Sipos, P.C.Ace Commercial Building2nd FloorP.O. Box 2069Pohnpei, FM 96941Michael J. Sipos(msipos@mail.fm)Tel: (691) 320-6450www.pacificlawyersmicronesia.comwww.pacific-lawyers.comFRANCEPARISCourtois Lebel15 rue Beaujon75008 ParisFranceFrédéric Cohen(fcohen@courtois-lebel.com)Philippe Courtois(pcourtois@courtois-lebel.com)Tel: 33-1-5844-9292Fax: 33-1-5844-9258www.courtois-lebel.comGERMANYHEIDELBERGTiefenbacherIm Breitspiel 969126 HeidelbergGermanyMarcello Di Stefano(distefano@tiefenbacher.de)Gero Schneider(g.schneider@tiefenbacher.de)Tel: 49-6221-311357Fax: 49-6221-311311www.tiefenbacher.deDRESDENTiefenbacherCaspar-David-Friedrich str. 601219 DresdenGermanyMarcello Di Stefano(distefano@tiefenbacher.de)Gero Schneider(g.schneider@tiefenbacher.de)Tel: 49-6221-311357Fax: 49-351-477820-50www.tiefenbacher.de38

FRANKFURTTiefenbacherEschersheimer Landstraße 1060322 Frankurt am MainGermanyMarcello Di Stefano(distefano@tiefenbacher.de)Gero Schneider(g.schneider@tiefenbacher.de)Tel: 49-6221-311357Fax: 49-69-2972388-99www.tiefenbacher.deSTUTTGARTTiefenbacherPariser Platz 770173 StuttgartGermanyMarcello Di Stefano(distefano@tiefenbacher.de)Gero Schneider(g.schneider@tiefenbacher.de)Tel: 49-6221-311357Fax: 49-711-12714473www.tiefenbacher.deGHANAACCRAAB & David8 Dr. Isert Road, North RidgeP.O. Box TF 330Trade Fair, AccraGhanaDavid Ofosu-Dorte(david@abdavid.com)Isabel Boaten(isabel@abdavid.com)Tel: +233-30-225 3073+233-30-701 2129Fax: +233-30-225 3075www.abdavid.comKUMASIAB & David3rd FloorChelsea Hse. No. OTB 74Harper RoadAdum, KumasiGhanaAnna Fordjuor(anna@abdavid.com)Tel: +233-30-225 3073+233-30-701 2129Fax: +233-30-225 3075www.abdavid.comGREECEATHENSG. Mourgelas & AssociatesLaw Firm6 Iraklidon str.11851 AthensGreeceEftychios Horiatakis(horiatakis@mourgelas.gr)Lambros Kipriotis(kipriotis@mourgelas.gr)Tel: +30 210-342-1579Fax: +30 210-342-1913www.mourgelas.grGUAMHAGATNABerman O’Connor & MannBank of Guam BuildingSuite 503111 Chalan Santo PapaHagatna, Guam 96910Michael J. Berman(mjberman@pacific-lawyers.com)Tel: (671) 477-2778www.pacificlawyersguam.comwww.pacific-lawyers.com39

INTERNATIONAL MEMBER FIRMSGUATEMALAGUATEMALAAbogados y Notarios NovalesAvenida La Reforma 10-00 zona 9Condomino Reforma despacho 5BGuatemala CentroaméricaCristián Novales Schlesinger(cnovales@novales.com.gt)Javier Novales Schlesinger(jnovales@novales.com.gt)Silvia Gándara Berger(sgandara@novales.com.gt)Tel: (502) 2383 0555Fax: (502) 2383 0556www.novales.com.gtHONG KONGHONG KONGHampton, Winter and Glynn20th FloorPrinting House6 Duddell Street, CentralHong KongDavid H. Glynn(dhglynn@hwg-law.com)Martin Waldron(mwaldron@hwg-law.com)Vanky Mak(vankymak@hwg-law.com)Tel: 852-2847-2300Fax: 852-2845-9168www.hwg-law.comHUNGARYBUDAPESTForgó, Damjanovic & PartnersLaw FirmAlkotás u. 17-191123 BudapestHungaryDr. Gábor Damjanovic(damjanovicg@fdlaw.hu)Tel: +36-1-214-0080Fax: +36-1-214-0078www.fdlaw.huINDIABANGALOREKochhar & Co.201 Prestige Sigma3 Vittal Mallya RoadBangalore 560001Karnataka, IndiaStephen Mathias(stephen.mathias@bgl.kochhar.com)Suhas Srinivasiah(suhas.srinivasiah@bgl.kochhar.com)Tel: 91-80-40308000Fax: 91-80-4112-4998www.kochhar.comCHENNAIKochhar & Co.Suite 305, Delta WingThird Floor, “Raheja Towers”#177, Anna SalaiChennai 600 002Tamil Nadu, IndiaRamachandran Ravichandran(ravichandran@chennai.kochhar.com)Ajith CR(ajith@chennai.kochhar.com)Tel: 91-44-4040-5222Fax: 91-44-2860-7588www.kochhar.comGURGAONKochhar & Co.3rd Floor, Tower BTechnopolis BuildingSector 54, DLF Golf Course RoadGurgaon 122002Haryana, IndiaK.V. Singh(kv.singh@kochhar.com)Tarvinder Singh(tarvinder.singh@kochhar.com)Tel: 91-124-4545-222Fax: 91-124-437-5596www.kochhar.com40

INTERNATIONAL MEMBER FIRMSISRAELRAMAT GANDardik, Gross & Co.Abba Hillel Road 14Beit-OzRamat Gan 52506, IsraelDan Gross(gross@dglaw.co.il)Amnon Dardik(dardik@dglaw.co.il)Tel: 972-3-6122624Fax: 972-3-6122587www.dglaw.co.ilITALYMILANUghi E Nunziante Law FirmVia Visconti di Modrone, 1120122 MilanItalyFiorella F. Alvino(ffalvino@unlaw.it)Tel: 39-2-762171Fax: 39-2-76009535www.unlaw.itROMEUghi e Nunziante Law FirmVia Venti Settembre lRome 00187ItalyFiorella F. Alvino(ffalvino@unlaw.it)Tel: 39-06-474831Fax: 39-06-4870397www.unlaw.itJAPANTOKYOAtsumi & SakaiFukoku Seimei Bldg.,12th Floor2-2, Uchisaiwaicho 2-chomeChiyoda-ku, Tokyo 100-0011JapanBonnie Dixon(bonnie.dixon@aplaw.jp)Daniel Hounslow(daniel.hounslow@aplaw.jp)Tel: +81-3 5501-2111Fax: +81-3 5501-2211www.aplaw.jpKOREASEOULBarun LawBarun Law Building92 gil 7, Teheran-roDaechi-dong, Gangnam-guSeoul 135-846 KoreaThomas P. Pinansky(tom.pinansky@barunlaw.com)Ki Tai Park(kitai.park@barunlaw.com)Joo Hyoung Jang(joohyoung.jang@barunlaw.com)Hijoung OH(hijoung.oh@barunlaw.com)Tel: +82-2-3479-7517Fax: +82-2-3476-5995www.barunlaw.com42

LUXEMBOURGLUXEMBOURGDSM Di Stefano MoyseAvocats à la Cour55-57 rue de MerlL-2146 LuxembourgLuxembourgMario Di Stefano(mdistefano@dsmlegal.com)Tel: 352-262-562-1Fax: 352-262-562-2www.dsmlegal.comMALAYSIAKUALA LUMPURShook Lin & Bok20th Floor,AmBank Group BuildingNo 55 Jalan Raja Chulan50200 Kuala LumpurMalaysiaDato Cyrus Das(cydas@shooklin.com.my)Jal Othman(jal@shooklin.com.my)Tel: +60-3-20311788Fax: +60-3-20311775/8/9www.shooklin.com.myMARSHALL ISLANDSMAJUROLaw Offices of Davor PevecRRE Commercial Center, Suite219P.O. Box 230Majuro, Marshall Islands 96960Davor Pevec(dzpevec@aol.com)Tel: (808) 599-5655www.pacificlawyersmarshallislands.comwww.pacific-lawyers.comMÉXICOMÉXICO CITYVon Wobeser y Sierra, S.C.Guillermo González Camarena1100 - 7° pisoSanta Fé, Centro de CiudadDelegación Álvaro Obregón01210 México, D.F.MéxicoClaus von Wobeser(cvonwobeser@vwys.com.mx)Javier Lizardi(jlizardi@vwys.com.mx)Tel: 52-55 5258-1000Fax: 52-55 5258-1098www.vonwobeserysierra.comTHE NETHERLANDSAMSTERDAMKennedy Van der LaanHaarlemmerweg 3331051 LH AmsterdamThe NetherlandsAlfred P. Meijboom(alfred.meijboom@kvdl.nl)Eva Knipschild(eva.knipschild@kvdl.nl)Tel: +31-20-5506633Fax: +31-20-5506733www.kvdl.nl43

INTERNATIONAL MEMBER FIRMSNEW ZEALANDAUCKLANDAnthony HarperLevel 8, Chorus House66 Wyndham StreetPO Box 2646Auckland 1140New ZealandMalcolm Hurley(malcolm.hurley@ah.co.nz)David Gould(david.gould@ah.co.nz)Peter Woods(peter.woods@ah.co.nz)Tel: +64 9 920 6400Fax: +64 9 920 9599www.anthonyharper.co.nzCHRISTCHURCHAnthony HarperLevel 9, HSBC Tower62 Worcester BoulevardPO Box 2646Christchurch 8140New ZealandMalcolm Hurley(malcolm.hurley@ah.co.nz)David Gould(david.gould@ah.co.nz)Peter Woods(peter.woods@ah.co.nz)Tel: +64 3 379 0920Fax: +64 3 366 9277www.anthonyharper.co.nzNIGERIALAGOSSterling Partnership17A Wumego CrescentOff Christ AvenueOff Admiralty WayLekki Phase ILagos, NigeriaBoma Ozobia(boma@spnglegal.com)Tel: +234 (0) 1 453 7881Fax: +234 1 271 7366www.spnglegal.comABUJASterling Partnership46 Lobito CrescentWuse 2AbujaBoma Ozobia(boma@spnglegal.com)Tel: +234 (0) 1 453 7882Fax: +234 1 271 7366www.spnglegal.comNORWAYOSLOBlix AdvokatfirmaP.O. Box 1533 Vika,No-0117 OsloNorwayBjørn Blix(bb@blix-law.no)Trine Næssvik(tn@blix-law.no)Tel: + 47 22 83 80 30Fax: + 47 21 08 47 00www.blix-law.no44

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2015InternationalClientSeminarALFAINTERNATIONAL2015INTERNATIONALCLIENTSEMINARFIRSTWORLDCHALLENGES:FINDINGPRACTICALSOLUTIONSIN ASHRINKINGGLOBALECONOMYCOURSEMATERIALS

2015 INTERNATIONAL CLIENT SEMINARFairmont Scottsdale Princess, Scottsdale, ArizonaMarch 5 – 8, 2015The Politics of LitigationCharles A. “Chuck” StewartBRADLEY ARANT BOULT CUMMINGSLLPMontgomery, Alabama(334) 956-7608cstewart@babc.comJeanne DemersAssociate General CounselSCHNEIDER ELECTRICFoxboro, Massachusettswww.schneider-electric.comKevin G. OwensJOHNSON & BELL, LTDChicago, Illinois(312) 984-0270owensk@jbltd.comMark FuchsVice President, General Counsel andCorporate SecretaryLOUISIANA PACIFIC CORPORATIONNashville, Tennesseewww.lpcorp.comThomas JohnsonDirector of LitigationKawasaki MotorsCorporation USAIrvine, Californiawww.kawaasaki.com

The Politics of Litigation 1I. IntroductionToday’s manufacturer faces more challenges than ever before. Higher stakes, moresophisticated plaintiffs’ attorneys, not to mention the explosion of social media, by whichan otherwise pedestrian injury claim can quickly morph into a “bet the company” crisis.This paper and presentation will endeavor to explore the challenges confronted byproduct manufacturers as they confront life in today’s shrinking global economy.II.Hypothetical ScenarioOne morning while Delbert Adams, Path-O-Tech Walls’ (commonly referred to in thewall industry as “Path-Os” which is pronounced “Pathos”) senior vice president andGeneral Counsel, was looking through the company’s catalogue of new productofferings, he got a call from his Claims Manager, Wally Jefferson. Wally needed to seeDelbert. In a short time standing in Delbert’s office, Wally explained to Delbert thatWally received a call from Ted Van Buren from Wood River, Illinois. Mr. Van Burenwanted to register a claim on one of Pathos’ products that was making his wife andchildren sick. Apparently, Mr. Van Buren bought some Cherry Wud from High’s HomeImprovement and built a play structure for his daughter which she uses in the livingroom. Cherry Wud was manufactured in South Burma by Panels Everywhere Inc. andwas imported and resold by Pathos.1 Materials prepared by Virginia Broughton Reeves and Chuck Stewart of the ALFA Montgomery, AL firmBradley Arant Boult Cummings LLP, and Kevin Owens of the ALFA Chicago, IL firm Johnson & Bell, Ltd.2

Delbert knows that Cherry Wud is a revolutionary panel that, when applied to walls,makes an average room look like an historic Presidential reading room at a very lowcost because the product is manufactured in Southeast Asia, where wood and laborwere cheap. In fact, it looks so good Delbert used it to panel his own home office.Delbert was not concerned about the significant glue used to bind the small pieces ofBois de Rose wood. The off-gassing is prevented by the photograph of cherry woodgrain being laminated to the one side of the panel, and the other side glued tight againstthe drywall.The installation instructions demonstrate proper installation in easy-to-follow pictorials.The installer need not speak South Burmese or English.When installed correctly,there is no measurable off-gassing based on Pathos’ research. Pathos’ research foundno measurable off-gassing. Further, Delbert has noticed no off-gassing at his home,and his contractor told him that he has installed hundreds of these offices with only ravereviews.After expressing his great satisfaction with Cherry Wud, Delbert asked Wally why wouldanyone use this product for a playhouse when it is clearly intended to be wall paneling?Wally went on to explain to Delbert in great detail that the largest buyers of this productwere High’s Home Improvement and similar big box/retail lumber yards, and the mostcommon use of this product was to build playhouses and treehouses. The cost of thepanels was so low, the product was easy to cut and looked so nice that people wantedtheir children to have upscale play structures.3

After Wally left, Delbert figured out that Wally knew too much about the sales of thisproduct for this to be the first claim involving Cherry Wud. Delbert e-mailed Wally andasked that he send back to him a loss run on the Cherry Wud product dating back tolast year when the product was first introduced by Path-O’s. He also asked him toprovide any analysis that had been performed by the claims group, any communicationsfrom Claims to the sales or financial people, as well as Wally’s thoughts in regard toproduct performance and what Pathos’ ultimate exposure might be.Wally immediately sent back an email with a .pdf attachment of the loss run that listed73 settled claims over the fifteen-month life of Cherry Wud. Wally also attached theExcel spreadsheet and Word document that comprised an “excellent” risk analysis byAsok Monroe, the summer intern from the local community college (who needed onemore project to complete his program). Wally told Delbert that, based on Asok’sanalysis and all of the information he saw, every single claim was due to the improperuse of the panel, thus, Pathos had no ultimate liability. Also, Wally wanted to know ifDelbert wanted to see the various medical records from some of the people makingclaims. And finally, Wally said he and the Claims group had no communications onthese issues because they were deleted because the Claims group deletes all e-mailsevery Friday evening as a standard practice.Something in Delbert’s memory told him to call his former partner, L. Howard Jackson,at the mega-law firm of Jackson, Rush, Will & Delay. Delbert was a deal-maker, not alitigator like Howard. As it turned out, Howard was happy to help out his old friend, andhe would bring every associate and the full weight of Jackson, Rush, Will & Delay tohelp sort out these issues.4

Howard filled Delbert’s mind with war stories of terrible tales of juries that had awardedmillions of dollars for similar claims. Delbert knew those are all “worst case scenarios.”Delbert hoped that these early claims were simply due to the introduction of a newproduct and they should soon be eliminated. He wasn’t sure Howard’s recommendationof a full blown investigation was necessary. He might just keep quiet and wait it out untilthe claims went away.After consulting with Howard, Delbert knew he had to inform P.H. “Boss” Washingtonand Alice Madison, Pathos’ Chief Executive Officer and Chief Financial Officer,respectively. Delbert knew that Boss didn’t understand legal matters well and wasalways worried about how investors would take any negative news about Pathos. Healso knew that Alice had a short temper, especially when it came to spending moneywithout adding value to the bottom line. Not wanting to rush in with bad news and largeexpenses, and since Boss and Alice were preparing for an investor conference in NewYork, Delbert set up a meeting the following week to discuss the issues raised by theCherry Wud claims.The extra time would give Delbert an opportunity to evaluate how real the variousissues raised by Howard would be, and if they were real, put the insurance carriers onnotice of a possible claim and start the investigation. The extra time would also givehim an opportunity to find the contract between Pathos and Panels Everywhere. Surely,if there was responsibility, Panels Everywhere was the company with the risk sincePathos was just an importer of that product, and there was probably a favorableindemnity section in the contract. Delbert also hoped there was an arbitration clause inthe agreement so the parties could avoid a public dispute.5

The morning before Delbert’s meeting with Boss and Alice, Pathos was served with alawsuit filed in Madison County, Illinois by nationally recognized plaintiff attorney EvolCatberg-Harding on behalf of Ted Van Buren and his family. Then, to make mattersworse, Delbert’s administrative assistant brought in a certified letter from the ConsumerProduct Safety Commission.Delbert began to update his notes for his meeting with Boss and Alice. This meetingwould likely be much longer he thought.III.Issues PresentedThese facts, not unlike situations confronted by counsel for product manufacturersalmost daily, present a number of issues for review and consideration that havepractical, legal, and ethical implications. In-house counsel must be careful to identifyjust who is the client. Care must be taken to preserve privilege over any internalinvestigations or the like. The company will be faced with decisions including when andif to alert its insurers, raising questions about the control of the investigation and anyresulting litigation, as well as conflicts of interest between counsel, carrier and company.This paper will attempt to address some of these questions in detail.IV.For In-House Counsel, Who Is Your Client?In-house counsel in certain litigation or potential litigation situations will need to exercisecare in identifying just who – or what – is the client. The American Bar AssociationModel Rules provide some guidance, as follows:6

ABA Rule 1.13 Organization as Client(a)A lawyer employed or retained by an organization represents theorganization acting through its duly authorized constituents…(f)In dealing with an organization’s directors, officers, employees,members, shareholders or other constituents, a lawyer shall explain theidentity of the client when the lawyer knows or reasonably should knowthat the organization’s interests are adverse to those of the constituentswith whom the lawyer is dealing.(g)A lawyer representing an organization may also represent any of itsdirectors, officers, employees, members, shareholders or otherconstituents, subject to the provisions of Rule 1.7. If the organization’sconsent to the dual representation is required by Rule 1.7, the consentshall be given by an appropriate official of the organization other thanthe individual who is to be represented, or by the shareholders.Determining who the client is in a corporate setting can be confusing. In turn, thisconfusion leads to problems when counsel attempts to shield documents andcommunications from discovery by asserting a claim of privilege. The model rulesestablish that an attorney acting as in-house counsel represents his employer. At firstblush, this issue may seem clear, however, because a corporation is run by individuals,individuals can easily be lead to believe that in-house counsel represents them. If anemployee’s interests are adverse to the corporation’s interests, Rule 1.13 mandates thatthe in-house attorney communicate to the employee that he represents the company,7

not the individual. If this occurs, in-house counsel should encourage the employee toretain separate counsel and advise the employee that their communications are notprotected by the attorney-client privilege.Moreover, although in-house counsel could represent an employee of the corporationas well as the corporation, the attorney must do so only after clearing the conflict ofjoint-representation under Rule 1.7. After considering these various issues andestablishing who the client is, in-house counsel can then determine whichcommunications are protected by the attorney-client privilege.V. Preservation of the Attorney PrivilegeCare must be taken, particularly by in-house counsel, to protect the attorney – clientprivilege. “The attorney-client privilege is the oldest of the privileges for confidentialcommunications known to the common law.” 2“Its purpose is to encourage full andfrank communication between attorneys and their clients and thereby promote broaderpublic interests in the observance of law and administration of justice.” 3To fostercandid communication, the privilege runs both ways: It “exists to protect not only thegiving of professional advice to those who can act on it but also the giving of informationto the lawyer to enable him to give sound and informed advice.” 4Likewise, “[t]he[attorney-client] privilege recognizes that sound legal advice or advocacy serves public2 Upjohn Co. v. United States, 449 U.S. 383, 389 (1981); Ebner, Lawrence S., Protecting PrivilegedInternal Investigation Communications, In-House Defense Quarterly (2014).3 Id.4 Id. at 390.8

ends and that such advice or advocacy depends upon the lawyer’s being fully informedby the client.” 5“The privilege applies to a confidential communication between attorney and client ifthat communication was made for the purpose of obtaining or providing legal advice tothe client.” 6In order to be protected, the primary purpose of the communication mustbe to facilitate legal advice. 7Additionally, the privilege belongs to the corporation, notits attorney.Importantly, the attorney-client privilege does not attach when in-house counsel actssolely in his business capacity. 8This presents special problems for the in-houseattorney who has mixed business and legal responsibilities. Indeed, courts maypresume that in-house counsel’s communications are more for business rather thanlegal purposes. In determining which communications are privileged, courts may look tothe dominant purpose of the communication, and if the dominant purpose was forbusiness advice, the privilege may not attach. 9Courts may also scrutinize allegedlyconfidential communications more closely when outside counsel is not involved.Consequently, in-house counsel should consider associating with outside counsel whenlitigation is foreseeable to ensure that the privilege attaches.5 Id. at 388.6 In re Kellogg Brown & Root, Inc., 756 F.3d 754, 757 (D.C. Cir. 2014) (citing RESTATEMENT (THIRD) OF THELAW GOVERNING LAWYERS §§ 68-72 (2000)); see also Fed. R. Evid. 501 (“The common law-as interpretedby United States courts in light of reason and experience-governs a claim of privilege.").7 Upjohn Co., 449 U.S. at 389.8 See, e.g., Aetna Cas. & Surety Co. v. Sup. Ct., 153 Cal. App. 3d 467, 475 (Cal. Ct. App. 1984).9 Costco Wholesale Corp. v. Sup. Ct., 219 P.3d 736, 742 (Cal. 2009).9

In Upjohn, the company was subject to a claim that its foreign subsidiary made illegalpayments to secure a foreign government’s business. In response, the companyinitiated an investigation and sent out a questionnaire to all of its foreign general andarea managers to determine the nature and magnitude of such payments. After Upjohndisclosed the payments to the Securities and Exchange Commission, the InternalRevenue Service demanded production of all the files relating to the investigation.Upjohn refused to produce these materials, citing privilege. The court rejected the“control group” test applied by the lower appellate court, concluding that even low-leveland mid-level employees could have the information necessary to defend against thepotential litigation, and that Fed. R. Evid. 501 protected any client information that aidedthe orderly administration of justice. The court rejected the lower appellate court’sconclusion that the work-product doctrine did not apply to tax summonses, butremanded the issue because the work-product at issue was based on potentiallyprivileged oral statements. The doctrine could only be overcome upon a strong showingof necessity for disclosure, and unavailability by other means. 10In Illinois, the IllinoisSupreme Court has held that “attorneys’ notes and memoranda of oral conversationswith witnesses or employees are not routinely discoverable” and noted a “rarelyoperable” exception where the notes and memoranda “constitute the only source offactual material”. 11“[A]ttorney’s notes or memoranda are discoverable only if the party10 Upjohn, 449 U.S. at 392.11 Consolidation Coal Co. v. Bucyrus-Erie Co., 432 N.E.2d 250, 253 (Ill.1982) (emphasis added).10

seeking disclosure conclusively demonstrates the absolute impossibility of securingsimilar information from other sources.” 12The Illinois Supreme Court also agrees with the United States Supreme Court that: “notesregarding oral statements of witnesses, whether in the form of attorney’s mentalimpressions or memoranda, necessarily reveal in varying degrees the attorney’s mentalprocesses in evaluating the communications.” 13The Consolidation Coal decision alsowas based on the fact that “notes of conversation with witnesses are so much a productof the lawyer’s thinking and so little probative of the witnesses’ actual words” 14 , findingthe attorney’s summaries of witness and defendant’s employee interviews protected bythe Attorney Work Product Doctrine. 15The Illinois Supreme Court also has held that“verbatim statements of [a] witness” are not protected the way summaries are, since thesummaries reveal “a particular marshalling of the evidentiary facts” and “reveal theattorney’s mental processes in shaping his theory of his client’s cause.” 16The elements required to establish that a communication is within the attorney-clientprivilege are well settled:(1) Where legal advice of any kind is sought (2) from a professional legaladviser in his capacity as such, (3) the communications relating to thatpurpose, (4) made in confidence (5) by the client, (6) are at his instance12 Id.13 Id. (citing Upjohn, 449 U.S. at 399-400)).14 Id. (citing In re Grand Jury Investigation, 412 F.Supp. 943, 949 (E.D. Pa. 1976))15 Id. at 254.16 Monier v. Chamberlain, 221 N.E.2d 410, 418 (Ill. 1966).11

permanently protected (7) from disclosure by himself or by the legaladvisor, (8) except the protection be waived. 17The attorney-client privilege applies to all communications “between in-house counsel andcorporate employees to the same extent as communications between outside counsel anda client.” 18The power to exercise or waive the corporate attorney-client privilege generally restswith the client, which is the company’s current management in the corporate context. 19The managers must “exercise the privilege in a manner consistent with their fiduciaryduty to act in the best interests of the corporation and not of themselves asindividuals.” 20Therefore, an employee that serves as both in-house counsel and as ahigh-level manager may be considered the client. In-house counsel serving dual rolesmust be aware of this, because as current management, they have the authority towaive the privilege.VI.Work-Product and Protecting Internal InvestigationsThe Federal Rules of Evidence prevent opposing parties from obtaining documents andtangible things that are prepared in anticipation of litigation. There is an exception,17 Scurto v. Commonwealth Edison Co., 1999 U.S. Dist. LEXIS 513, at *4 (N.D. Ill. Jan. 11, 1999) (citingUnited States v. Lawless, 709 F.2d 485, 487 (7th Cir. 1983)).18 Id. (citing Ames v. Black Entm’t Television, 1998 U.S. Dist. LEXIS 18053, at *20 (S.D.N.Y. Nov. 17, 1998)).See also Upjohn Co, 449 U.S. at 383-403 (reversing lower court judgment where low- and mid-levelemployees’ information was protected by the attorney-client privilege where it was necessary to defendagainst potential litigation); EEOC v. Koch Meat Co., 1992 U.S. Dist. LEXIS 17133 (N.D. Ill. Nov. 4, 1992)(holding that the EEOC was free to question employees concerning the matter at issue, but communicationsbetween the employer and the attorney were privileged).19 Commodity Futures Trading Comm’n v. Weintraub, 471 U.S. 343, 348 (1985).20 Id. at 348-49.12

to successfully protect an investigation under the work-product doctrine down the road,the best practice is to inform employees in writing that they are being interviewed tohelp the company obtain legal advice.The purpose of the investigation must also beprominent; however, the investigation will be protected so long as the “primary purpose”of the communication is to obtain legal advice.VII.CompetencyIn-house counsel must be particularly sensitive to issues concerning his or hercompetence to represent corporate clients, particularly individuals within the corporationwhose conduct may be at issue in a civil matter or in dealing with government regulatorsor law enforcement. The ABA Model Rules provide guidance in this area, as well:ABA Rule 1.1 CompetenceA lawyer shall provide competent representation to a client. Competentrepresentation requires the legal knowledge, skill, thoroughness and preparationreasonably necessary for the representation.In-house counsel is responsible for a wide variety of legal issues that arise, therefore, itis imperative that they are aware of their ethical duty to provide competentrepresentation for a client. The comments state that an attorney may possess certainskills that apply to any legal problem, regardless of the attorney’s familiarity with theissue. These skills include the ability to analyze precedent, evaluating evidence, andlegal drafting. The comments also state that “[p]erhaps the most fundamental legal skillconsists of determining what kind of legal problems a situation may involve, a skill that14

necessarily transcends any particular specialized knowledge.” Thus, in-house counselmust possess not only the fundamental skills but also the ability to recognize when theyare ill-equipped to handle a certain legal situation.Although in-house counsel may lack experience, they may be able to gain competencythrough preparation. Preparation includes studying the field that the lawyer is unfamiliarwith and/or associating with outside counsel who is familiar with the subject at issue inorder to establish competency.In order to provide competent in-house representation, inside counsel must be aware ofthe duty to preserve evidence. This duty exists when a party foresees litigation with areasonable degree of certainty. Failure to comply with the duty may lead to liability forspoliation, the ‘intentional destruction, mutilation, alteration, or concealment ofevidence.’” 24“Sanctions for spoliation of evidence are ‘intended to prevent unfairprejudice to litigators and to insure the integrity of the discovery process.’” 25 Spoliationis enforced by the court through the imposition of penalties against the party whodestroyed evidence. The penalties can range from monetary sanctions, dismissal of theaction, adverse inferences, or disallowing certain evidence from being introduced attrial.There are typically three elements that must be met before spoliation penalties areimposed: (1) the party with control over the evidence had a duty to preserve it at thetime of destruction; (2) the evidence was destroyed with a “culpable state of mind”; and24 Swofford v. Eslinger, 671 F. Supp. 2d 1274, 1279 (M.D. Fla. 2009) (quoting BLACK'S LAW DICTIONARY1437 (8th ed. 2004)).25 Id. (citations omitted).15

(3) the destroyed evidence was relevant to the party’s claim or defense. 26 In-housecounsel’s duty to provide competent representation includes a duty to ensure theiremployer’s document retention policy is adequate to avoid spoliation issues. Likewise,in-house counsel should instruct other employees responsible for the storing anddestruction of company information that this process must be stopped when litigation isreasonably foreseeable.The extent of in-house counsel’s duty is explained in thefollowing case:[I]t is not sufficient to notify all employees of a litigation hold and expect that theparty will then retain and produce all relevant information. Counsel must takeaffirmative steps to monitor compliance so that all sources of discoverableinformation are identified and searched. This is not to say that counsel willnecessarily succeed in locating all such sources, or that the later discovery ofnew sources is evidence of a lack of effort. But counsel and client must takesome reasonable steps to see that sources of relevant information are located. 27In-house counsel cannot escape ethical reprimands by claiming that the e-mails weredestroyed before actual litigation arose. Indeed, “the duty to preserve is triggered “notonly during litigation, but also extends to the period before litigation when a party shouldreasonably know that evidence may be relevant to anticipated litigation.” 28counsel is on notice if he receives a letter that openly threatens litigation. 29In-houseFailure to26 Byrnie v. Town of Cromwell, 243 F.3d 93, 102-12 (2d Cir. 2001).27 Zubulake v. UBS Warburg LLC, 229 F.R.D. 422, 432 (S.D.N.Y. 2004).28 Surowiec v. Capital Title Agency, Inc., 790 F. Supp. 2d 997, 1005 (D. Ariz. 2011).29 Id. at 1006.16

suspend a company’s document retention policy at this point warrants spoliationsanctions. 30The duty to preserve evidence does not mean that companies can never destroydocuments. In fact, Federal Rule of Civil Procedure 37(e) shields a party fromsanctions if electronically stored information is lost as the result of the routine, goodfaithoperation of an electronic information system. But, a party only acts in good-faith ifit continues operating its electronic information system before it is aware that litigation islikely to occur. After a party is put on notice that litigation is probable, it loses theprotection of this rule.VIII. Duty to Supervise OthersBoth retained counsel and in-house counsel have obligations relative to the reliance onor employment of non-attorneys to assist in litigation or pre-suit investigation and similarmatters. ABA Model Rule 5.2 suggests the following relative to the employment of orassociation with a non-lawyer:With respect to a non-lawyer employed or retained by or associated with alawyer:(b)a lawyer having direct supervisory authority over the non-lawyer shallmake reasonable efforts to ensure that the person’s conduct iscompatible with the professional obligations of the lawyer; and30 Id.17

(c)a lawyer shall be responsible for conduct of such a person that would bea violation of the Rules of Professional Conduct if engaged in by alawyer if:(1) the lawyer orders or, with the knowledge of the specific conduct,ratifies the conduct involved; or(2) the lawyer is a partner or has comparable managerial authority inthe law firm in which the person is employed, or has directsupervisory authority over the person, and knows of the conduct ata time when its consequences can be avoided or mitigated butfails to take reasonable remedial action.Importantly, in-house counsel’s duty to provide competent representation requires themto supervise others in a responsible manner. Model Rule 5.3 addresses this duty andstates that when supervising a non-lawyer, in house counsel must make reasonableefforts to ensure that the person’s conduct is compatible with the standard forcompetency. The rule requires that in-house counsel give appropriate instructions tothe non-lawyer. So, in implementing a document retention policy, in-house counsel hasan ongoing duty to oversee non-lawyers to ensure the system complies with thecompany’s legal obligations.18

IX.Ethical Duty of ConfidentialityRetained and in-house counsel share ethical duties to maintain confidentiality relative totheir representation of corporations and individuals.ABA Rule 1.6 governingconfidentiality of information provides in relevant part:(a)A lawyer shall not reveal information relating to the representation of aclient unless the client gives informed consent, the disclosure is impliedlyauthorized in order to carry out the representation or the disclosure ispermitted by paragraph (b)….(c)A lawyer shall make reasonable efforts to prevent the inadvertent orunauthorized disclosure of, or unauthorized access to, informationrelating to the representation of a client.Rule 1.6 is broader than the attorney-client privilege and encompasses all informationrelating to the representation. It also gives rise to a duty to safeguard client informationfrom inadvertent disclosure.In-house counsel should associate competent outsidecounsel to advise them on how to safeguard electronic information. Furthermore,Federal Rule of Evidence 502 may be used to protect privileged information frominadvertent disclosure.In the event of an inadvertent disclosure of confidential information, in federal courtcounsel has some protection. Fed. R. Evid. 502 provides:19

(b)Inadvertent Disclosure. When made in a federal proceeding or to afederal office or agency, the disclosure does not operate as a waiver in afederal or state proceeding if:(1) the disclosure is inadvertent;(2) the holder of the privilege or protection took reasonable steps toprevent disclosure; and(3) the holder promptly took reasonable steps to rectify the error,including (if applicable) following Federal Rule of CivilProcedure 26 (b)(5)(B).In-house counsel has a safe harbor under Federal Rule of Evidence 502, which protectsthe inadvertent disclosure of information so long as counsel took reasonable steps toprevent it and attempted to rectify the error. Federal Rule of Evidence 26(b)(5)(B)allows counsel to reclaim documents that have already been produced by notifying theparty who inadvertently received them. After learning of the inadvertent disclosure, theparty who received the information must return, sequester, or destroy the specifiedinformation.X. Role of Manufacturer, Defense Counsel and InsurerSituations such as the one presented in the hypothetical, above, often require themanufacturer to place its insurers on notice of the potential claim. Typically, thecontract of insurance obliges the carrier to retain defense counsel for the manufacturer,20

triggering a potential conflict of interest. By way of example, in Illinois, defenseattorneys hired by insurance companies to represent insureds are obliged to abide bythe Illinois Rules of Professional Conduct relative to conflicts of interest. Rule 1.7, theGeneral Rule in regard to conflict of interest, provides as follows:(a)A lawyer shall not represent a client if the representation of that client willbe directly adverse to another client, unless:(1) the lawyer reasonably believes the representation will notadversely affect the relationship with the other client; and(2) each client consents after disclosure.(b)A lawyer shall not represent a client if the representation of that clientmay be materially limited by the lawyer’s responsibilities to another clientor to a third person, or by the lawyer’s own interests, unless:(1) the lawyer reasonably believes the representation will not beadversely affected; and(2) the client consents after disclosure.(c)When representation of multiple clients in a single matter is undertaken,the disclosure shall include explanation of the implications of thecommon representation and the advantages and risks involved.21

Likewise, Opinion No. 98-08 of the Illinois State Bar Association (“ISBA”), affirmed by itsBoard of Governors in January 2010, provides that:Whatever the duties owed by defense counsel to the insurer, the relevant Illinoiscases, the Restatement, and this Committee's prior opinions make clear thatassigned counsel owes the insured the same professional obligations as if thelawyer had been personally retained by the insured. From this basic principle, itappears that the insured is, at a minimum, the defense lawyer's primary client. Asthe lawyer's primary client, entitled to the same professional obligations as aclient that had personally retained the lawyer, the insured should have priorityover the insurer whenever the interests of the insured and the insurer areinconsistent.The ISBA Opinion relied on several specific rules of the Illinois Rules of ProfessionalConduct, including Rules1 .2(a) and 5.4(c). Rule 1.2(a) provides that:A lawyer shall abide by a client's decisions concerning the objectives ofrepresentation and shall consult with the client as to the means by which they areto be pursued.Rule 5.4(c) provides that:a lawyer shall not permit a person who recommends, employs, or pays thelawyer to render legal services for another to direct or regulate the lawyer'sprofessional judgment in rendering those services.22

The Opinion concludes that an insurer may not compromise the lawyer's exercise of hisor her independent professional judgment, and that the insured must consent to anyrestrictions placed by an insurer on the lawyer's professional conduct on behalf of theinsured.This conclusion is mirrored in the Restatement (Third) of Law Governing Lawyers §134(2000), which provides in relevant part:(2) A lawyer's professional conduct on behalf of a client may be directed bysomeone other than the client if:(a)the direction does not interfere with the lawyer's independence ofprofessional judgment(b)the client consents to the direction under the limitations andconditions provided in §122.Finally, ABA Rule 5.4 speaks to a lawyer’s duty to remain independent, as follows:(c)a lawyer shall not permit a person who recommends, employs, orpays the lawyer to render legal services for another to direct orregulate the lawyer's professional judgment in rendering such legalservices.In-house counsel must also be mindful of their ethical obligation to exerciseindependent discretion as an attorney. This duty may be more challenging for the inhouseattorney, because they may feel more pressure from the CEO and CFO whose23

job is to protect the company’s bottom line. Consequently, in-house attorneys shouldtake time to explain their ethical obligations to their superiors, as well as theconsequences for failing to exercise independent discretion.Illinois courts have ruled that an attorney-client relationship exists between an insuredand the attorney hired by the insurer, which imposes upon the attorney the sameprofessional obligations that would exist had the attorney been personally retained bythe insured. 31In Nandorf, the plaintiff insured was sued by parties who alleged that they were yelled at,shoved, and imprisoned by employees in a store owned by plaintiffs. Defendant insurertendered a defense, but informed plaintiff that it would not be responsible for anypunitive damages. Plaintiff then retained an independent law firm, but defendant refusedto alter its position regarding punitive damages, relinquish control of the litigation, orreimburse plaintiff for expenses incurred in retaining the independent counsel. Plaintifffiled a declaratory judgment action, but defendant's motion to dismiss was granted andplaintiff appealed. The appellate court reversed the dismissal and remanded forinstructions to grant plaintiff relief, finding, in part, that the parties shared a commoninterest in a finding of no liability, but that if plaintiff was found liable, their interestsdiverged because defendant's interests would have been just as well served by anaward of minimal compensatory damages and substantial punitive damages. The courtheld that defendant's fidelity to plaintiff was hampered by its own interests, and found31 Nandorf, Inc. v. CNA Ins. Cos., 479 N.E.2d 988, 972 (Ill. App. Ct. 1985); see also Rogers v. Robson,Masters, Ryan, Brumund & Belom, 392 N.E.2d 1365 (Ill. App. Ct. 1979); Bartosiak, Harry E., Conflicts ofInterest Within the Tri-partite Relationship, IDC Quarterly (Illinois Association of Defense Trial Counsel),Vol. 6, No. 4.24

that a conflict of interest existed as between insurer and insured once the insureradvised the insured that it would not be responsible for any punitive damage award. 32The Nandorf court recognized that an attorney hired by an insurance company todefend in an action against its insured owes fiduciary duties to two clients, the insurerand the insured. The attorney-client relationship between the insured and the attorneyhired by his or her insurer imposes upon the attorney the same professional obligationsthat would exist had the attorney been personally retained by the insured. Courts haverecognized, however, that in reality, the insurer's attorneys may have closer ties with theinsurer that is paying counsel’s bills, and a more compelling interest in protecting theinsurer's position, whether or not it coincides with what is best for the insured. Thisreality frequently gives rise to conflicts of interest between insurer and insured. Thus, inIllinois, when conflicts arise, the Illinois Supreme Court has recognized a "limitedexception" to the general rule that an insurer controls the defense of its insured. Theinsured is entitled to assume control of his or her own defense in the underlying action.The conflict confronting the attorney employed by the insurer may be resolved by fulldisclosure and consent from the parties. However, the ethical problem is not solved bythe insurer's electing to defend under a reservation of rights. In a conflict situation wherethe insured rejects the insurer's offer to defend under a reservation of rights, theinsurer's obligation to defend is satisfied by reimbursing the insured for the costs ofindependent counsel 33 .32 Nandorf, Inc, 479 N.E.2d at 972.33 Id. at 990-92.25

Therefore, when an insurance company retains an attorney to defend an action againstone of its insureds, the attorney must work toward furthering the interests of both theinsured and insurance company. 34 In Peppers, the insured owned a building adjacent toa pizza restaurant. The building was insured by appellee insurer under a general liabilitypolicy and the insured's home was covered under a homeowner's policy by appellantinsurer. The insured injured a trespasser on his property whom the insured thought wasburglarizing the property. When appellee insurer denied coverage of the incident, theinsured sought coverage and defense from appellant insurer under the homeowner'spolicy. Appellant brought a declaratory judgment action seeking a declaration of itsrights and obligations.The trial court held that the general liability policy did not cover the occurrence inquestion and that appellant was obligated under its homeowner's policy to defend theinsured in the personal injury action. The court reversed the holding as to the denial ofcoverage. On appeal, the court reinstated the trial court's ruling with respect tocoverage, as no prejudice to the insured resulted, but held that the trial court erred infinding that the insured had intentionally caused the injury to the trespasser becausesuch a finding was premature and not proper in the declaratory judgment action. TheIllinois Supreme Court affirmed the appellate court's judgment affirming the judgment ofthe trial court as to appellee insurer, reversed the appellate court's holding thatappellant insurer was estopped to deny coverage under its policy, and vacated thefinding of the trial court that the injury was not within the coverage of either policy34 See generally Md. Cas. Co. v. Peppers, 355 N.E.2d 24 (Ill.1976).26

ecause it was intentionally inflicted. 35In its decision, the Court noted that indetermining whether an insurer owes a duty to the insured to defend an action broughtagainst him, it is the general rule that the allegations of the complaint determine theduty. If the complaint alleges facts within the coverage of the policy or potentially withinthe coverage of the policy the duty to defend has been established. This duty to defendextends to cases where the complaint alleges several causes of action or theories ofrecovery against an insured, one of which is within the coverage of a policy while theothers may not be. 36Further, “whether an insured is prejudiced by an insurer's conductin entering an appearance and assuming the defense of an action is a question of fact.Prejudice will not be conclusively presumed from the mere entry of appearance andassumption of the defense. If, however, by the insurer's assumption of the defense theinsured has been induced to surrender his right to control his own defense, he hassuffered a prejudice which will support a finding that the insurer is estopped to denypolicy coverage.” 37In essence, then, an attorney who is hired by an insurance company to represent aninsured has dual clients, at least in terms of ethical questions which may arise duringthe course of this relationship. An attorney is obligated to recognize and addresspotential conflicts of interest that may arise between the insurer and the insured. 38Above and beyond considering application of the specific Rules of ProfessionalResponsibility to the tripartite relationship, attorneys must be aware that they owe35 Id. at 26-28.36 Id. at 28-29.37 Id. at 29.38 Ill. Mun.League Risk Mgmt. Ass’n v. Seibert, 585 N.E.2d 1130 (Ill. App. Ct. 1992).27

fiduciary duties to both the insured and the insurer. 39Likewise, however, the insurer’sposition relative to coverage may require that it surrender control of the litigation andsatisfy its obligations under the policy of insurance by paying for counsel of themanufacturer’s own choosing.In some circumstances, this potential for a conflict, orthe appearance of one, makes it advisable to make full disclosure to the manufacturerand obtain its consent to the representation.39 Nandorf, 479 N.E.2d at 991.28

2014 INTERNATIONAL CLIENT SEMINARFAIRMONT SCOTTSDALE PRINCESS,SCOTTSDALE, ARIZONAMARCH 5 – 8, 2015Yearning For A Yin To Your Yang:Finding Balance in an Unbalanced WorldChristopher A. PageYOUNG MOORE AND HENDERSON,P.A.Raleigh, North Carolina(919) 861-5502chris.page@youngmoorelaw.comHeather AndersonSenior Corporate CounselBEST BUYEncinitas, Californiawww.bestbuy.comMelanie R. CheairsLORANCE & THOMPSON, P.C.Houston, Texas(713) 868-5560mrc@lorancethompson.comErik LindsethGeneral CounselLIFETIME FITNESS, INC.Chanhassen, Minnesotawww.lifetimefitness.com

Yearning for a Yin to Your Yang:Finding Balance in an Unbalanced World 1He who learns but does not think, is lost! He who thinks but does not learn is in greatdanger.--ConfuciusA true balance between work and life comes with knowing that your life activities areintegrated, not separated.-- Michael Thomas SunnarborgI'm killing time while I wait for life to shower me with meaning and happiness.--Calvin; Calvin and HobbesI. The Yin-Yang SymbolEver taken more than a moment to think about the "Yin-Yang" symbol? It was createdthousands of years ago by the Chinese to reflect the movement of the sun over theyear's celestial calendar. To the Chinese and other Asian cultures, the symbol came torepresent much more in terms of an understanding of life and a way of being. To manyAmericans, in comparison, they paid the symbol cursory attention, simply noting that itreflected, on its face, the concept of balance.1 This article was prepared by Chris Page and Melanie Cheairs. Chris is a member of the ALFAInternational firm of Young Moore and Henderson, P.A. of Raleigh, North Carolina; Melanie is amember of the ALFA International firm of Lorance and Thompson, P.C. of Houston, Texas.2

For many, that is enough attention paid to balance. They acknowledge that balance is alaudable goal but delve no further. They go on about their lives, focusing on careers,paying the bills, raising families, and preparing for retirement. "Balance" becomes justanother vague ideal, the fodder for idle dinner party conversation, and is paid littleserious consideration.This perspective is shared by many hard-working professionals, especially attorneys.But it is a view fraught with peril. Attorneys may be distinguished from other professionsby their zeal for success and their competitiveness, perfectionism, and analytical nature.But these qualities are factors that lead attorneys down dark paths. The statistics arestaggering: attorneys abuse alcohol or drugs at a figure twice the rate of the generalpopulation, and of those attorneys, it is estimated that 50% are dealing with depression,33% are addictions involving illegal drugs, prescription drugs, sex and gambling, and15% involve schizophrenia and bipolar disorder. The collateral damage is substantial.In addition to the incalculable impact on families, it is estimated that over 50% oflawyers facing disciplinary actions have mental health or substance abuse issues. Anda very hard fact to confront: lawyers have the highest rate of suicide of any profession. 22 A more in-depth discussion of these and related statistics are found further within this paper. There aremany resources reporting on the relationship between attorneys and alcohol, drug abuse, and mentalhealth. For a review of many of the relevant statistics, see generally, 17 Statistics on Drug AbuseAmong Lawyers, Intervention Strategies (January 7, 2014); http://interventionstrategies.com/17-statistics-on-drug-abuse-among-lawyers/; The Rough Road to Redemption, August 2013 ABA Journal,at 51; Alcoholism, Drug Abuse and Lawyers: Are We Ready to Address the Denial? Rick B. Allan, 31CREIGHTON LAW REVIEW 265 (1997); Substance Abuse within the Legal Profession: A Symptom of aGreater Malaise, NOTRE DAME JOURNAL OF LAW, ETHICS & PUBLIC POLICY, Vol. 7, Article 9 (February2014); and http://www.americanbar.org/groups/lawyer_assistance.html (last visited 12/29/14).3

Fortunately, State Bars across the country have recognized the need to help theirmembers.Treatment and resources are available through Lawyer AssistancePrograms in all 50 states. Professional counseling, medication, and support groups allcontinue to help the struggling attorney. There are also hundreds of books and coursesfor the professional seeking self-analysis, wisdom, and practical advice.But each of these avenues for treatment, healing, and self-improvement share one thingin common: the principle embodied by the Yin-Yang symbol -- BALANCE.To Asian cultures, the circle encompassing Yin and Yang represents the unity andbalance of the forces in the universe. This unity is made up of two opposite butcomplementary forces that we find in every object and every process. They are theforces of light and darkness, left and right, ebb and flow, positive and negative, maleand female, good and evil. We see them in the change of seasons, in the movement ofthe tides, and in the existence of a harmonic universe. The Yin and Yang cannot existwithout each other. Both are necessary in the universe and in our lives. The boundarybetween these forces creates the harmony and balance from which everything iscreated. Yin and Yang are symbolic of eternal change and the natural rhythms of life.The symbol for them is not static. It is kinetic and flowing. It depicts a serene cycle ofconstant flux.To this ideal of balance, and in particular "work-life balance", this paper and thepresentation accompanying it are directed. The authors do not pretend to be expertson, or prime examples of, the subject of "work-life balance," but they care deeply aboutthe subject, have read and thought extensively on it, and hope, through offering the4

esources presented in this paper (and perhaps a useful thought or two in their multimediapresentation at the 2015 ICS), that they will encourage everyone involved toponder this issue a bit more, and work more earnestly toward a "balanced life." 3Each of the hard-working professionals that attend the ALFA International ClientSeminar know the burden of responsibility: paying the bills, getting new clients, doinggood work in our jobs, family, college expenses, saving for retirement, etc. Let'sconsider the things that are part of our lives that represent "responsibility" to be the"Yang" in our lives. Those things are understandably important to us, but for each of us,our responsibilities can weigh us down and cause depression, mental and emotionalfatigue, alcoholism, drug addiction and more. Our lives can spiral out of control, leadingus to make poor choices in our daily work decisions and in our personal lives.We all recognize that our lives are happier when we have BALANCE in our lives. Weneed a "Yin" to our "Yang." We need those things that are not "have to do" things but"want to do" things. We need things to be passionate about, that are fun, and that arefulfilling on a deep level. When we have those things in our lives, the things thatrepresent our responsibilities don't feel quite so burdensome.We yearn for a Yin to our Yang.3 It is quite possible, if not probable, that some of the thoughts expressed herein were the subject ofmultiple conversations with deep-thinking and like-minded friends on covered porches and long drives.Don't most good ideas originate that way? The authors admit that this is a hard thing to "cite" to withany Bluebook authoritative rule, but they acknowledge with gratitude their friends, muses, and musicalinspirations for causing them to think beyond the 9 to 5.5

II.The Challenge that Confronts UsIf it's your job to eat a frog, it's best to do it first thing in the morning. And if it's your jobto eat two frogs, it's best to eat the biggest one first.--Mark TwainThe price of anything is the amount of life you exchange for it.--Henry David Thorough9 to 5, whoa what a way to make a livin'Barely gettin' by, it's all takin' and no givin'They just use your mind and they never give you creditIt's enough to drive you crazy if you let it9 to 5, yeah they got you where they want youThere's a better life, and you dream about it, don't you?It's a rich man's game no matter what they call itAnd you spend your life puttin' money in his wallet--Dolly PartonA. The Hard TruthsStudies indicate that the law, along with other helping professions such as medicine,dentistry and social work, tend to attract a statistically greater number of thoseindividuals who are prone to develop of chemical dependencies, predominantlyalcoholism. Similarly, depression among lawyers exceeds all other professions. Finallyand tragically, the legal profession claims the highest rate of suicide among all otheroccupations. The statistics supporting these facts are stunning.The American Bar Association’s Commission on Impaired Attorneys shocked theprofession in 1991 when it estimated that 18 to 20 percent of the nation’s lawyers abuse6

alcohol or drugs. 4By comparison, among the general population, including persons inother highly stressful professions such as physicians and pilots, the estimated rate ofchemical abuse is at a much lower eight to ten percent. 5More recently, studiesconducted in numerous jurisdictions have pegged the rate of alcoholism in the legalprofession at between 15% and 24%. 6Likewise, illicit drug use is prominent in the legalprofession. In 1990, the international Journal of Law and Psychiatry published a studyon the prevalence of drug abuse in the legal profession and found that 26 percent oflawyers had used cocaine at least once, a rate more than twice the general population. 7Many jurisdictions have discovered that there is a correlation between alcoholism andmalpractice and discipline. Studies in Canada and in the United States estimate thatapproximately 60% of discipline prosecutions involve alcoholism. Similarly, over 60% ofall malpractice claims involve alcohol abuse. 8More significantly, a recent study hassuggested that 90% of serious disciplinary matters involve alcohol abuse. It is clear thatalcoholism in the legal profession is a very, very costly problem. 9Of similar concern, depression among lawyers is higher than all other professions.Research shows 33 percent of lawyers suffer from mental health issues, and that 194 Todd C. Scott, Lawyer seeks Treatment, Boss Seeks Assurance, ABA LAW TRENDS AND NEWS, Vol. 7,No. 3 (Spring 2011)http://www.americanbar.org/newsletter/publications/law_trends_news_practice_area_e_newsletter_home/2011_spring/managing_lawyer_treatment.html.5 Id.6 Id.7 Id.8 See note 4, supra.9 Legal Profession Assistance Conference, Drug and Alcohol Abuse & Addiction in the Legal Profession,http://www.benchmarkinstitute.org/t_by_t/mcle/sa.pdf.7

percent of the lawyers studied suffered from significant elevated levels of depression—more than twice the national average. 10Other studies from around the country reflectalarming statistics. A study by Johns Hopkins University found that among more than100 occupations studied, lawyers were three times more likely to suffer from depressionthan any other profession. 11In Washington State, a research study of 801 lawyers inthe State of Washington found that 19% suffered from depression. 12In Florida, anotherstudy found 1 in 4 lawyers suffer from elevated feelings of psychological distress,including feelings of inadequacy, inferiority, anxiety, social alienation, isolation anddepression. 13 The quality of life survey by the North Carolina Bar Association in 1991revealed that almost 26% of respondents exhibited symptoms of clinical depression,and almost 12% said they contemplated suicide at least once a month. 14Mostimportantly, some studies estimate that of the one million lawyers in this country,approximately 250,000 suffer from some form of depression. 15The fact that substance abuse among lawyers is double the national average becomesan even greater concern when considering that substance abusers are ten times morelikely to commit suicide. 16This sad statistic is evident in the fact that the legalprofession claims the highest rate of suicide among all other occupations, and ranks as10 See note 4, supra.11 Ted David, Can Lawyers Learn to Be Happy?, 57 No. 4 Prac. Law 29 (2011); see more at:http://abnormaluse.com/2012/03/the-lawyers-epidemic-depression-suicide-and-substanceabuse.html#sthash.mdFPJpFh.dpuf12 The Prevalence of Depression, Alcohol Abuse, and Cocaine Abuse Among United States Lawyers, 13Journal of Law and Psychiatry 233 (1990).13 Benjamin Sells, Facing the Facts About Depression in the Profession, Florida Bar News, March 1995.14 Michael J. Sweeney, The Devastation of Depression; research conducted by Campbell University.15 Depression is the Law’s Occupational Hazard” The Complete Lawyer, 3/1/08, Daniel Lukasik.16 Id.8

the third leading cause of death among attorneys, after cancer and heart disease. 17Astudy conducted by the National Institute for Safety and Health found that male lawyersbetween the ages of 20 and 64 are more than twice as likely to die from suicide thanmen of the same age in other occupations. (Those most at risk were lawyers and judgesaged 48 to 65.) A Canadian bar study puts attorney suicide at nearly six times thesuicide rate in the general population. 18B. Looking in the MirrorPsychologist Lynn Johnson points to two personality traits many lawyers have:perfectionism and pessimism. 19The Lawyers Helping Lawyers Commission, out ofSouth Carolina, made an interesting finding. Research suggested that those who sufferfrom intense perfectionism are at higher risk for suicide than those who do not. They aredriven by an intense need to avoid failure. To these people, nothing seems quite goodenough, and they are unable to derive satisfaction from what ordinarily might beconsidered even superior performance. 20As recently noted in Drug and Alcohol Abuse & Addiction in the Legal Profession, “thework of the legal profession requires communication, together with persuasion,creativity and consistency; lawyers learn to exhibit a professional demeanor and to hidetheir own alarm, fear, disgust, abhorrence, boredom, as we conduct our professional17 UTAH STATE BAR JOURNAL, August/September 2003.18 See note 4, supra.19 Lynn Johnson, Stress Management, UTAH STATE BAR JOURNAL, January/February 2003.20 Dr. Sidney J. Blatt, The Destructiveness of Perfectionism: Implications for the Treatment of Depression,AMERICAN PSYCHOLOGIST, Volume 49, Number 12 (1997).9

lives. We develop a tough exterior and we repress our own weaknesses. We learn toexpect and give little support to and from our colleagues. We learn to work with otherlawyers as professionals and not as people. It is no surprise that many lawyers findthemselves alienated and alone as people while maintaining a clear identity as lawyerswithin the profession.” 21“Lawyers are treatment resistant,” says William Messinger, a lawyer and president ofAureus, Inc. a St. Paul, Minnesota, company that assists legal professionals and theiremployers with recovery and relapse preventions strategies. 22“Lawyers ask a lot ofquestions and are not self-revealing,” says Messinger. 23Such attributes are generallyseen by treatment counselors as uncooperative behavior and can delay effectiverecovery for the lawyer. Firm problems add to addiction issues. Messinger also pointsout that firm culture often serves as a barrier for the chemically dependent lawyer to geteffective treatment: “The whole [recovery] process is counterintuitive to the legalprofession,” says Messinger. “In a law firm, showing support often means covering upfor the lawyer instead of letting him or her fail so the problem can be identified.” 24Lawfirms may hesitate to approach the troubled lawyer about an addiction problem out of adeep understanding of the stresses and anxiety that the practice of law brings, as wellas the shame and stigma that their colleagues face when seeking help. Worse yet,some firms with knowledge of a lawyer’s past addictive behavior and sudden relapse21 See note 9, supra.22 See note 4, supra.23 Id.24 Id.10

may avoid intervening on behalf of the lawyer if they feel the timing of the event wouldpose economic concerns for the firm, such as the delay of a matter set for trial.C. What's Being Done?While alcoholism and substance abuse have been major causes of negligence claimsand disciplinary complaints in the legal profession for quite some time, it is only inrecent decades that bar associations have directly dealt with them. While the AmericanMedical Association began a program for impaired physicians in 1972, it was not until1988 that the American Bar Association set up its Commission on Impaired Attorneys. 25Just as national bar associations have begun examining and focusing on the disease ofaddiction, so have state and provincial bar associations begun examining what they cando for lawyers. Todd C. Scott, Vice President of Member Services and RiskManagement at Minnesota Lawyers Mutual Insurance Company, notes that a lawyerassistance program or committee now exists in every state, whereas 25 years ago only15 states had programs for lawyers who abuse drugs and alcohol. 26 Lawyer AssistanceProgram (LAPs) now have an impressive array of resources to provide services andsupport to lawyers and law students in need, backed by an army of recovering lawyersand counselors sympathetic to the stresses and difficulties of trying to make it in thelegal profession.25 See note 9, supra.26 See note 4, supra.11

III.Hello. Who am I? I'm a lawyer. Right?I don’t look at myself as a basketball coach. I look at myself as a leader who happens tocoach basketball.--Coach KIt's just a job. Grass grows, birds fly, waves pound the sand. I beat people up.--Muhammed AliWhoooooo . . . are you? Who who ... who who?--The WhoAt the risk of venturing into what may seem like self-help schlock, please humor us byanswering a question that lays at the foundation for finding balance. If someone asksyou who you are, what is the first thing you say after giving your name?Take a moment and answer that question. (Task completed? Now read on.)Does your occupation come first? Or the fact that you are married or single? A parent?A Christian, Muslim, or Jew? A Democrat or Republican? A native of your hometown?A fan of your college sports team? Does your answer simply take into account thecircumstances you are in? "I'm an attorney with [insert firm name here]." Or "I'm Kacie'smom." Or "I'm a Duke Blue Devil." Or "I'm a volunteer with the Food Bank today."Have you considered the proposition that you are not your job or even a person definedby your relationship with others? You may say, "Of course, I'm not my job. That'sridiculous." Ridiculous? How much of your waking resources do you commit to yourjob? Greater than 75%? Likely yes for most attorneys.12

Consider this thought: at its core, who and what you are is a unique human being; youruniqueness lies in the bundle of talents, gifts, weaknesses, and personality traits thatyou were either born with or developed as you grew up. You would be this person ifyou lost or changed your occupation, and even if you lost or changed your humanrelationships. You would be this person if all of that was taken away from you, and youwere all alone on the other side of the world.What would your closest friend or relative say at your funeral about who you were? Is itpossible that your occupation wouldn't be in the top 5 things they would mention?Perhaps not even the top 10 or 20?If, as noted above, Coach K considers himself a "leader that also happens to coachbasketball," then what traits make up you (who also happens to be a lawyer)? Are youcreative, smart, curious, passionate, faithful, art-loving, history-loving, science-loving,service-loving, compassionate, adventurous, etc.? The possibilities are endless. Andonly you, and perhaps your closest friends and family, know how to answer thatquestion. But asking -- and answering -- the question is critical.If your answer is "I'm a creative, arts-loving person that happens to be a lawyer," thenhow much of your life are you committing to the part that is creative and arts-loving?What are you doing to balance the part of you that is your "day job"? While that jobhelps to pay the bills and to support you and your family, it does not define who you are.Why let it encompass so much of your waking life that you leave no room to explore thegreat, wide world with everything else that you have to offer?13

IV.Finding Balance in an Unbalanced WorldWe know what we are, but not what we may be.--William ShakespeareWork is a rubber ball. If you drop it, it will bounce back. The other four balls-- family,health, friends, integrity-- are made of glass. If you drop one of these, it will beirrevocably scuffed, nicked, perhaps even shattered.― Gary Keller, The One Thing: The Surprisingly Simple Truth BehindExtraordinary ResultsThe more relaxed you are, the better you are at everything: the better you are with yourloved ones, the better you are with your enemies, the better you are at your job, thebetter you are with yourself.--Bill MurrayWe've reached the big finale -- the point in this paper where we provide all the answersyou've been looking for. And it should come as no surprise that . . . we don't have them,at least for your individual life. There are loads and loads of self-help authors and guruswho have loads and loads of advice for you. And for much of that advice, "load" is theright word (as the second part of a two-part phrase). Nevertheless, it's helpful toappreciate the intent of this advice, which is that having a "balance" between your workand your life is a good thing. We can all agree upon that, right?What is the right approach for you? Only you can work that out. If you were to throw allof the books, articles, websites, and videos on work-life balance into a giant heap, oncethe dust settles you would see the following common themes and advice:14

1. Decide if work-life balance is important to you.2. If it is, then make the commitment to develop, and stick to, a plan togain more balance in your life.3. Take the time to think about your life and set your values andpriorities. (Consider doing this daily.)4. Define success for yourself.5. Be creative with how you find balance.6. Establish and enforce boundaries between work and "not work."(a)(b)Manage technology. Don't always be plugged in.Let clients, office staff, and family know what yourboundaries are.7. Build support networks at home and at the office.8. Exercise regularly.9. Drop activities (and people if you can) that sap your time andenergy.(a)(b)Do fewer things and do them well.Be willing to say no.10. Build downtime into your daily schedule. Take the time to “get youryour Zen on,” meditate or just reflect thoughtfully, especially if youcan do it outside with no electronic input other than music.11. Start small and build from there.Now, it is entirely possible that the subject of this paper is just more mushy "get in touchwith yourself" psychobabble for the parents of the Millennial generation. A 2014 Timemagazine article on work-life balance noted that a Lexis-Nexis study found that in theten years from 1986 to 1996, work-life balance was mentioned in the media 32 times.15

In 2007 alone, it was mentioned 1674 times. 27Perhaps prior generations would call allof this nonsense. But others would say that focusing on this issue is a step in the rightdirection for our society. It is right to think about how to be happier. The terriblestatistics for attorneys, standing alone, show that we must figure out a better way towork and to enjoy life.So, the question is: Do YOU yearn for a Yin to your Yang? Does your life need morebalance? To all of you high-achieving, uber-successful (or perhaps struggling) folkswho have taken the time to read this paper, are you disciplined enough to take the timeto make some progress on this laudable goal? Can you make a plan of action to have abalanced life? Can you make a commitment to yourself, to your family, and live up tothat promise? What does it take? Courage, discipline, and commitment.One of the most quoted bits of advice that you will ever hear, whether you are religiousor not, is the "Serenity Prayer." It goes like this:God grant me the serenityto accept the things I cannot change;the courage to change the things I can;and the wisdom to know the difference. 28What many people seem to focus on is the concept in the first phrase, of accepting thethings you cannot change. It can be applied to adult relationships, tragedies, illnessesand much more.27 How to Achieve Work-Life Balance in Five Steps, Time Magazine (April 2, 2014).28 This was authored by the American theologian Reinhold Niebuhr (1892–1971). Notably, it has beenadopted by Alcoholics Anonymous and other twelve-step programs.16

But we encourage our readers to think about the second part. Without even focusing onthe concept of a "prayer" (and we make no point of whether and how our readers shouldpray), the point is focusing on the things you CAN change. The list of things you canchange is virtually endless, and it starts with how you choose to spend your time. Youhave control over this most important aspect of your life. You have chosen to read thisarticle because the topic appealed to you. How you choose to spend the rest of the daytoday, tomorrow, and the days after that, is entirely up to you. Sure, you could get hit bya bus or struck by lightning (and that would certainly be a major bummer and a mess toclean up), but do you want to live life waiting for that to happen? If you are fortunateenough to live into retirement, do you want to look back on your life realizing that youhad a chance for a "balanced life" and did little to nothing about it? If you are artsy or ascience/math nerd or love to travel or love to help those in need, what will you tell yourretired self are the things you did when you were younger to nurture and encourage thatpart of your talents?If you look at how you spend your time as entirely within your power, then yourperspective on everything changes. And it's an exciting new point of view. You gainaccountability for your actions. You stop whining. You are no victim of circumstance.You are a doer. You become the architect of your own fun, your own passions, yourown life. If you yearn for a Yin to your Yang, what are you waiting for?17

2015InternationalClientSeminarALFAINTERNATIONAL2015INTERNATIONALCLIENTSEMINARFIRSTWORLDCHALLENGES:FINDINGPRACTICALSOLUTIONSIN ASHRINKINGGLOBALECONOMYTRACK1:COMPLEXLITIGATION

2015 INTERNATIONAL CLIENT SEMINARFAIRMONT SCOTTSDALE PRINCESS HOTELSCOTTSDALE, ARIZONAMARCH 5 – 8, 2015ROOT CAUSE ANALYSIS:Looking for Black & White in a World of GrayPeter A. DubrawskiHaight, Brown & Bonesteel, LLPLos Angeles, CApdubrawski@hbblaw.com(213) 542-8007J.K. LeonardNaman Howell Smith & Lee, PLLCSan Antonio, TXjkleonard@namanhowell.com(210) 731-6358Bryan D.A. LarsonDirector - Property & Casualty Risk ManagementLeggett & Platt, Inc.Carthage, MOwww.leggett.comCurt PaulsenSr. Vice-President & General CounselSafway Group Holding, LLCWaukesha, WIwww.safway.comThomas O. McGimpseyExecutive Vice President – CorporateDevelopment & General CounselAdvanced Energy Industries, Inc.Fort Collins, COwww.aei.com

Root Cause Analysis:Looking for Black & White in a World of Gray 1When something unplanned happens, we all want answers. It’s human nature. Thelengths to which one will go to determine “why” is typically in direct proportion to theperceived seriousness (or frequency) of the event. For example, a guest falls whiledescending the stairway in your home. The guest professes to have “slipped” on a stepand assures you that they are not hurt, merely shaken. You take a quick look at thestairs and do not notice anything that appears significant at all. Given your guest’sexplanation, you make no further inquiry. In contrast, consider the level of inquiry whenthe injury is a broken bone, or when several people fall on the step. You now examinethe stairs in detail and you notice a slight “hump” in the stair in the area where the fallshave occurred. Digging further, you discover a loose board under the carpet that moveseach time guests step on it. In all likelihood, you repair the board and carpet and moveon. Some, however, may dig even further to find “why” the board came loose in the firstplace, determining who or what created the condition that led the board to loosen overtime.In this simple example is a microcosm of what is known as “root cause analysis” – theinvestigation, analysis and determination of the factors that lead to an event. While notevery business will use this terminology, each will, at some point, likely perform what inessence is a root cause analysis of a product, process or business practice. Even if theterminology is used, however, differing approaches or styles may be used to performthe investigation and analysis. Even more frustrating for those who seek accurate1 Article prepared by ALFA International attorneys J.K. Leonard (Naman Howell Smith & Lee, PLLC, SanAntonio, TX) and Peter Dubrawski (Haight, Brown & Bonesteel, LLP, Los Angeles, CA).2

information is that they will find that differing styles and methods may lead to differingconclusions for the same set of circumstances. In effect, when one is looking for blackand white answers, one will learn that the process of root cause analysis may oftenyield a gray response, affected by bias, habit, incomplete analysis or insufficientresources to truly reach the “bottom line” of the cause. It is advisable to have a workingknowledge of root cause analysis and its potential benefits and drawbacks so that areasoned decision can be made whether (and when) to conduct one. This paper willnot attempt to sway the reader in any direction; rather, it will simply introduce at leastone view of the process 2 , provide alternate resources for differing methodologies, andgenerally discuss some perceived issues with root cause analysis as a practice.I. What is Root Cause Analysis?Although the term “root cause analysis” seems direct, there is not one generallyaccepted definition or methodology to capture it. Much like Justice Potter Stewart’s oftquotedreference to hard core pornography – “…I know it when I see it…” 3– theconcept of root cause analysis is immediately recognizable to most companies, yet hardto define. At its core, root cause analysis is “a structured investigation that aims toidentify the true cause of a problem and the actions necessary to eliminate it.” 4Even inthis “definition”, one can easily see how differing approaches and methods can satisfythe description of a root cause analysis, yet involve vastly different tasks, yielding2 The concepts discussed in this article have been heavily influenced by the works of Duke Okes, a wellknown expert in the area of quality management. See, Duke Okes, ROOT CAUSE ANALYSIS: THE COREOF PROBLEM SOLVING AND CORRECTIVE ACTION (2009).3 Jacobellis v. Ohio, 378 U.S. 174, 197 (1964) (Potter, J., concurring).4 Bjørn Anderson & Tom Fagerhaug, ROOT CAUSE ANALYSIS, SIMPLIFIED TOOLS AND TECHNIQUES 12 (2 nd ed.2006).3

inconsistent results. What is the exact structure of the investigation? (It depends - onthe method chosen, people involved, the assigned task). What is meant by “truecause”? (It depends - how long/far do you want to dig?). What actions are necessary toeliminate the cause? (It depends - what level of cause do you want to attack? Are we tonote all identified causes? Only top level? Somewhere in between?) 5 . How deep canwe dig in this analysis? (It depends – how much time and resources (i.e.,money) areavailable?). In short, while a root cause analysis, on its face, appears to be acommendable endeavor, the details of how it will be conducted, and how far it will go,often cloud the issues before the first action is even taken.Despite the challenges discussed above, it should be noted that many, if not most,companies perform root cause analyses with some frequency. There are scores ofresources and training available on the topic. Root cause analysis has been describedas “a collective term to describe a wide range of approaches, tools, and techniques touncover causes of problems.” 6There is no one generally accepted method for rootcause analysis. 7Despite this, one must acknowledge that, for all the variables that mayinfluence the end product, the concept of a root cause analysis is well accepted. This isnot surprising. If an incident occurs, or there is a breakdown in a process, it is not onlycommendable, but (at some level) expected that a concerted effort will be undertaken tofigure out why. Yet root cause analysis differs from typical investigations to go beyondsimply the “why” and reach the issue of what can be done to prevent futureoccurrences. Root cause also does not stop at the most obvious immediate cause of5 “Root cause” has been termed the “evil at the bottom” – the trigger for all other causes. Id. At 56 Id. at 13.7 Duke Okes, ROOT CAUSE ANALYSIS: THE CORE OF PROBLEM SOLVING AND CORRECTIVE ACTION 4 (2009)(noting five methodologies for root cause analysis contained in U.S. Department of Energy guidelines).4

the problem, but reaches further to consider all factors that influence the problem –including the people, processes, environment, equipment and external factors. 8Rootcause analysis, regardless of methodology, involves some degree of each of thefollowing:• Investigation to identify the problem• Determining the cause of the problem• Identifying and implementing solutions• Monitoring and sustaining results 9II.Step One: Identify the Problem (Investigate)The initial step in the process involves conducting an investigation to identify theproblem at hand. This actually includes several underlying issues to be addressed.Chief among them is the determination of what incidents or events to make subject to aroot cause analysis. It is possible that the decision may be forced upon you – by law,regulators, customers, or the sheer magnitude of the issue requiring investigation. Inother situations, the choice is not as clear as one might think.A business mustevaluate and decide what factors are important to it in determining whether to takeaction. Is moderate injury enough? Are multiple events and/or claims the triggering8 Lee N. Vanden Heuvel, et al., ROOT CAUSE ANALYSIS HANDBOOK: A GUIDE TO EFFICIENT INCIDENTINVESTIGATION 10 (3d ed. 2008).9 Okes, supra at 5.5

point? Does an incident involving death or serious injury always qualify? Is a majorproperty loss (typically internally defined) enough? In short, there is no cookie-cutteranswer to the question of whether to subject an event to a root cause analysis. Whilesome events may fit neatly into this category – the event is so overwhelming that ananalysis is obviously needed - many others do not. A company should not waste criticaltime by waiting for an event to occur before it holds this conversation. A wiser approachwould be to decide well in advance if there are subjective factors that, in the company’sexperience, dictate that a root cause analysis be performed. The key is being able torespond quickly and in an organized fashion. Delaying the conversation on whetherand when to investigate incidents will unnecessarily delay the ability to respond timely.Resources exist which can assist a company in the selection of events to investigateand analyze. 10Another critical consideration at this stage is the determination of who will conduct theinvestigation. An investigation is only as good as the quality of the team conducting it.If the team is inexperienced, lazy, careless, or slanted towards bias, the quality ofinformation which is discovered will likely reflect that. Investigation teams assembledunder the stress of an event (as opposed to an existing policy/process) are selectedmore on the basis of availability than on competency. To provide for a truly effectiveprocess, time and care must be taken to identify the appropriate members of theinvestigation team. The available team members should be broad-based and, ifanything, over inclusive – not all members will necessarily respond to each event, butthere should be those who are ALWAYS involved to ensure consistency in approach. It10 See, e.g., Vanden Heuvel, et al., supra at 119-132.6

is far easier to exclude members of the team from a particular response that it is tolocate, educate and charge a person who has no idea what it means to be a teammember and how to investigate an incident after the event has occurred and timepressures are in full effect.A corollary of the above is that the team is only as good as its leader. A strong,organized and experienced individual should be identified to act as the team leader forthe investigation. The leader may not be the most knowledgeable person on all aspectsor products of the company, but that is not as important as whether the leader willcommit to learn as much as he/she can about those issues AND include and workclosely with others on the team who can fill the gaps in this respect. In the same vein,the fact that a person is the top expert on a particular product or process does NOTautomatically mean that they are effective investigative team leaders. Often, peoplewho have spent a career designing, manufacturing, installing, using or trouble-shootingitems are quick to reach conclusions on what may have occurred, resulting in lessthorough documentation of all aspects of the event. This is counter-productive. Theinvestigation team needs to be methodical, patient and thorough, avoiding thetemptation to jump to conclusions before documenting evidence that would allow theconclusions to be validly drawn based on all factors in play. In fact, the tendency toshort-circuit an investigation goes against the grain of a root cause analysis in that thisanalysis seeks to go beyond the obvious and consider much deeper factors(environment, process, external, etc). The team leader needs to recognize and committo a thorough investigation process – and to garner the respect of the knowledgeablepersonnel he or she must lead.7

III.Step Two: Determine the Cause(s)Perhaps the single most challenging aspect of a root cause analysis is living up to thetitle itself – finding root cause. There are often differing levels of “cause” for any singleevent. These differing levels of “cause” have been described in the following manner:a. Symptoms – not an actual cause, but an indication of a problem;b. First-level causes – causes directly leading to/resulting in a problem;c. Higher level causes – causes that lead to the first-level cause(s) and,eventually, the problem;d. Root cause – the cause that sets the above in motion. 11The levels of potential causes have alternately been described as follows:1) Symptoms – a signal that something is wrong;2) Physical cause – the immediate reason a symptom occurs;3) System cause – the reason a physical cause occurs. 12Under this approach, root cause is intertwined with “system cause” because a systemcause is considered to be the highest level reason that a chain of events begins. 13The goal of a root cause analysis can be difficult for a variety of reasons. Challengesinclude the ability to identify and gather critical data, time/resource pressures, bias and11 Anderson & Fagerhaug, supra at 4-5.12 Okes, supra at 13-14.13 Id. at 15.8

general lack of understanding of the tools available to assist in a thorough analysis ofavailable data. Perhaps the most apparent challenge is the tendency to stop once “areason” is found for an event. It is perhaps our nature to stop at the first “AHA!!”moment – to stop looking at the first instance where something is revealed that, ifcorrected, would have prevented the event from occurring. It will take discipline tocontinue from this point, to press for deeper understanding of the chain of events thattranspired. It also takes the commitment of a company to spend the time and moneynecessary to allow this “deep dig” to occur.Several approaches to determining possible causes have been widely used. Theseinclude flowcharts, logic trees, brainstorming, barrier analysis, and change analysis. 14Other tools also exist, such as programs for cause “mapping”. 15No one approach isuniversally accepted, nor should one be used exclusively. The key to this aspect of theanalysis is that the company must commit to its best efforts to identify the variouscauses of an event so that the remaining activities are appropriately focused.14 Id. at 49-62.15 Vanden Heuvel et al., supra at 84-88.9

IV.Identify and Implement SolutionsOnce an investigation team has identified the potential causes of an event andcategorized them properly, the team should commit to an analysis of potential correctiveaction(s). As with the initial decision of whether to conduct an analysis at all, thoughtmust be given to just what will be done to correct issues the team identifies. In theprocess of a root cause analysis, it is highly possible that many potential issues maycome to light. The cost and effort to correct all of these may not be feasible. Someissues identified may be so minor, with little to no resulting consequence, that thecorrective action is unnecessary.Faced with decisions on what to change, companies often adopt a structured approachbased on the Pareto Principle – focusing on causes that have the highest potential cost(of non-compliance), risk or frequency. 16In this manner, companies focus their effortson the issues that are likely to have the greatest impact on the situation, and negligibleitems do not absorb an inordinate amount of attention and effort. As we have noted,this does not mean that other potential causes are neglected entirely; rather, thecauses are addressed in order until the investigation team makes a reasoned decisionthat the corrective efforts are sufficient to address the problem(s) the team hasidentified. 17Not unlike initial product development, the creation of a corrective action isoften the product of debate, brainstorming, consensus-building, cost-benefit analysis,and testing. These efforts ensure that the solution does not solve the identifiedproblem, yet create new and, perhaps, more vexing problems.16 Okes, supra at 17.17 Id.10

The efforts to this point are arguably pointless if there is no implementation of thecorrective actions the investigation identifies, if any. The speed with which the actionsare implemented will be highly dependent on the complexity of the process and theseriousness of the problem (either in terms of frequency or severity). As important asthe initial implementation of the change itself is, the follow up necessary to ensure that itis actually being used in practice is equally important. Okes describes this as“institutionalization” – making sure that the corrective action becomes the norm becauseit must be used and the former practice cannot be used. 18 Only then can the correctiveaction truly be considered as fully implemented.V. Monitor and Sustain Results“I can give you a six-word formula for success: Think things through – then followthrough” – Eddie Rickenbacker, World War I fighter pilot and aviation pioneerThe best path to success does not include ignoring the results of a given plan. Nomatter the level of effort or expense dedicated to developing a plan of action, it willalways require follow through. Then, and only then, can the action be judged by itsfruits. To cap off a successful root cause analysis, companies must monitor the resultsof any corrective action taken. Ideally, the results will include improved safety,production and reliability with no adverse effect created by the corrective action itself.Efforts to sustain this performance will be obvious – standardization, regulation,designing barriers to prevent fallback habits. As technology and knowledge progress,18 Id. at 117-118.11

efforts to improve the corrective action itself may become necessary or desirable.Regardless, the key here is to fight the urge to pack away the efforts of the analysis and“close the book”. Effective quality management dictates that continued monitoring andevaluation be an integral part of the process.VI.A Note on the Legal FrontAs practicing lawyers, we are rarely, if ever, involved in a root cause analysis conductedby clients. Our exposure to this type of report is almost exclusively the result of litigationand the inevitable request for investigation materials such as this. This issue – thepotential discoverability of a root cause analysis – will often influence the decision ofwhether to even conduct one. It is the proverbial double-edged sword for companies. Ifyou do not conduct a root cause analysis, you are portrayed as uncaring and willing tosimply absorb the cost of catastrophe as a part of your business model. On the otherhand, if you commit to such an analysis, you are fully expected to be completelytransparent and share it with anyone and everyone, even if the results are sensitive anddamning.For this reason, we have included an Appendix for your consideration. The firstappendix is a 50-state (plus D.C.) compendium of the discoverability of investigativematerials. There is surprising similarity, but not unanimity, in the approaches thevarious states take. An often discussed factor is whether the work product and resultsof the investigation can be protected from discovery. This, of course, is often a difficultissue to address as it will be governed by local laws. Insight into why one might not12

choose to investigate every event can be found in the Federal Rules of Civil Procedure.Rule 26(b) (3) provides, in pertinent part, as follows:Documents and Tangible Things. Ordinarily, a party may notdiscover documents and tangible things that are prepared inanticipation of litigation or for trial by or for another party orits representative (including the other party's attorney,consultant, surety, indemnitor, insurer, or agent). 19The key to this provision, and an important factor in most every jurisdiction, is thatmaterials prepared in anticipation of litigation are afforded protection under the workproduct doctrine. Materials created “in the regular course of business” are typically notprotected and are fair game for discovery by opposing parties. A policy to investigateevery claim makes it much more difficult to argue that the investigation was made “inanticipation of litigation” as opposed to being conducted “in the regular course ofbusiness.” Beyond this distinction, there is also a challenge in that differing jurisdictionsrely on differing standards to determine whether an action is taken “in anticipation oflitigation.” 20A company is understandably hesitant to open its investigation of events toopposing parties in later litigation. A determination that certain claims are likely to leadto litigation, supported with concrete reasons and, if possible, historical data, to support19 See, Fed. R. Civ. Proc. 2620 Compare, United States v. Adlman, 134 F.3d 1194, 1202 (2d Cir. 1998)(expressing view that materialsare to be given protection only when they are created “because of” existing or expected litigation), withUnited States v. El Paso Co., 682 F.2d 530, 543 (5 th Cir. 1982)(providing protection for materials wherethe “primary motivating purpose behind the creation of the [materials] was to aid in possible futurelitigation", even if there are also business purposes for the materials).13

that belief will go a long way towards bolstering the position that the investigation isprivileged and should not be produced to other parties.Another issue covered in the appendix, is, perhaps, even more important than theabove. Within each state’s coverage, there is a brief treatment of each state’s view onthe concept known as a “self-critical analysis” (or “critical self-analysis”, in some areas)privilege. This concept, which found its genesis in the case of Bredice v DoctorsHospital, 21 contemplates a privilege for materials generated by a company in a safetyanalysis, under certain circumstances. First, the privilege must be invoked by thecompany critically analyzing itself. Second, the information must be of such a naturethat the public has a valid interest in encouraging its flow. Third, the information mustbe such that allowing free discovery of it would result in the activity being curtailed. 22The privilege is much like the “peer review” privilege statutorily enacted by most statesto shield discovery of medical peer review committee minutes and proceedings. 23Therationale is that the public safety is benefitted by the critical review undertaken, but thatthis critical review will be chilled if the materials are allowed to be discovered in civillitigation. The obvious problem is that the courts have not widely recognized theconcept outside of specific statutes supporting the privilege. Nonetheless, this potentialargument should be kept in mind, especially when in a jurisdiction where the privilegehas received at least some favorable discussion.21 50 F.R.D. 249 (D.D.C. 1970).22 See, e.g., Dowling v, American Hawaii Cruises, Inc., 971 F.2d 423, 426 (9 th Cir. 1992).23 See, e.g., TEX. OCC. CODE ANN. § 160.010.14

VII.ConclusionRoot cause analysis can be a powerful tool in the arsenal of quality management and/orrisk management systems. However, a company should not undertake any suchanalysis without an understanding of the tools available to assist in the analysis, thelimitations inherent in any such analysis, and a firm purpose in pursuing it. To bepartially committed to the process, or to be committed to an investigation, but not tomaking adjustments identified by the analysis, is a recipe for potential disaster.15

APPENDIXCATASTROPHIC LOSS INVESTIGATIONSA 5O-STATE (PLUS D.C.) COMPENDIUM OF KEY QUESTIONSALFA INTERNATIONAL2015 PRODUCT LIABILITY & COMPLEX TORTS SEMINARScottsdale, AZThis appendix contains a state-by-state approach to two key questions involvedwith any pre-suit/pre-claim investigation:1. Does your state recognize an exemption from discovery (or a privilege) forpre-suit investigation materials? Is there a key to preserving thisexemption/privilege (i.e. involvement of counsel)?;2. What is your state’s rule with regard to the discoverability of written orrecorded statements taken during investigation of an incident?; and3. Does your state recognize a self-critical analysis privilege?The responses to these questions have been assembled from experienced ALFAcounsel in each of the 50 states, plus the District of Columbia. The attorney(s)providing the responses are listed for each jurisdiction. Please contact thoseattorneys with any questions you may have regarding their contribution to thisproject.

ALABAMACharles A. “Chuck” Stewart IIIBRADLEY ARANT BOULT CUMMINGS LLPRSA Dexter Avenue Building445 Dexter Avenue, Suite 9075Montgomery, AL 36104Phone: (334) 956-7608www.babc.comcstewart@babc.com1. Does your state recognize an exemption from discovery (or a privilege) forpre-suit investigation materials? Is there a key to preserving thisexemption/privilege (i.e. involvement of counsel)?There is no clear right to a privilege for pre-suit investigation materials. Pre-suitinvestigation materials are only privileged when they are prepared in anticipation oflitigation, not when produced in the ordinary course of a party’s business. That is, thepre-suit materials must have been prepared or obtained because of the prospect oflitigation. Involving counsel helps to establish the burden. However, the privilege canextend to non-lawyers, as well, so long as the investigative materials can fairly be saidto have been prepared in anticipation of litigation. Routine investigations do notautomatically gain the protection of the privilege. See Ex parte Mobile Service GasCorp., 123 So. 3d 499 (Ala. 2013); Adams v. City of Montgomery, 282 F.R.D. 627 (M.D.Ala. 2012).2. What is your state’s rule with regard to the discoverability of written orrecorded statements taken during investigation of an incident?A party or witness is entitled to his/her own written or recorded statement. However,statements which are taken in anticipation of litigation constitute work product if theymeet the test set out above in paragraph one. Even if the work product privilegeapplies, however, an exception exists when the party requesting the material can showa substantial need for it coupled with undue hardship. See Ex parte Norfolk SouthernRy. Co., 897 So.2d 290 (Ala. 2004); Ala. R. Civ. P. 26(b)(4).3. Does your state recognize a self-critical analysis privilege?No.

ALASKAPeter A. DubrawskiCristina GuidoHAIGHT BROWN & BONESTEEL, LLP555 South Flower Street, Forty-Fifth FloorLos Angeles, CA 90071Phone (213) 542-8000www.hbblaw.compdubrawski@hbblaw.com1. Does your state recognize an exemption from discovery (or a privilege) forpre-suit investigation materials? Is there a key to preserving thisexemption/privilege (i.e. involvement of counsel)?Yes, Alaska generally recognizes an exemption from discovery for pre-suit investigationmaterials. Generally, a party may obtain discovery regarding any matter relevant to thesubject matter involved in the action that is not otherwise privileged pursuant to 26(b)(1)of Alaska Rules of Civil Procedure. However, a party may discover documents andtangible things prepared in anticipation of litigation or for trial by or for another party orby or for that other party’s representative (including the other party’s attorney,consultant, surety, indemnitor, insurer, or agent) where the party seeking discovery canshow: (1) there is a substantial need of the materials in the preparation of the party’scase and (2) the party is unable without undue hardship to obtain the substantialequivalent of the materials by other means. Even where this showing is made, Rule26(b)(4) forbids the disclosure of the mental impressions, conclusions, opinions, or legaltheories of an attorney or other representative of a party concerning the litigation. Inorder to preserve this exemption, the party must expressly assert the claim or privilegeor protected trial materials. Additionally, the party must describe the nature of thedocuments, communications, or things not produced or disclosed in a manner that willenable the other party to assess the applicability of the privilege or protection.2. What is your state’s rule with regard to the discoverability of written orrecorded statements taken during investigation of an incident?Pursuant to Rule 26(b)(3) of Alaska Rules of Civil Procedure, “[a] party may obtainwithout the required showing [as discussed above] a statement concerning the action orits subject matter previously made by that party. Furthermore, following a request, aperson who is not a party to the action may obtain without the required showing astatement concerning the action or its subject matter previously made by that person.For purposes of this provision, a statement previously made includes a writtenstatement (signed or otherwise adopted by the person making it), as well ascontemporaneously recorded statement that is substantially verbatim of the oralstatement that was made.

3. Does your state recognize a self-critical analysis privilege?Yes, in some instances. “A court or administrative hearing office with jurisdiction mayrequire disclosure of confidential self-evaluation and analysis contained in an auditreport in a civil or administrative proceeding” if the court or administrative hearing officedetermines that disclosure is warranted after consideration of certain factors. (AlaskaCode of Civil Procedure, § 09.25.465.)Of note, the Ninth Circuit, in Dowling v. American Hawaii Cruises, Inc., 971 F.2d 423,426 (1992) held that “no privilege of ‘self-critical analysis’ protects routine internalcorporate review of matters related to safety concerns.”

ARIZONABill Sowders, Esq.RENAUD COOK DRURY MESAROS, PAOne North Central, Ste. 900Phoenix, Arizona 85004Phone: (602) 307-9900www.rcdmlaw.combsowders@rcdmlaw.com1. Does your state recognize an exemption from discovery (or a privilege) forpre-suit investigation materials? Is there a key to preserving thisexemption/privilege (i.e. involvement of counsel)?Arizona does not generally provide an exception from discovery for investigationmaterials of this type. It is important to note that Arizona courts recognize that “there isno work product immunity for documents prepared in the regular course of businessrather than for purposes of litigation.” Brown v. Superior Court in and For MaricopaCounty, 137 Ariz. 327, 333, 670 P.2d 725, 731 (Ariz. 1983). The Brown Court did notethat materials reflecting the mental impressions, conclusions, opinions, or legal theoriesof an attorney or other representative of a party are entitled to additional protection andcan be discovered not only by showing substantial need but also “where the materialsought to be discovered is central to a party’s claim or defense.” Brown, 137 Ariz. at338, 670 P.2d at 736. The best way to avoid having to produce such investigationmaterials is to rely upon the attorney client privilege. In Salvation Army v. Bryson, 229Ariz. 204, 273 P.3d 656 (App. 2012), the Court of Appeals held that redactedsummaries of defendant’s employees’ interviews completed by a private investigator atthe direction of counsel for the defendant were subject to the attorney client privilege.However, this decision does not preclude the production of interviews of nonemployees.2. What is your state’s rule with regard to the discoverability of written orrecorded statements taken during investigation of an incident?Pre-suit written or recorded statements are often held to be discoverable. Persons whomake the statements are entitled to discover his/her own statement. Klaiber v. Orzel,148 Ariz. 320, 323, 714 P.2d 813, 816 (Ariz. 1986). Statements of an insured to his/herinsurer are generally discoverable.. State Farm Co. v. Roberts 99 Ariz. 169, 368 P.2d617 (Ariz. 1965). Further, Arizona Courts have recognized that statements “givenshortly after an occurrence are unique and can never be duplicated precisely.” Butler v.Doyle, 112 Ariz. 522, 544 P.2d 204 (Ariz. 1975).To protect against disclosure, the safest way to proceed is for its counsel of his/her staffto initially interview a witness and only make notes of the conversation. If the witness isfavorable, a statement can then be taken without as much downside risk.

3. Does your state recognize a self-critical analysis privilege?Arizona follows the national trend with regard to the self-critical analysis privilege.Courts have been willing to deem documents and discussions privileged for publicpolicy reasons where the information concerns self-critical analysis aimed at preventingpotential future harm. The legislature has passed legislation SB-1106 amending Sec.20-158 A.R.S. establishing a self critical analysis privilege for insurance companieswhen providing documents and information during an investigation by the Department ofInsurance. Arizona also recognizes the peer review privilege for health care providers.Theses statutorily prescribed self-critical analysis privileges are at odds with Arizona'svery liberal compulsory disclosure rule. A.R.C.P. 26.1. Courts still must weigh thepresumptive and compulsory disclosure duties of companies and individuals against thenotion that self-critical analysis is and should be privileged.

ARKANSASMichael D. BarnesKathryn A. PryorWRIGHT, LINDSEY & JENNINGS, LLP200 West Capitol Avenue, Suite 2300Little Rock, AR 72201-3699Phone: (501) 371-0808www.wlj.commbarnes@wlj.comkpryor@wlj.com1. Does your state recognize an exemption from discovery (or a privilege) forpre-suit investigation materials? Is there a key to preserving thisexemption/privilege (i.e. involvement of counsel)?Arkansas recognizes both the attorney-client privilege and work-product privilege as itrelates to pre-suit investigation materials, as long as they are developed in anticipationof litigation. The Eighth Circuit has ruled that "the party seeking protection must showthe materials were prepared in anticipation of litigation, [because] the work product ruledoes not come into play merely because there is a remote prospect of future litigation,"Schipp v. GMC, 457 F. Supp. 2d 917, 923, 2006 U.S. Dist. LEXIS 72940, 66 Fed. R.Serv. 3d (Callaghan) 941 (E.D. Ark. 2006) (citing Diversified Indus., Inc. v. Meredith,572 F.2d 596, 604 (8th Cir. 1977)). Files such as insurance claim files or aninvestigation report of the insurance adjuster are work product prepared in anticipationof litigation, and therefore, protected from discovery. Schipp v. GMC, 457 F. Supp. 2d917, 923, 2006 U.S. Dist. LEXIS 72940, 66 Fed. R. Serv. 3d (Callaghan) 941 (E.D. Ark.2006) (citing Fed. R. Civ. P. 26(b)(3)). It is the burden of the party asserting theprivilege to prove that one exists. Kinkead v. Union Nat'l Bank, 51 Ark. App. 4, 11, 907S.W.2d 154, 158 (1995) (citing Shankle v. State, 309 Ark. 40, 827 S.W.2d 642 (1992)).2. What is your state’s rule with regard to the discoverability of written orrecorded statements taken during investigation of an incident?Witness statements are also often entitled to protection from discovery. A witnessstatement is not discoverable if the witness is available for the opposing party tointerview themselves. Baker v. GMC (In re GMC), 209 F.3d 1051, 1054, 2000 U.S.App. LEXIS 6828, 46 Fed. R. Serv. 3d (Callaghan) 369 (8th Cir. Mo. 2000). Notes andmemoranda of an attorney, or an attorney's agent, from a witness interview are opinionwork product entitled to almost absolute immunity. Id. In order to establish thestatements are not protected by the work product rule, one must show that they were 1)not prepared in anticipation of litigation or for trial, or 2) a substantial need exists for thematerials in question, in conjunction with plaintiff's inability to obtain the substantialequivalent of the materials by other means. Rule 26(b)(3), Federal Rules of CivilProcedure. Fontaine v. Sunflower Beef Carrier, Inc., 87 F.R.D. 89, 91 (E.D.Mo. 1980).

3. Does your state recognize a self-critical analysis privilege?No.

CALIFORNIAPeter A. DubrawskiHAIGHT BROWN & BONESTEEL, LLP555 South Flower Street, Forty-Fifth FloorLos Angeles, CA 90071Phone (213) 542-8000www.hbblaw.compdubrawski@hbblaw.com1. Does your state recognize an exemption from discovery (or a privilege) forpre-suit investigation materials? Is there a key to preserving thisexemption/privilege (i.e. involvement of counsel)?Yes, pursuant to California Code of Civil Procedure section 2018.030, writings thatreflect an attorney's impressions, conclusions, opinions, or legal research or theoriesare protected and not discoverable under any circumstances. This is an absoluteprivilege. In addition, the work product of an attorney other than that just described isnot discoverable unless the court determines that the denial of discovery will unfairlyprejudice the party seeking discovery in preparing that party's claim or defense, or willotherwise result in an injustice. This is a qualified privilege.California case law examining section 2018.030 has determined that this privilege alsoextends to writings and materials prepared by an attorney while acting in a non-litigationcapacity. (County of Los Angeles v. Superior Court (Axelrad) (2000) 82 Cal.App.4th819; Rumac Inc. v. Bottomley (1983) 143 Cal.App.3d 810.) While the attorney is theholder of this privilege, a client can assert the privilege if the attorney is not present.2. What is your state’s rule with regard to the discoverability of written orrecorded statements taken during investigation of an incident?In California, all witness statements procured by or at the direction of an attorney areentitled to at least qualified protection under the attorney work product doctrine. (Coitov. Superior Court (2012) 54 Cal.4th 480, 499.) A written or recorded statementprocured by an attorney during an investigation is entitled to absolute protection "onlywhen a witness's statement are 'inextricably intertwined' with explicit comments or notesby the attorney state his or her impressions of the witness." (Id. at 495.) Statementsindependently prepared by a witness are not entitled to absolute or qualified protection,even if later turned over to an attorney. (Id. at 500.) Even if a witness statement doesnot qualify for protection under the work product doctrine, such statements procured bycounsel are discoverable only where good cause is shown. This requirement stemsfrom California Code of Civil Procedure section 2031.310. For example, where a party’sdemand to inspect a witness statement is denied, the burden rests on the demandingparty to “set forth specific facts showing good cause justifying” the demand.

3. Does California recognize a self-critical analysis privilege?No. (See Cloud v. Superior Court, 58 Cal. Rptr. 2d 365, 369 (Cal. Ct. App. 1996)(“[T]he privileges contained in the Evidence Code are exclusive and the courts are notfree to create new privileges as a matter of judicial policy.)Of note, the Ninth Circuit, in Dowling v. American Hawaii Cruises, Inc., 971 F.2d 423,426 (1992) held that “no privilege of ‘self-critical analysis’ protects routine internalcorporate review of matters related to safety concerns.”

COLORADOKevin E. O’BrienHALL & EVANS, LLC1001 17th Street, Suite 300Denver, CO 80202Phone (303) 628-3300www.hallevans.comobrienk@hallevans.com1. Does your state recognize an exemption from discovery (or a privilege) forpre-suit investigation materials? Is there a key to preserving thisexemption/privilege (i.e. involvement of counsel)?No, there is no per se exemption or privilege applicable to pre-suit investigationmaterials. In order to claim such materials are not discoverable, the party opposingdiscovery must show that the investigation materials were prepared or obtained incontemplation of specific litigation, or that the party’s attorney was involved in obtainingor preparing the materials—the mere fact that litigation may result from an accident isnot sufficient to withhold pre-suit investigation materials. Compton v. Safeway, Inc., 169P.3d 135, 137-39 (Colo. 2007); Colorado Rule of Civil Procedure (“C.R.C.P.”) 26(b)(3)2. What is your state’s rule with regard to the discoverability of written orrecorded statements taken during investigation of an accident?Generally, there is a presumption that written or recorded statements taken during theinvestigation of an accident are discoverable, unless the party opposing discovery canshow “that the witness statements were obtained after a specific claim had arisen, forthe purpose of defending that claim, and at a time when ‘there was a substantialprobability of imminent litigation over the claim or a lawsuit had already been filed.’”Compton v. Safeway, Inc., 169 P.3d 135, 137 (Colo. 2007); C.R.C.P. 26(b)(3).3. Does your state recognize a self-critical analysis privilege?Unlikely, but possible. In Combined Communications Corp. v. Public Service Co., 865P.2d 893 (Colo.App., 1993) the Colorado Court of Appeals left open the possibility ofrecognizing the privilege while noting that it has been dampened by the US SupremeCourt and that it only applies in very limited circumstances that were not present in thatcase.

CONNECTICUTHenry M. Beck, Jr.Joseph G. Fortner, Jr.Kaitlin M. HumbleHALLORAN & SAGE, LLPOne Goodwin Square225 Asylum StreetHartford, CT 06103Phone (860) 522-6103www.halloransage.combeck@halloransage.comfortner@halloransage.com1. Does your state recognize an exemption from discovery (or a privilege) forpre-suit investigation materials? Is there a key to preserving thisexemption/privilege (i.e. involvement of counsel)?Connecticut recognizes the work product doctrine, under which materials otherwisediscoverable and prepared “in anticipation of litigation” may be obtained “only upon ashowing that the party seeking discovery has substantial need of the materials in thepreparation of the case and is unable without undue hardship to obtain the substantialequivalent of the materials by other means.” Conn. Practice Book §13-3(a).Connecticut has long held that counsel’s involvement is “dispositive” to claims thatinvestigation material is protected by the work product doctrine, Stanley Works v. NewBritain Redevelopment Agency, 155 Conn. 86, 95, 230 A.2d 9 (1967), and theattorney’s activities must “have been conducted with a view to pending or anticipatedlitigation,” form an essential step in the development of the materials, and constituteduties normally attended to by attorneys. Id. Compare Winot v. Dragon, 1995 WL107321 (Conn. Super. 1995) (ordering disclosure of statements to employer riskmanager). While, as in other jurisdictions, a court may order portions disclosed wherethe requesting party establishes that the investigatory materials cannot be duplicated,see Page v. DiMaggio Plumbing & Heating Inc., 2000 WL 1861849 (Conn. Super.2000), courts are to prevent disclosure of “the mental impressions, conclusions,opinions, or legal theories of an attorney or other representative of a party concerningthe litigation.” Conn. Practice Book § 13-3(a). In addition, a specific, limited statutorybar to disclosure does exist under Conn. Gen. Stat. § 19a-17b for written opinions ofhealth care providers concerning evidence of medical negligence.2. What is your state’s rule with regard to the discoverability of written orrecorded statements taken during investigation of an incident?Under Connecticut Practice Book §13-3(b), parties may obtain “without the showingrequired under [§13-3(a)], discovery of the party’s own statement and of anynonprivileged statement of any other party concerning the action or its subject matter.”

“Statements” include both written and recorded materials, see Practice Book §13-1.Thus, unless protected by another recognized privilege (such as one’s own attorneyclientprivilege), all party statements – not just the requesting party’s own priorstatements -- are discoverable. See § 13-3(b). See Winot v. Dragon, 1995 WL 107321(Conn. Super. 1995); see also Matos v. Allstate Ins. Co., 2008 WL 5481711, at *1(Conn. Super. 2008). In addition, Connecticut courts favor production ofcontemporaneous eyewitness statements, see Decossard v. Pate, 1995 WL 79975(Conn. Super. 1995); Lopez v. Transportation General, Inc., 1994 WL 146832 (Conn.Super. 1994); and have, in some cases, ordered production even where the investigatorobtains the nonparty statement at the direction of counsel. See Crespo v. Marchand,2010 WL 1496331*2 (Conn. Super. 2010) (production ordered of nonparty statementtaken by investigator at counsel’s direction).3. Does your state recognize a self-critical analysis privilege?Likely no.Connecticut has no statutory self-critical analysis privilege, and the few State trial courtswhich have addressed this have mostly declined to recognize a common law self-criticalanalysis privilege. See Office of Consumer Counsel v. Dep't of Pub. Util. Control, 44Conn. Supp. 21, 665 A.2d 921(Conn. Super. 1994); see also Caccavale v. Ne. Utilities,No. CV 90-0377190S, 1994 WL 411315 (Conn. Super. 1994). In one case, theassertion of this privilege (along with others) was not rejected out of hand, see Dotsonv. Hartford Roman Catholic Diocesan Corp., 2011 WL 1021745*7 (Conn. Super. 2011),but instead was to be reviewed on a document-by-document basis through a privilegelog, id. Federal Courts within Connecticut have been somewhat more receptive to thisasserted privilege, see Miller v. Praxair, Inc., 2007 WL 1424316*3 (D. Conn. 2007)(precluding disclosure based upon Second Circuit law); but see United States v. DexterCorp., 132 F.R.D. 8 (D. Conn. 1990).

DELAWAREJames W. SempleMORRIS JAMES, LLP500 Delaware Avenue, Suite 1500Wilmington, DE 19801-1494Phone (302) 888-6800www.morrisjames.comjsemple@morrisjames.com1. Does your state recognize an exemption from discovery (or a privilege) forpre-suit investigation materials? Is there a key to preserving thisexemption/privilege (i.e. involvement of counsel)?In general, Delaware courts permit discovery of materials prepared in theordinary course of business. Hopkins v. Chesapeake Utilities Corp., 300 A.2d12 (Del.Super. 1972)[ internal factual memorandum which was prepared by telephonecompany in accordance with its general practice]; Conley v. Graybeal, 315 A.2d609 (Del.Super. 1974) [a sketch of accident scene and a transcription of recordedinterview of the driver prepared by employee of driver's insurer]. Pursuant to DelawareSuperior Court Rule 26(b) (3), a party may obtain discovery of documents and tangiblethings prepared in anticipation of litigation or for trial only upon a showing that the partyseeking discovery has substantial need of the materials in the preparation of the party'scase and that the party is unable without undue hardship to obtain the substantialequivalent of the material by other means.In determining whether materials were prepared in anticipation of litigation and,therefore, protected under the work product doctrine, Delaware courts have adopted thefive-factor test enunciated in Mullins v. Vakili, 506 A.2d 192, 198 (Del. Super. Ct. 1986):(1) whether the event that prompted the preparation of the materials is one that is likelyto lead to litigation; (2) whether the materials contain legal analysis and opinions orpurely factual matters; (3) whether the materials were prepared or requested by theparty or a representative; (4) whether the materials were routinely prepared; (5) whetherspecific claims were present or whether discussion or negotiation had occurred at thetime the materials were prepared.The Delaware Supreme Court has interpreted Rule 26(b) (3) as requiring a partyto show that it has a more "substantial need" to review opinion work product than wouldbe required for that party to review non-opinion work product. Tackett v. State Farm Fireand Cas. Ins. Co.,53 A.2d 254 (Del. Supr. 1995). In order to obtain mental impressionsunder Rule 26(b) (3), the mental impressions must be directed to the pivotal issue in thecurrent litigation and the need for the material must be compelling. Id.As a matter of prudent practice, clients should retain an attorney to direct theinvestigation of any significant claim.

2. What is your state's rule with regard to the discoverability of written orrecorded statements taken during investigation of an incident?The same law as set out above will apply.3. Does Delaware recognize a self-critical analysis privilege?No, but several courts have discussed it.In situations where the self-critical analysis privilege has been asserted, Delawarecourts have thus far refused to recognize the privilege. The first case analyzing theprivilege was Register v. Wilmington Medical Center, Inc., Del. Supr., 377 A.2d 8(1977). In Register, a medical malpractice case, the Delaware Supreme Court held thatthe trial court had committed reversible error by refusing to admit evaluation reportscontaining opinions of hospital physicians concerning the professional competence ofanother physician. The Court rejected arguments that such evaluations wereconfidential and that disclosure would chill the evaluative process because there was noprinciple of Delaware law that would make the report privileged or subject to nondisclosure.The Delaware General Assembly thereafter created a statutory privilege formedical peer review reports, but did not extend that privilege outside that context. See24 Del.C. § 1768. The Delaware General Assembly has also created a statutoryprivilege for depository institutions and affiliates. 5 Del.C. § 940.The second Delaware case to consider a claim of self-critical analysis privilegewas Artesian Water Company v. New Castle County, Del.Ch., C.A. No. 5106, Marvel,C., 1981 WL 15606 (April 9, 1981). In Artesian, the Court of Chancery refused to applythe privilege relying in part upon the Supreme Court's holding in Register that such aprivilege had never been recognized in Delaware.In Grimes v. DSC Communications Corp,724 A.2d 561(Del.Ch.1998), the Courtof Chancery recited the lack of any authority in Delaware that recognized the privilege,and concluded that even if Delaware were to adopt this privilege, it could not properlybe asserted in the context of that case. The Court rejected the defendant's argumentthat rejection of the privilege would have a chilling effect on the special committeeprocess of corporations residing in Delaware, that the integrity of the process itself waslikely to be compromised because corporations would no longer be honest in their selfevaluationsand thus have an adverse impact on shareholders, or that boards andspecial committees would no longer have any incentive to perform an objective andcandid analysis of the issues raised by the demand.In Wealton v. Werner Enterprises, Inc., 2000 WL 33115690 (Del. Super.), theSuperior Court analyzed a defendant’s assertion of the privilege by starting its analysiswith D.R.E., Rule 501:

Except as otherwise provided by Constitution or statute, or by courtdecision, or by these or other rules of court, no person has a privilege to:(1) Refuse to be a witness;(2) Refuse to disclose any matter;(3) Refuse to produce any object or writing; or(4) Prevent another from being a witness or disclosing any matteror producing any object or writing.None of the privileges spelled out in Article V of the Rules ofEvidence create a self-critical/self-analysis privilege. Nor does such a privilegeexist in any Delaware statute, except for certain medical evaluations, or in anyconstitutional provision. That means, the source of the privilege in Delaware, byD.R.E. 501, must be by court decision.The Court recognized that no court had recognized the privilege, yet reviewedthe documents at issue in camera and concluded that their relevancy was “too great toallow Werner to successfully assert a privilege no court in Delaware has evenrecognized.”

DISTRICT OF COLUMBIAJames W. Bartlett, IIIEric M. LeppoSEMMES, BOWEN & SEMMES25 South Charles Street, Suite 1400Baltimore, Maryland 21201Phone: (410) 576-4833jbartlett@semmes.comwww.semmes.com1. Does your state recognize an exemption from discovery (or a privilege) forpre-suit investigation materials? Is there a key to preserving thisexemption/privilege (i.e., involvement of counsel)?District of Columbia Superior Court Rule 26(b)(3) operates in essentially the same wayas FED.R.CIV.P. 26(b)(3)(A). A party may obtain documents prepared by the oppositionin anticipation of litigation or for trial only upon showing substantial need of the materialsand that the party cannot obtain the substantial equivalent without undue hardship.There is no reported opinion from the Superior Court or the Court of Appeals for theDistrict of Columbia applying Superior Court Rule 26(b)(3). The D.C. federal courtshave suggested that an incident report would not be protected as work product.Groover, Christie & Merritt v. LoBianco, 336 F.2d 969 (D.C.Cir. 1964) (citing Hickman v.Taylor, 329 U.S. 495 (1947)). In Fann v. Giant Food, Inc., 1987 WL 12370 (D.D.C.1987), the United States District Court for the District of Columbia cited favorably toGroover as well as Janicker v. George Washington University, 94 F.R.D. 648, 650(D.D.C. 1982), stating that an insurance investigator’s report and statements collectedwere not in anticipation of litigation simply because the investigator knew Plaintiff hasretained an attorney. As such, routine claim investigation will generally not beconsidered to be performed in anticipation of litigation, and it would generally beadvisable to retain counsel to coordinate and direct a catastrophic loss investigation.2. What is your state’s rule with regard to the discoverability of written orrecorded statement taken during investigation of an incident?A written or recorded statement from a loss investigation will fall within the work productdoctrine as long as it is deemed to have been obtained in anticipation of litigation.However, as noted above, statements taken during a “routine” investigation of apossible claim will likely not be protected. Additionally, Superior Court Rule 26(b)(3)provides that any person − whether or not a party to the case − is entitled to obtain acopy of any statement that he or she made previously without showing undue hardshipor expense. If the statement is not provided voluntarily, the person or party may seek acourt order.3. Does your state recognize a self-critical analysis privilege?

There is no D.C. "state" court opinion, nor is there a D.C. statute, providing for the selfcriticalanalysis privilege. A D.C. federal court opinion, Bredice v. Doctors Hospital, Inc.,50 F.R.D. 249, 251 (D.D.C.1970), aff'd, 479 F.2d 920 (D.C.Cir.1973), recognized it in amedical peer review case, but it has not been extended beyond that context.

FLORIDAChristopher E. Knight, Esq.Michael J. Drahos, Esq.FOWLER WHITE BURNETT, P.A.Espirito Santo Plaza1395 Brickell Avenue, 14th FloorMiami, FL 33131Phone (305) 789-9200www.fowler-white.comcknight@fowler-white.com1. Does your state recognize an exemption from discovery (or a privilege) forpre-suit investigation materials? Is there a key to preserving thisexemption/privilege (i.e. involvement of counsel)?Investigative materials and internal investigative reports of a party, when prepared inanticipation of litigation, constitute work product and are not generally subject todiscovery in Florida. See Southern Bell Tel. & Tel. Co. v. Deason, 632 So. 2d 1377,1384 (Fla. 1994). Seaboard Air Line R. Co. v. Timmons, 61 So. 2d 426, 427–28 (Fla.1952); Federal Exp. Corp. v. Cantway, 778 So. 2d 1052, 1053 (Fla. 4th DCA 2001);Karch v. MacKay, 453 So. 2d 452, 453 (Fla. 4th DCA 1984); New Life Acres, Inc. v.Strickland, 436 So. 2d 391 (Fla. 5th DCA 1983); Winn–Dixie Stores, Inc. v. Nakutis, 435So. 2d 307, 308 (Fla. 5th DCA 1983). Such reports need not be ordered by an attorneyin order to be considered work product, see Metric Engineering, Inc. v. Small, 861 So.2d 1248, 1250 (Fla. 1st DCA 2003) (“The material does not need to actually begathered by the attorney to be work product, but must be gathered in anticipation oflitigation.”); Snyder v. Value Rent–A–Car, 736 So. 2d 780 (Fla. 4th DCA 1999), and theycan constitute work product even if they are prepared before a claim is filed. See DistrictBd. of Trs. of Miami–Dade Cnty. Coll. v. Chao, 739 So. 2d 105 (Fla. 3d DCA 1999); Cityof Sarasota v. Colbert, 97 So. 2d 872 (Fla. 2d DCA 1957).2. What is your state’s rule with regard to the discoverability of written orrecorded statements taken during investigation of an incident?Pursuant to Florida Rule of Civil Procedure 1.280(b)(3), written or recorded statementstaken during an accident investigation are discoverable upon a showing that the partyseeking discovery “has need of the materials in the preparation of the case and isunable without undue hardship to obtain the substantial equivalent of the materials byother means.” See Genovese v. Provident Life and Accident Ins. Co., 74 So. 3d 1064,1067-1068 (Fla. 2011); Publix Super Markets, Inc. v. Anderson, 92 So. 3d 922, 923(Fla. 4th DCA 2012); Heartland Express, Inc., of Iowa v. Torres, 90 So .3d 365, 367(Fla. 1st DCA 2012)3. Does your state recognize a "critical self analysis" privilege?

No. While accepted in the federal sector, the critical self analysis privilege has not beenexplicitly endorsed in Florida. See Southern Bell Tel. & Tel. Co. v. Beard, 597 So.2d 873(Fla. 1 st DCA 1992). However, a similar peer review privilege does exist by statute inthe medical/nursing home setting. See Beverly Enterprises v. Ives, 832 So.2d 161 (Fla.5 th DCA 2002).

GEORGIAKirby MasonHUNTER MACLEAN EXLEY & DUNN, P.C.200 East Saint Julian StreetP.O. Box 9848Savannah, GA 31412Phone (912) 236-0261www.huntermaclean.comkmason@huntermaclean.com1. Does your state recognize an exemption from discovery (or a privilege) forpre-suit investigation materials? Is there a key to preserving thisexemption/privilege (i.e. involvement of counsel)?Georgia does not recognize a self-critical analysis privilege for products liabilityinvestigations, so any pre-suit must fall within the attorney-client privilege/work productdoctrine to be privileged. In order for the attorney-client privilege to apply, it is advisablethat outside counsel be hired to provide legal advice and conduct the investigation. Inorder for the work product doctrine to apply, there must be reasonable grounds tobelieve that litigation is imminent (apart from the mere fact that an accident occurred).Naturally, the communications of the investigation should be restricted to the properparties to avoid a waiver of the privilege. OCGA §9-11-26; Atlantic Coast Line R. Co. v.Gause, 116 Ga. App. 216 (1967) (statements taken by counsel following accident whichwere routinely taken are not privileged.)2. What is your state’s rule with regard to the discoverability of written orrecorded statements taken during investigation of an incident?Every witness who provides a statement is entitled to a copy of their statement uponrequest, and can provide it to anyone they choose. Statements obtained by claimsagents, investigators and attorneys are not necessarily immune from discovery wheretaken routinely. However, where taken after reasonable grounds to believe thatlitigation is imminent, under direction of counsel, in anticipation of trial and whichincludes mental impressions, conclusions, opinions and legal theories will be protectedfrom discovery absent a showing of substantial need or undue hardship from theopposing party. OCGA §9-11-26; Atlantic Coast Line R. Co. v. Gause, 116 Ga. App.216 (1967) (statements taken by counsel following accident which were routinely takenare not privileged.); Warmack v. MiniSkools, 164 Ga. App. 737 (1982) (statementsprotected from discovery); Lowe’s of Georgia, Inc. v. Webb, 180 Ga. app. 755 (1986).3. Does your state recognize a self-critical analysis privilege?Please see No. 1 above.

HAWAIIPeter A. DubrawskiCristina GuidoHAIGHT BROWN & BONESTEEL, LLP555 South Flower Street, Forty-Fifth FloorLos Angeles, CA 90071Phone (213) 542-8000www.hbblaw.compdubrawski@hbblaw.com1. Does your state recognize an exemption from discovery (or a privilege) forpre-suit investigation materials? Is there a key to preserving thisexemption/privilege (i.e. involvement of counsel)?Yes, Hawaii generally recognizes an exemption from discovery for pre-suit investigationmaterials. Generally, a party may obtain discovery regarding any matter relevant to thesubject matter involved in the action that is not otherwise privileged pursuant to 26(b)(1)of Hawai’i Rules of Civil Procedure. However, a party may discover documents andtangible things prepared in anticipation of litigation or for trial by or for another party orby or for that other party’s representative (including the other party’s attorney,consultant, surety, indemnitor, insurer, or agent) where the party seeking discovery canshow: (1) there is a substantial need of the materials in the preparation of the party’scase and (2) the party is unable without undue hardship to obtain the substantialequivalent of the materials by other means. Even where this showing is made, Rule26(b)(4) forbids the disclosure of the mental impressions, conclusions, opinions, or legaltheories of an attorney or other representative of a party concerning the litigation. Inorder to preserve this exemption, the party must expressly assert the claim or privilegeor protected trial materials. Additionally, the party must describe the nature of thedocuments, communications, or things not produced or disclosed in a manner that willenable the other party to assess the applicability of the privilege or protection.2. What is your state’s rule with regard to the discoverability of written orrecorded statements taken during investigation of an incident?Pursuant to Rule 26(b)(4) of Hawai’i Rules of Civil Procedure, “[a] party may obtainwithout the required showing [as discussed above] a statement concerning the action orits subject matter previously made by that party. Furthermore, following a request, aperson who is not a party to the action may obtain without the required showing astatement concerning the action or its subject matter previously made by that person.For purposes of this provision, a statement previously made includes a writtenstatement (signed or otherwise adopted by the person making it), as well ascontemporaneously recorded statement that is substantially verbatim of the oralstatement that was made.3. Does your state recognize a self-critical analysis privilege?

Hawaii does not recognize a self-critical analysis privilege in tort, but does recognize aform of this privilege in its insurance code. (Hawaii Insurance Code, § 431:2D-107 (“Noinsurer shall be compelled to disclose an insurance compliance self-evaluative auditdocument or waive any statutory or common law privilege . . .”).)Of note, the Ninth Circuit, in Dowling v. American Hawaii Cruises, Inc., 971 F.2d 423,426 (1992) held that “no privilege of ‘self-critical analysis’ protects routine internalcorporate review of matters related to safety concerns.”

IDAHORichard H. GreenerGREENER BURKE SHOEMAKER, P.A.950 W. Bannock StreetSuite 950Boise, ID 83702Phone (208) 319-2600www.greenerlaw.comrgreener@greenerlaw.com1. Does your state recognize an exemption from discovery (or a privilege) forpre-suit investigation materials? Is there a key to preserving thisexemption/privilege (i.e. involvement of counsel)?Although the Idaho Rules of Evidence do not explicitly recognize a privilege orexemption for pre-suit investigation materials, Rule 26(b)(3) of the Idaho Rules of CivilProcedure likely provides protection to pre-suit investigation materials that wereprepared in anticipation of litigation. I.R.C.P. 26(b)(3); see Sanders v. Ayrhart, 89 Idaho302, 404 P.2d 589 (1965). However, the protection of Rule 26(b)(3) can be abrogated ifthe “party seeking discovery has substantial need of the materials in the preparation ofthe party’s case and that the party is unable without undue hardship to obtain thesubstantial equivalent of the materials by other means.” There does not appear to be a“key” to preserving Rule 26(b)(3) protection. Ayrhart, 89 Idaho 302, 404 P.2d 589; butsee I.R.E. 510 (“A person upon whom these rules confer a privilege against disclosureof the confidential matter or communication waives the privilege if the person or theperson’s predecessor while holder of the privilege voluntarily disclose or consents to thedisclosure of any significant part of the matter or communication.”)2. What is your state’s rule with regard to the discoverability of written orrecorded statements taken during investigation of an incident?Idaho courts have held that Rule 26(b)(3) of the Idaho Rules of Civil Procedure protectsfrom discovery written statements taken during the investigation of an accident.I.R.C.P. 26(b)(3); Sanders v. Ayrhart, 89 Idaho 302, 312 404 P.2d 589, 594 (1965)(holding that the statements of witness – which were requested in writing and in a haecverba recitation – were protected from discovery by Rule 26(b)(3)). Even though it doesnot appear that Idaho courts have addressed the discoverability of recorded statementstaken in anticipation of litigation, it is likely that they would be protected under Rule26(b)(3). Id.3. Does your state recognize a self-critical analysis privilege?Idaho only recognizes it in the medical peer review context. See I.C. § 39-1392b.

ILLINOISKevin OwensJOHNSON & BELL, LTD33 West Monroe Street, Suite 2700Chicago, IL 60603Phone (312) 372-0770www.johnsonandbell.comowensk@jbltd.com1. Does your state recognize an exemption from discovery (or a privilege) forpre-suit investigation materials? Is there a key to preserving thisexemption/privilege (i.e. involvement of counsel)?Illinois favors the policy of disclosure. Monier v. Chamberlain, 66 Ill. App. 2d 472, 484(3d Dist. 1966). However, pretrial investigation materials may be exempt from discoveryif the materials are privileged under Ill. S. Ct. R. 201(b)(2), which states:All matters that are privileged against disclosure on the trial, includingprivileged communications between a party or his agent and the attorneyfor the party, are privileged against disclosure through any discoveryprocedure. Material prepared by or for a party in preparation for trial issubject to discovery only if it does not contain or disclose the theories,mental impressions, or litigation plans of the party's attorney.The burden of proving the privilege lies with the party claiming the exemption.Consolidation Coal Co. v. Bucyrus-Erie Co., 89 Ill. 2d 103, 119 (1982). In the corporatecontext, Illinois courts follow the “control-group” test for the attorney-client privilege.Consolidation Coal, 89 Ill. 2d at 118-19. An employee is in the control group, andtherefore a “client” for the purposes of the privilege, if the top management would notmake decisions without his advice or opinion, and if his opinion in fact forms the basis ofany final decision by those with authority within the corporation. Id. Consulting experts’investigation materials are privileged from disclosure to the extent that such materialsreveal the experts’ thought processes. Neuswanger v. Ikegai Am. Corp., 221 Ill. App. 3d280, 286 (3d Dist. 1991). However, all other portions of the investigation materials thatdo not reveal such thought processes are discoverable. Id.2. What is your state’s rule with regard to the discoverability of written orrecorded statements taken during investigation of an incident?If written or recorded statements were taken during the investigation of an incident, andthe person attempting to prevent pretrial discovery of any such statements can provethat the statements are privileged as attorney-client or insurer-insured communication,discovery of the statement is prohibited. Exline, 277 Ill. App. 3d at 12 (wherein therecorded statement given by the insured plaintiff to the insurer’s employee during the

investigation of a claim was a privileged communication protected from discovery underIll. S. Ct. R. 201(b)(2)); Koch v. Miller, 49 Ill. App. 2d 251, 257 (5th Dist. 1964) (the courtheld that a written statement signed by the insured on the back of an accident reportregarding an auto collision was privileged against discovery because the report andstatements were given to the insurance adjuster as an agent to be made available to anattorney that may have been selected to defend any action brought against the insured);Ryan, 30 Ill. 2d at 461 (the Illinois Supreme Court held that the written statement madeby an insured to the investigator of the insurance company, which was later placed inthe insurance file and given to an attorney who was defending the insured on criminalcharges, retained its privilege); Claxton, 201 Ill. App. 3d at 237-38 (the written statementmade by the director of the employer to the employer’s insurer was not privilegedagainst discovery because the director was not part of the corporate control group;however, had the director been a member of the control group, he would not have hadto disclose the statements otherwise covered by attorney-client privilege simplybecause he actually witnessed the incident at issue). Otherwise, such statements aregenerally discoverable.3. Does your state recognize a self-critical analysis privilege?Illinois does not recognize a self-critical analysis privilege. Harris v. One Hope United,Inc., 377 Ill.Dec. 851, 2 N.E.2d 1132, 2013 Ill.App. LEXIS 869 (1st Dist. 2013). The loneexception is in the context of our Medical Studies Act, 735 ILCS 5/8-2101, which has asits purpose to ensure the effectiveness of professional self-evaluation, by members ofthe medical profession, in the interest of improving the quality of health care. TheMedical Studies Act is premised on the belief that, absent a statutory peer reviewprivilege, physicians would be reluctant to sit on peer review committees and engage infrank evaluations of their colleagues.

INDIANADina M. CoxLEWIS WAGNER, LLP501 Indiana Avenue Suite 200Indianapolis, IN 46202Phone (317) 237-0500www.lewiswagner.comdcox@lewiswagner.com1. Does your state recognize an exemption from discovery (or a privilege) forpre-suit investigation materials? Is there a key to preserving thisexemption/privilege (i.e. involvement of counsel)?Yes, Indiana recognizes the work product privilege as a privilege from the discovery ofpre-suit investigation materials as long as those materials were assembled “inanticipation of litigation.” Burr v. United Farm Bureau Mut. Ins. Co., 560 N.E.2d 1250,1254 (Ind. Ct. App. 1990) (citing Am. Bldgs. Co. v. Kokomo Grain Co., Inc., 506 N.E.2d56 (Ind. Ct. App. 1987) (internal citations omitted)). The privilege applies to materialsprepared by an attorney as well as those materials created by agents of the attorney,consultant advisors, and the client. Indiana State Bd. Of Pub. Welfare v. Tioga PinesLiving Ctr., Inc., 592 N.E.2d 1274, 1278 (Ind. Ct. App. 1992). Factors that a court mayconsider in this analysis include the following: (1) whether the party claiming theprivilege has hired an attorney; (2) consultation between the party and an attorney; and(3) other subjective factors that support the contention that the party anticipatedlitigation. See Richey v. Chappell, 572 N.E.2d 1338, 1341 (Ind. Ct. App. 1991). Thepresence of an investigation alone does not automatically mean that the investigationwas conducted in anticipation of litigation; moreover, the fact that a party has hired anattorney does not independently warrant a finding that the investigation was conductedin anticipation of litigation. See Burr v. United Farm Bureau Mut. Ins. Co., 560 N.E.2d1250, 1254 (Ind. Ct. App. 1990) (citing Taroli v. Gen. Elec. Co., 114 F.R.D. 97, 98 (N.D.Ind. 1987)). However, a party’s consultation with an attorney generally weighs in favorof application of the work product privilege. Id. If the materials are found not to havebeen prepared in anticipation of litigation, then they are freely discoverable, includingthe mental impressions, conclusions, and opinions of the preparer. CIGNA-INA/Aetnav. Hagerman-Shambaugh, 473 N.E.2d 1033, 1037 (Ind. Ct. App. 1985). Materialsprepared in anticipation of litigation, are discoverable only by a showing (1) ofsubstantial need for the material and (2) that the party seeking discovery is unablewithout undue hardship to obtain a substantial equivalent of the material by othermeans. Id. (citing Ind. R. Trial P. 26(B)(3)). Even if the party seeking discovery canmake such a showing, the mental impressions, conclusions, opinions, or legal theoriesof the preparer of the materials are protected from disclosure. Id. (citing Ind. R. Trial P.26(B)(3)).

Indiana does not recognize a self-critical analysis privilege. Scroggins v. Uniden Corp.of Am., 506 N.E.2d 83, 86 (Ind. Ct. App. 1987).2. What is your state’s rule with regard to the discoverability of written orrecorded statements taken during investigation of an incident?The privileges discussed above also apply to written and recorded statements takenduring investigation of an accident.3. Does your state recognize a self-critical analysis privilege?Please see No. 1 above.

IOWAMatthew D. JacobsonBernard L. (Jerry) SpaethJason M. CasiniWHITFIELD & EDDY, P.L.C.317 Sixth Ave. Suite 1200Des Moines, Iowa 50309-4195Phone: (515) 288-6041www.whitfieldlaw.comJacobson@whitfieldlaw.com1. Does your state recognize an exemption from discovery (or a privilege) forpre-suit investigation materials? Is there a key to preserving thisexemption/privilege (i.e. involvement of counsel)?Pursuant to Iowa Rule of Civil Procedure 1.503(3), trial-preparation materials areexempt from discovery, absent a showing by the party seeking the materials that it hasa substantial need of the materials for preparation of its case, and is unable withoutundue hardship to obtain the substantial equivalent of the materials by other means.Under Iowa law, pre-suit investigation materials are included in this exemption when “inlight of the nature of the document and the factual situation in the particular case, the[materials] can fairly be said to have been prepared or obtained because of the prospectof litigation.” Wells Dairy, Inc. v. American Industrial Refrigeration, Inc. 690 N.W.2d 38,48 (Iowa 2004). Conversely, “if [materials] would have been created in essentiallysimilar form irrespective of the litigation, it cannot fairly be said that they were created‘because of’ actual or impending litigation.” Id.2. What is your state’s rule with regard to the discoverability of written orrecorded statements taken during investigation of an incident?Under Iowa law, a statement made by a witness during the course of pre-suitinvestigation is afforded the same protection under Iowa Rule of Civil Procedure1.503(3) as other pre-suit investigation materials, so long as the statement was taken inanticipation of litigation. Berg v. Des Moines General Hospital Co., 456 N.W.2d 173, 176(Iowa 1990). However, Iowa courts have recognized that there is no substantialequivalent to an eyewitness statement taken immediately after an event, and as suchhave found that a mere lapse will ordinarily be enough to show a substantial need toobtain the statement of an eyewitness taken shortly after the event in question. Id.

3. Does your state recognize a self-critical analysis procedure?With the exception of medical peer review committees, the Iowa Legislature has notcreated a privilege for self-critical analysis materials. Id. at 49. Further, the IowaSupreme Court, absent legislative directive, has refused to recognize a common lawself-critical analysis privilege. Id.

KANSASKenneth R. LangHINKLE LAW FIRM, LLC301 North Main Street, Suite 2000Wichita, KS 67202Phone (316) 267-2000www.hinklaw.comklang@hinklaw.com1. Does your state recognize an exemption from discovery (or a privilege) forpre-suit investigation materials? Is there a key to preserving thisexemption/privilege (i.e. involvement of counsel)?Yes, Kansas recognizes the work product privilege as a privilege from discovery for presuitinvestigation materials when, in light of the nature of the material and the factualsituation of the particular case, the material can fairly be said to have been prepared orobtained in anticipation of litigation. K.S.A. §60-226(b)(4). Kansas courts have appliedthis work product privilege to pre-suit investigation materials created by an insurancecompany at the request of counsel. See Heany v. Nibbelink, 23 Kan. App. 2d 583 (Kan.Ct. App. 1997). By virtue of counsel’s intervention, any subsequent investigationmaterial produced is considered to be work product, and as such, is privileged. “[W]hena file is prepared at the request of counsel and in anticipation of litigation, that file fallsunder the definition of work product as outlined in K.S.A. 60-226(b)(3).” Wedel v.Woods, 1999 Kan. App. Unpub. LEXIS 1132, 13 (Kan. Ct. App. Feb. 5, 1999). Prior tothe Nibbelink decision, the Kansas Supreme Court had recognized the distinctionbetween materials requested by counsel and those produced independently. In HenryEnterprises, Inc. v. Smith, the Court noted: “the initial investigation of a potential claim,made by an insurance company prior to the commencement of litigation, and notrequested by or made under the guidance of counsel, is made in the ordinary course ofbusiness of the insurance company, and not 'in anticipation of litigation or for trial' asthose terms are used in K.S.A. 60-226(b)(3)." Henry Enterprises, Inc. v. Smith, 225 Kan.615, 623, 592 P.2d 915 (1979).2. What is your state’s rule with regard to the discoverability of written orrecorded statements taken during investigation of an incident?Kansas has no specific rules regarding written or recorded statements taken during presuitinvestigation. As such, those materials are subject to the same tests as any othermaterial to determine whether they qualify as work product materials and are thuslyprivileged.

3. Does your state recognize a self-critical analysis privilege?No statewide accepted recognition of the self-critical analysis privilege.

KENTUCKYD. Craig YorkJ. Tanner WatkinsDINSMORE & SHOHL, LLP101 S. Fifth St., Ste. 2500Louisville, KY 40202Phone: (502) 581-8000www.dinsmore.comcraig.york@dinsmore.com1. Does your state recognize an exemption from discovery (or a privilege) forpre-suit investigation materials? Is there a key to preserving thisexemption/privilege (i.e. involvement of counsel)?Kentucky has a qualified privilege for pre-suit investigation materials under its workproduct doctrine. See Ky R. Civ. P. 26.02(3); Duffy v. Wilson, 289 S.W.3d 555 (Ky.2009). Such materials are not discoverable absent a showing of: 1) substantial need;and 2) the inability to locate the information from another source. Ky. R. Civ. P.26.03(2). An attorney need not be present for a party’s pre-suit investigation to qualifyas work product. Transit Authority of River City v. Vinson, 703 S.W.2d 482, 486 (Ky. Ct.App. 1985).2. What is your state’s rule with regard to the discoverability of written orrecorded statements taken during investigation of an incident?Written or recorded statements taken during an investigation are entitled to a qualifiedprivilege from production under the work product doctrine. Duffy v. Wilson, 289 S.W.3d555 (Ky. 2009). The party seeking the statement must show substantial need for thestatement and the inability to locate the information contained within the statementelsewhere. Id. at 558-559.3. Does your state recognize a “self critical analysis”?With the exception of the limited “self critical analysis” privilege created for hospitals andhealthcare providers in the Federal Patient Safety and Quality Improvement act of 2005,42. U.S.C.S § 299b-21 et seq., Kentucky Courts have refused to recognize a “selfcritical analysis” privilege. University of Kentucky v. Louisville Courier Journal &Louisville Times Co., 830 S.W.2d 373 (Ky. 1992).LOUISIANA

W. Paul AnderssonLEAKE & ANDERSSON, LLP1100 Poydras Street, Suite 1700New Orleans, LA 70163-1701Phone (504) 585-7500www.leakeandersson.companderson@leakeandersson.com1. Does your state recognize an exemption from discovery (or a privilege) forpre-suit investigation materials? Is there a key to preserving thisexemption/privilege (i.e. involvement of counsel)?In Louisiana, state court judges allow (or order) wide-ranging discovery. There isseldom recognition of “self-investigation” discovery protection. Louisiana pays lipservicefor protection for the results of investigations conducted “in anticipation oflitigation” –in state court, defendants are frequently ordered to produce such items. It isfrequently argued that plaintiffs should have to provide “good cause” to a court beforeinvestigation materials (site inspections, statements, and the like) ought to be orderedproduced. Defendants routinely contend that “good cause” is nothing short of thedemonstration of an absolute inability of plaintiffs to obtain the information in any otherway (such as a deposition of a witness who has given a withheld statement, forexample). Investigation results have the best chance of being protected, when theinvestigation appears to have been conducted or supervised by counsel. Accordingly, ifan investigator does work, the assignment and any report should come from and beaddressed to counsel.2. What is your state’s rule with regard to the discoverability of written orrecorded statements taken during investigation of an incident?Written statements obtained after an incident and taken “in anticipation of litigation”need not be produced, except after one’s opponent has successfully demonstrated“good cause” for such production – such as crucial fact information necessary for faultdetermination, and which one’s opponent cannot otherwise obtain. Statements actuallytaken by counsel, or at counsel’s specific instruction, have the greatest chance ofprotection. All of these fact-protection issues are handled more successfully andconsistently in federal court than before Louisiana state district judges.3. Does your state recognize a self-critical analysis privilege?No.

MAINEStephen HessertNORMAN, HANSON & DeTROY, LLC415 Congress StreetPortland, ME 04112Phone (207) 774-7000www.nhdlaw.comshessert@nhdlaw.com1. Does your state recognize an exemption from discovery (or a privilege) forpre-suit investigation materials? Is there a key to preserving thisexemption/privilege (i.e. involvement of counsel)?In general, accident reports and other routine reports prepared by the alleged tortfeasorare discoverable. Documents prepared by an insurer in investigating a claim is typicallymaterial prepared in anticipation of litigation and is protected by M.R. Civ. P 26(b)(3).See Harriman v. Maddocks, 518 A.2d 1027, 1033-34 (Me. 1986). Involvement of anattorney is not a prerequisite to the application of Rule 26(b)(3). Id. However, a partymay obtain documents and tangible things protected under the rule above, “upon ashowing that the party . . . has substantial need of the materials in the preparation of theparty's case and that the party is unable without undue hardship to obtain thesubstantial equivalent of the materials by other means. See M.R. Civ. P. 26(b)(3); seealso Springfield Terminal Ry. Co. v. Dept. of Transp,, 2000 ME 126, 754 A.2d 353, 357(Me. 2000).2. What is your state’s rule with regard to the discoverability of written orrecorded statements taken during investigation of an incident?A party may always obtain a copy of his or her own prior statement without the requiredshowing by requesting it or in routine discovery. M.R. Civ. P. 26(b)(3). Further, anonparty may request their own prior statement without the required showing. Id.3. Does your state recognize a self-critical analysis privilege?This has not been addressed by the Courts in Maine.

MARYLANDJames W. Bartlett, IIIEric M. LeppoSEMMES, BOWEN & SEMMES25 South Charles Street, Suite 1400Baltimore, Maryland 21201Phone: (410) 576-4833jbartlett@semmes.comwww.semmes.com1. Does your state recognize an exemption from discovery (or a privilege) forpre-suit investigation materials? Is there a key to preserving thisexemption/privilege (i.e. involvement of counsel)?Maryland’s version of the work product doctrine is found at MD. RULE 2-402(d) and canbe used to shield pre-suit investigation materials from discovery by the opposing partyas long as they were “prepared in anticipation of litigation.” As is true underFED.R.CIV.P. 26(b)(3)(A)(ii), such materials are only discoverable when “the partyseeking discovery has substantial need for the materials . . . and is unable withoutundue hardship to obtain the substantial equivalent of the materials by other means.”Whether a document was prepared in the anticipation of litigation is a question for thetrial court to determine, however, and the party who opposes the production ofdocuments bears the burden of demonstrating that the materials were prepared inanticipation of litigation, as opposed to being prepared in the ordinary course ofbusiness. Kelch v. Mass Transit Admin., 287 Md. 223, 229, 411 A.2d 449, 453 (1980).Moreover, written reports prepared by a party after an accident will be assumed by thecourt to be prepared in the ordinary course of business. See Maged v. Yellow Cab Co.,237 Md. 340, 345, 206 A.2d 257, 260 (1965). Therefore, involving an attorney at theoutset to coordinate any catastrophic loss investigation may assist in establishing thatthe documents were prepared in anticipation of litigation.2. What is Maryland’s rule with regard to the discoverability of written orrecorded statement taken during investigation of an incident?A written or recorded statement from a loss investigation will fall within the work productdoctrine as long as it is deemed to have been obtained in anticipation of litigation asnoted above. There are, however, important caveats in the Maryland law. First, anopposing party is always entitled to obtain a statement they previously provided to aparty or its insurer. MD. RULE 2-402(f). Additionally, the work product doctrine is not acomplete bar to production; disclosure of such statements may be required if obtainingthe information would cause undue hardship to the opposing party, or the information isno longer available. E.I. du Pont de Nemours & Co. v. Forma-Pack, Inc., 351 Md. 396,408, 718 A.2d 1129 (1998).3. Does your state recognize a self-critical analysis privilege?

Maryland does not recognize the self-critical analysis privilege beyond medical peerreview committees, but does have a statute protecting medical peer review committeework. MD. CODE, HEALTH OCCUPATIONS § 1-401.

MASSACHUSETTSGrace V.B. GarciaMORRISON MAHONEY LLP250 Summer StreetBoston, MA 02210Phone (617) 439-7500www.morrisonmahoney.comggarcia@morrisonmahoney.com1. Does your state recognize an exemption from discovery (or a privilege) forpre-suit investigation materials? Is there a key to preserving thisexemption/privilege (i.e. involvement of counsel)? Does your staterecognize a “self-critical analysis” privilege?Yes, but not under every circumstance. Mass. R. Civ. P. 26(b)(3) provides that a partymay obtain discovery of items prepared in anticipation of litigation upon a showing thatthe party seeking the discovery has both (1) a substantial need of the materials in thepreparation of his case and (2) that he is unable without undue hardship to obtain thesubstantial equivalent of the materials by other means.Massachusetts does not recognize a privilege against disclosure of internal self-criticalanalysis. While there is no Massachusetts appellate decision on point, several trialcourts have specifically refused to recognize such a privilege.2. What is your state’s rule with regard to the discoverability of written orrecorded statements taken during investigation of an incident?Mass. R. Civ. P. 26(b)(3) requires a party who has possession of a statement made byanother party or by a non-party witness concerning the subject matter of suit to producea copy of the statement to the person who made it. Therefore, a statement of a partymust be produced in response to a written discovery request; a statement of a witnessmust be produced to that witness upon written request. If counsel wants to learn therecollections of non-party witnesses without having to disclose to an opponent what islearned, the safest course is for an investigator to interview the witness and take notesof the interview, but not obtain a written statement from the witness because, if thewitness later gives an inconsistent recollection at trial, the investigator may then takethe stand to recount the prior inconsistent statement. By contrast, counsel may riskhaving to withdraw from representation if he or she wishes to take the stand to rebut thewitness's inconsistent testimony at trial.3. Does your state recognize a self-critical analysis privilege?Please see No. 1 above.

MICHIGANHenry B. CooneyMatthew StanczykEllisse ThompsonPLUNKETT COONEY535 Griswold StreetSuite 2400Detroit, MI 48226Phone (313) 965-3900www.plunkettcooney.comhcooney@plunkettcooney.com1. Does your state recognize an exemption from discovery (or a privilege) forpre-suit investigation materials? Is there a key to preserving thisexemption/privilege (i.e. involvement of counsel)?Generally, the investigative materials are considered to be work product under MCR2.302(B)(3)(a). However, “…if a party demonstrates the substantial need and unduehardship necessary to discover work product, that party may discover only factual, notdeliberative, work product.” Leibel v Gen Motors Corp, 250 Mich App 229, 247 (2002).2. What is your state’s rule with regard to the discoverability of written orrecorded statements taken during investigation of an incident?MCR 2.302(B)(3)(a) also applies to the discoverability of written or recorded statementstaken during the investigation of an incident. For example, in Jones v General MotorsCorp, 2002 WL 31956941 (Mich App rel’d Dec. 20, 2002), the Michigan Court ofAppeals rejected the defendant’s argument that the trial court erred in failing to orderplaintiffs to produce discovery statements recorded and videotaped from nine factwitnesses in the early stages of investigation where the defendant neither demonstrateda substantial need nor undue hardship.Similarly, with respect to written statements in Koster v June’s Trucking, Inc, 244 MichApp 162 (2000), a driver of a truck owned by defendant trucking company hit a vehicleand killed two people. The Court reversed the order for the insurer of the truck to turnover its entire claims file. Although the insurer could not claim attorney-client privilege,the documents could have been protected under the work product doctrine. UnderMCR 2.302(B)(3)(a), the documents prepared in anticipation of litigation by or for theinsurer were not discoverable absent a showing that appellees had a substantial needfor and were unable without undue hardship to obtain the substantial equivalent of thematerials by other means.

3. Does your state recognize a self-critical analysis privilege?No.

MINNESOTABrian N. JohnsonNILAN JOHNSON LEWIS, P.A.120 South Sixth Street, Suite 400Minneapolis, MN 55402-4501Phone (612) 305-7500www.nilanjohnson.combjohnson@nilanjohnson.com1. Does your state recognize an exemption from discovery (or a privilege) forpre-suit investigation materials? Is there a key to preserving thisexemption/privilege (i.e. involvement of counsel)?Not if the investigation was conducted as part of the regular course of business, e.g.,insurance adjusting or its in-house equivalent. In such circumstances, even if theinvestigation was conducted by attorneys, the investigative materials are not privileged.Even where a privilege might attach to a specific document prepared at counsel’srequest, the underlying facts discovered in the investigation are not privileged. SeeMarvin Lumber & Cedar Co. v. PPG Indus., 168 F.R.D. 641 (D. Minn. 1996); MissionNat'l. Ins. Co. v. Lilly, 112 F.R.D. 160 (D. Minn. 1986)2. What is your state’s rule with regard to the discoverability of written orrecorded statements taken during investigation of an incident?A party may obtain a statement concerning the action or its subject matter previouslymade by that party without making a showing that the party has substantial need of thestatement in the preparation of the party’s case and that the party is unable withoutundue hardship to obtain the substantial equivalent of the statement by other means.Upon request, a party or other person may obtain (again without the substantialneed/substantial equivalent showing) a statement concerning the action or its subjectmatter previously made by that person who is not a party. If the request is refused, theperson may move for a court order. See Minn. R. Civ. P. 26.02(d). For purposes of thisrule, a “statement” is defined as “(1) a written statement signed or otherwise adopted orapproved by the person making it, or (2) a stenographic, mechanical, electrical, or otherrecording, or a transcription thereof, that is a substantially verbatim recital of an oralstatement by the person making it and contemporaneously recorded.” Id.3. Does your state recognize a self-critical analysis privilege?Only in the medical malpractice context, not in the product liability context.

MISSISSIPPIStephen P. Huwe, Esq.DANIEL COKER HORTON & BELL4400 Old Canton Road, Suite 400Jackson MS 39211Phone (601)969-7607www.danielcoker.comshuwe@danielcoker.com1. Does your state recognize an exemption from discovery (or a privilege) forpre-suit investigation materials? Is there a key to preserving thisexemption/privilege (i.e. involvement of counsel)?Mississippi recognizes the work-product doctrine which protects documents andtangible things prepared in anticipation of litigation by a party or that party=srepresentative (attorney, consultant, surety, indemnitor, insurer, or agent) fromdiscovery. The filing of a suit or involvement of counsel is not necessarily the key fortriggering protection. Rather, the Mississippi Supreme Court has held that it is for thetrial court to determine when documents are prepared with Aan eye toward litigation andnot in the ordinary course of business.@ Powell v. McLain, 105 So. 3d 308, 313 (Miss.2012). In making this determination, the trial court considers the specific documentssought to be protected on a case-by-case basis, employing a detailed analysis andconsidering such factors as the relationship between the parties, the nature of thedocuments, etc.2. What is your state’s rule with regard to the discoverability of written orrecorded statements taken during investigation of an incident?Recorded statements receive some protection from discovery. In Powell v. McLain, 105So.3d 308, 313 (Miss. 2012), the Mississippi Supreme Court held that recordedstatements may be disclosed under certain circumstances; however, before the trialcourt mandates production, it must thoroughly analyze the statement under thework-product analysis. Thus, when a statement is taken with "an eye toward litigation,"the statement may still be disclosed if the requesting party demonstrates a substantialneed for the materials and demonstrates that substantially equivalent materials cannotbe obtained absent undue hardship.3. Does your state recognize a self-critical analysis privilege?No.

MISSOURIKara Trouslot StubbsBAKER STERCHI COWDEN & RICE, LLC2400 Pershing Road, Suite 500Kansas City, MO 64108-2533Phone (816) 471-2121www.bscr-law.comstubbs@bscr-law.com1. Does your state recognize an exemption from discovery (or a privilege) forpre-suit investigation materials? Is there a key to preserving thisexemption/privilege (i.e. involvement of counsel)?Missouri courts recognize a privilege from discovery for pre-litigation investigationmaterials by virtue of Missouri’s work product discovery rule. See State ex rel. Day v.Patterson, 773 S.W.2d 224, 228 (Mo. Ct. App. 1989); Mo. Sup. Ct. R. 56.01(b)(3).Such materials are not discoverable except upon a showing that the party seekingdiscovery has substantial need of the materials in the preparation of his case and thathe is unable without undue hardship to obtain the substantial equivalent of the materialsby other means. The materials must be prepared “in anticipation of litigation” to qualifyfor the work product privilege - specifically distinguishing from acts done to “facilitate theordinary and usual business” of an enterprise. May Dep't Stores Co. v. Ryan, 699S.W.2d 134, 138 (Mo. Ct. App. 1985). Missouri courts also recognize the sameprotection for employee-prepared incident reports. See State ex rel. St. Louis LittleRock Hospital v. Gaertner, 682 S.W.2d 146, 149 (Mo. App. 1984); Lindberg v. SafewayStores, Inc., 525 S.W.2d 571, 572 (Mo. App. 1975).2. What is your state’s rule with regard to the discoverability of written orrecorded statements taken during investigation of an incident?A party may obtain a statement concerning the action or its subject matter previouslymade by that party. See Mo. Sup. Ct. R. 56.01(b)(3). The statements – which includebut are not limited to written statements, recorded statements, and videotape footage –may be discovered without a showing that the party seeking the statement hassubstantial need for it and is unable to obtain the substantial equivalent without unduehardship. See Mo. Sup. Ct. R. 56.01(b)(3)(a)-(b); State ex rel. McConaha v. Allen, 979S.W.2d 188, 189-90 (Mo. 1998).3. Does this state recognize a “self-critical analysis” privilege?Generally, Missouri courts have declined to adopt the self-critical analysis privilege.See Cupp v. AMTRACK, 138 S.W.3d 766, 776 (Mo. App. E.D. 2004); West v. MarionLab., Inc., 1991 U.S. Dist. LEXIS 18457, *7 (W.D. Mo. 1991). However, R.S.Mo. §537.035.4 (2014) specifically protects health care services peer review committee workfrom discovery.

MONTANAT. Thomas SingerAXILON LAW GROUP, PLLCElectric Bulding, Suite 310115 North BroadwayBillings, Montana 59101Phone (406) 294-9466www.axilonlaw.comtsinger@axilonlaw.com1. Does your state recognize an exemption from discovery (or a privilege) forpre-suit investigation materials? Is there a key to preserving thisexemption/privilege (i.e. involvement of counsel)?Pre-suit investigation materials are discoverable unless made Ain anticipation oflitigation.@ Although exceptions can apply, Aanticipation of litigation@ typically occurs ator near the filing of suit. M.R. Civ. P. 26(b)(3). Cantrell v. Henderson, 718 P.2d 318,322, 221 Mont. 201, 207-208 (1986). If the information is gathered at the request of anattorney, or if it involves communications with in-house counsel, it is generally privilegedunless the usual exceptions apply (information is unavailable to opposing counsel fromother sources, etc.). Draggin' Y Cattle Co. v. Addink, 2013 MT 319, 45, 372 Mont.334, 347, 312 P.3d 451, 460.2. What is your state’s rule with regard to the discoverability of written orrecorded statements taken during investigation of an incident?Written or recorded statements taken during investigation are generally subject todiscovery. Rule 26(b)(6), M.R. Civ. P.; Cantrell v. Henderson, 718 P.2d 318, 322, 221Mont. 201, 207-208 (1986).3. Does your state recognize a self-critical analysis privilege?No.

NEBRASKARandall GoyetteBAYLOR, EVNEN, CURTISS, GRIMIT & WITT, LLP1248 O Street, Suite 600Lincoln, NE 68508Phone: (402) 475-1075www.baylorevnen.comrgoyette@baylorrevnen.com1. Does your state recognize an exemption from discovery (or a privilege) forpre-suit investigation materials? Is there a key to preserving thisexemption/privilege (i.e. involvement of counsel)?Pre-suit investigation is protected when it is done in anticipation of litigation, under theNebraska work product privilege (Nebraska Rules of Discovery 6-326(b)(3). Thus, presuitmaterials are best protected when they are developed at the direction and under thesupervision of counsel. If expert consultants are used, there is also protection againstdisclosing them in discovery if they will not be providing an opinion (Nebraska Rules ofDiscovery 6-326(b)(4).2. What is your state’s rule with regard to the discoverability of written orrecorded statements taken during investigation of an incident?There is a discovery rule that requires disclosure of a party’s own written or recordedstatement if requested (Nebraska Rules of Discovery 6-326(b)(3). However, statementsof other witnesses are protected if they can be shown to have been taken in anticipationof litigation.3. Does your state recognize a self-critical analysis privilege?While the self-critical analysis privilege has not been explicitly adopted or rejected inNebraska, in one Nebraska federal court decision, it has been found to be inapplicableto evidence characterized as routine internal corporate reviews of matters related tobusiness operations, recalls, and safety concerns. While the court referenced potentialapplication where a party was required by the government to create a report, thediscussion did not favor the privilege. Carlson v. Freightliner LLC, 226 F.R.D. 343(D.Neb. 2004).

NEVADASeetal Tejura,Esq.ALVERSON TAYLOR MORTENSEN & SANDERS7401 West Charleston Blvd.Las Vegas, NV 89117Phone: (702) 384-7000www.AlversonTaylor.comstejura@AlversonTaylor.com1. Does your state recognize an exemption from discovery (or a privilege) forpre-suit investigation materials? Is there a key to preserving thisexemption/privilege (i.e. involvement of counsel)?No. In order for post-incident, pre-litigation investigation materials to be considered nondiscoverable,it must be taken by an attorney or at the express direction of the attorney.Ballard v. District Court, 106 Nev. 83, 85, 787 P.2d 406, 408 (1990). However, if thepost-incident investigation would have been done in the ordinary course of businessregardless of counsel’s presence or involvement, the attorney-client or attorney workproductprivileges may not apply. Columbia/HCA Healthcare Corp. v. Eighth JudicialDist. Court, 113 Nev. 521, 527, 936 P.2d 844, 848 (1997).2. What is your state’s rule with regard to the discoverability of written orrecorded statements taken during investigation of an incident?A party can obtain a copy of his/her own pre-litigation statement, even if it was taken byan attorney. Nev. R. Civ. P. 26(b)(3). With regard to other statements, if it was takenby an attorney or at the direction of counsel, it is generally not discoverable. Ballard v.District Court, 106 Nev. 83, 85, 787 P.2d 406, 408 (1990). However, if the statementwould have been taken as part of the ordinary course of business regardless ofcounsel’s presence or involvement, the attorney-client or attorney work-product privilegemay not apply. Columbia/HCA Healthcare Corp. v. Eighth Judicial Dist. Court, 113 Nev.521, 527, 936 P.2d 844, 848 (1997).3. Does your state recognize a self-critical analysis privilege?Only in medical and dental peer reviews. (NRS 49.117-NRS 49.123).

NEW HAMPSHIREMarc R. ScheerJoseph G. MattsonWADLEIGH, STARR & PETERS, P.L.L.C.95 Market StreetManchester, New Hampshire 03101Phone: 603-669-4140www.wadleighlaw.commscheer@wadleighlaw.com1. Does your state recognize an exemption from discovery (or a privilege) forpre-suit investigation materials? Is there a key to preserving thisexemption/privilege (i.e. involvement of counsel)?Production of pre-suit investigation material is governed by New Hampshire SuperiorCourt Rule 21(e)(1) which permits a party to obtain discovery of “documents andtangible things…prepared in anticipation of litigation or for trial…upon a showing thatthe party seeking discovery has substantial need of the materials in the preparation ofhis case and that he is unable without undue hardship to obtain the substantialequivalent of the materials by other means.” The Court is required to “protect againstdisclosure of the mental impressions, conclusions, opinions, or legal theories of anyattorney or other representative of a party concerning the litigation.”2. What is your state’s rule with regard to the discoverability of written orrecorded statements taken during investigation of an incident?To obtain discovery of written or recorded statements taken during investigation of anincident that would otherwise be discoverable, a Plaintiff will have to show 1) substantialneed for the discovery and 2) that the plaintiff cannot obtain the “substantial equivalent,”without undue hardship. Specifically, Rule 21(e)(1) provides that “[a] party may obtaindiscovery of [information that is] otherwise discoverable and prepared in anticipation oflitigation…by or for another party or by or for that other party’s representative (includinghis or her attorney, non-attorney representative, consultant, surety, indemnitor, insurer,or agent) only upon a showing that the party seeking discovery has substantial need ofthe materials in the preparation of his or her case and that he or she is unable withoutundue hardship to obtain the substantial equivalent of the materials by other means.” Inallowing discovery under this rule, “the court shall protect against disclosure of themental impressions, conclusions, opinions, or legal theories of an attorney or otherrepresentative of a party concerning the litigation.” However, if a plaintiff seeks a copyof his own statement taken during investigation of an incident, he need not make theshowing required under Rule 21(e)(1). See N.H. R. Civ. P. 21(e)(2).

3. Does your state recognize a self-critical analysis privilege?Not in transportation or product liability.

NEW JERSEYJeffrey H. NewmanSILLS CUMMIS & GROSS P.C.One Riverfront PlazaNewark, NJ 07102Phone (973) 643-7000jnewman@sillscummis.comwww.sillscummis.com1. Does your state recognize an exemption from discovery (or a privilege) forpre-suit investigation materials? Is there a key to preserving thisexemption/privilege (i.e. involvement of counsel)?While New Jersey generally allows for broad discovery, the attorney-client privilege canprevent discovery of pre-suit investigation materials provided the communications arebetween the client and her attorney, are confidential, and regard legal advice orpreparation for litigation. N.J.S.A. 2A:84A-20; Fellerman v. Bradley, 99 N.J. 493 (1985).2. What is your state’s rule with regard to the discoverability of written orrecorded statements taken during investigation of an incident?The discoverability of written or recorded statements taken during an investigation of anincident depends on whether the attorney or in-house counsel participated and if herrole was that of the client’s attorney. The attorney-client privilege, therefore, is notapplicable if the attorney’s role was not for the purpose of preparing for litigation orproviding legal advice, but was instead for some other purpose. This is the case evenwhere litigation may arise from the subject of the attorney’s activities. Payton v. NewJersey Turnpike Authority, 148 N.J. 524, 550–51 (1997).3. Does your state recognize a self-critical analysis privilege?The New Jersey Supreme Court has declined to adopt a broad self-critical analysisprivilege. Payton, 148 N.J. at 545. However, New Jersey’s Patient Safety Act, N.J.S.A.26:2H-12.23 – 12.25, does recognize a self-critical analysis privilege with respect toaccident and adverse event investigations conducted by hospitals and other healthcarefacilities.

NEW MEXICOAlfred I. GreenBUT THORNTON & BAEHR, P.C.4101 Indian School road, NESuite 300 SouthAlbuquerque, NM 87110Phone: (505) 884-0777www.btblaw.comalgreen@btblaw.com1. Does your state recognize an exemption from discovery (or a privilege) forpre-suit investigation materials? Is there a key to preserving thisexemption/privilege (i.e. involvement of counsel)?In general, New Mexico protects materials prepared in anticipation of litigation or for trialby a party’s insurer or insurer’s agent from discovery. Rule 1-026(B)(4). If, upon ashowing of substantial need and undue hardship on the requesting party to obtain theequivalent, the court orders production of the claims file or other insurer materials, thecourt is to protect against disclosure of the mental impressions, conclusions, or legaltheories of the party concerning the litigation. Claims files or investigation materials willonly be protected against discovery in New Mexico where they are genuinely preparedin anticipation of litigation or for trial. Materials prepared during the course of ordinaryinvestigations or in the ordinary course of business are not subject to protection asmaterials prepared in anticipation of litigation. Hartman v. Texaco Inc., 1997-NMCA-032, 123 N.M. 220, 225, 937 P.2d 979, 984. A general rule of thumb is thatinvestigations conducted by or at the direction of any attorney, including statements,have a much better chance of being protected as attorney work product or under theattorney-client privilege.2. What is your state’s rule with regard to the discoverability of written orrecorded statements taken during investigation of an incident?In New Mexico, recorded witness statements, prepared in anticipation of litigation byand for a party’s attorney, whether or not a work-product, can be obtained upon ashowing of substantial need and undue hardship. Knight v. Presbyterian Hosp. Ctr.,1982-NMCA-125, 98 N.M. 523, 525, 650 P.2d 45, 47. “Good cause” is not required.Id. As noted above, one is more likely to be successful in protecting written or recordedstatements taken during investigation of an incident if it is obtained directly by legalcounsel. That being said, there have been recent discovery rulings by two judges (oneState; one Federal) where they held that failure to disclose the existence of suchstatements (as well as the existence of other documents from an adjuster’s file) on aPrivilege Log at the time discovery answers and responses were issued, resulted inwaiver of the protection and privilege.3. Does your state recognize a self-critical analysis privilege?

No statewide accepted recognition of the self-critical analysis privilege.

NEW YORKWilliam D. YoquintoCARTER, CONBOY, CASE, BLACKMORE,MALONEY & LAIRD, P.C.20 Corporate Woods BoulevardAlbany, NY 12211-2350Phone (515) 465-3484www.carterconboy.comwyoquinto@carterconboy.com1. Does your state recognize an exemption from discovery (or a privilege) forpre-suit investigation materials? Is there a key to preserving thisexemption/privilege (i.e. involvement of counsel)?Yes – if the material was prepared in anticipation of litigation. Agovino v. Taco Bell5083, 225 AD2d 569, 639 N.Y.S.2d 111 (2d Dept 1996). The scope of disclosure isdefined under New York Civil Practice Law and Rules § 3101 (CPLR). The general ruleof full disclosure is tempered by the rule that, subject to exception, privileged matter,attorney's work product and trial preparation materials are not discoverable. CPLR §3101 (b),(c). Protected materials may be obtained only upon a showing of a substantialneed and the inability, without undue hardship, to obtain their substantial equivalent byother means. The burden of proving that materials are exempt is on the party opposingdiscovery. The argument is strengthened when “anticipation of litigation” is clearlyindicated as the only purpose of the report, the authors and recipients are identified andwhen it is stated that the investigation was prepared at the suggestion of counsel. SeeCrazytown Furniture, Inc. v. Brooklyn Union Gas Co., 145 A.D.2d 402; 535 N.Y.S.2d401 (2nd Dept. 1988). Do not label any document as an "accident report" as there"shall be full disclosure of any written report of an accident report prepared in theregular course of business operations or practices…" CPLR § 3101 (g). This part ofthe statute is intended to relate to discovery of regular course of business materials; notinvestigation for anticipated litigation, so avoid the opportunity for confusion. When aproduct is no longer available for inspection, New York Courts typically will requiredisclosure of the otherwise protectable material. See Lamitie v. Emerson Elec.Company-White Rodgers Div., 208 A.D.2d 1081, 617 N.Y.S.2d 924 (3rd Dept. 1994).2. What is your state’s rule with regard to the discoverability of written orrecorded statements taken during investigation of an incident?New York requires that statements of an opposing party must be disclosed. CPLR §3101 (e). The discovery of written or recorded statements of non-parties is governedby the rules discussed above. Even when production is ordered, the court is required toprotect against disclosure of the mental impressions, conclusions, opinions or legaltheories of an attorney or other representative of a party concerning the litigation. CPLR§ 3101 (d)(2).

3. Does your state recognize a self-critical analysis privilege?No.

NORTH CAROLINADavid M. DukeShannon S. FrankelDavid A. Senter, Jr.YOUNG MOORE AND HENDERSON, P.A.3101 Glenwood Avenue, Suite 200Raleigh, NC 27612Phone: (919) 782-6860www.youngmoorelaw.comdmd@youngmoorelaw.com1. Does your state recognize an exemption from discovery (or a privilege) forpre-suit investigation materials? Is there a key to preserving thisexemption/privilege (i.e. involvement of counsel)?Generally, yes. North Carolina courts consistently hold that documents created inanticipation of litigation are considered work product or trial preparation materials andare, therefore, protected. Documents prepared in anticipation of litigation include notonly materials prepared after the other party has secured an attorney, but also thoseprepared under circumstances in which a reasonable person might anticipate litigation.Materials prepared in the ordinary course of business, however, are generally notprotected as they are not prepared under circumstances in which a reasonable personmight anticipate a possibility of litigation. See Fulmore v. Howell, 189 N.C. App. 93,101, 657 S.E.2d 437, 443 (2008); Willis v. Duke Power, 291 N.C. 19, 35, 229 S.E.2d191, 201 (1976). However, an adverse party may still discover these materials undercertain circumstances. N.C. R. Civ. P. 26(b)(3) provides that “a party may obtaindiscovery of documents and tangible things otherwise discoverable . . . and prepared inanticipation of litigation or for trial by or for another party . . . upon a showing that theparty seeking discovery has substantial need of the materials in the preparation of thecase and that the party is unable without undue hardship to obtain the substantialequivalent of the materials by other means. Even when the required showings havebeen made, however, the court still may not permit “disclosure of the mentalimpressions, conclusions, opinions, or legal theories” of an attorney or otherrepresentative concerning the subject litigation.2. What is your state’s rule with regard to the discoverability of written orrecorded statements taken during investigation of an incident?With regard to a party’s own statement, Rule 26(b)(3) provides that “[a] party may obtainwithout the required showing [i.e. substantial need, undue hardship] a statementconcerning the action or its subject matter previously made by that party.” On the otherhand, a party seeking the statement of a witness or other related individual will besubject to the work product provisions of Rule 26(b)(3), discussed above.

3. Does your state recognize a self-critical analysis privilege?No.

NORTH DAKOTAM. Daniel VogelVOGEL LAW FIRM218 NP AvenueFargo, ND 58102Phone: (701) 237-6983www.vogellaw.comdvogel@vogellaw.com1. Does your state recognize an exemption from discovery (or a privilege) forpre-suit investigation materials? Is there a key to preserving thisexemption/privilege (i.e. involvement of counsel)?Documents and tangible things produced by a party or its representative in anticipationof litigation are not discoverable unless the opposing party shows a substantial need forthe information that cannot otherwise be obtained without undue hardship. N.D. R. Civ.P. 26(b)(3)(A); Western Horizons Living Centers v. Feland, 2014 ND 175, 853 N.W.2d36; see also, N.D. R. Civ. P. 26(b)(4)(B) (non-exam materials produced by experts inanticipation of litigation not discoverable unless showing is made of exceptionalcircumstances).2. What is your state’s rule with regard to the discoverability of written orrecorded statements taken during investigation of an incident?The previous statement of a witness is always discoverable by that person without therequirement to show substantial need and undue hardship. N.D. R. Civ. P. 26(b)(3)(C)Otherwise, statements taken in anticipation of litigation are subject to the rulesdiscussed above.3. Does your state recognize a self-critical analysis privilege?No.

OHIOAndrew R. KwiatkowskiDINSMORE & SHOHL, LLP255 E. Fifth St., Suite 1900Cincinnati, Ohio 45202Phone: (513) 977-8680www.dinsmore.comandrew.kwiatkowski@dinsmore.com1. Does your state recognize an exemption from discovery (or a privilege) forpre-suit investigation materials? Is there a key to preserving thisexemption/privilege (i.e. involvement of counsel)?Like many states, Ohio courts recognize the attorney client privilege and work productdoctrine in the context of pre-suit investigations. The attorney-client privilege is the mostdifficult to overcome, so it is prudent to involve outside independent counsel early in anyinvestigation process. Materials prepared in anticipation of litigation or trial can beconsidered privileged pursuant to the work-product doctrine, but this may be overcomeby a showing of substantial need of the requesting party and an inability to obtain theinformation without undue hardship. Grace v. Mastruserio, 182 Ohio App.3d 243, 2007-Ohio-3942, 30 (1st Dist.). Other than a privilege for proceedings and records of a“peer review committee” of a health care entity under O.R.C. § 2305.252 in actionsagainst a health care entity, Ohio courts have not yet recognized any type of “selfcriticalanalysis” privilege that would protect pre-suit investigation materials. Ohio courtshave, so far, declined to pass judgment on whether such a privilege is recognized inOhio. Geggie v. Cooper Tire & Rubber Co., 3rd Dist. Hancock No. 5-05-01, 2005-Ohio-4750, 30 (noting that the “self-evaluating privilege has yet to be recognized in Ohio.”).2. What is your state’s rule with regard to the discoverability of written orrecorded statements taken during investigation of an incident?Ohio courts have held that the attorney client privilege protects statements that aregiven to one’s counsel for the purpose of defending a lawsuit. Joyce v. Rough, 6th Dist.Lucas No. L-09-1089, 2009-Ohio-5731, 9. Investigators should turn over theirdocuments to their attorney after the investigation in order to strengthen a claim ofprivilege. See Hunter v. Wal-Mart Stores, Inc., 12th Dist. Clinton No. CA2001-10-035,2002-Ohio-2604, 38-39. Be aware, however, that if a statement is otherwisediscoverable, merely sending the statement to one’s counsel may not be enough toestablish the privilege. Harpster v. Advanced Elastomer Sys., L.P., 9th Dist. Summit No.22684, 2005-Ohio-6919, 14, 21 (materials created in ordinary course of business,where defendant failed to establish that the investigation was actually conducted ordirected by its counsel, were deemed not privileged).3. Does your state recognize a self-critical analysis privilege?

Please see No. 1 above.

OKLAHOMAAlexander J. SisemoreFRANDEN | FARRIS | QUILLINGOODNIGHT + ROBERTSWilliams Center Tower IITwo West 2 nd Street, Suite 900Tulsa, Oklahoma 74103-4514Phone: (918) 583-7129www.tulsalawyer.comasisemore@tulsalawyer.com1. Does your state recognize an exemption from discovery (or a privilege) forpre-suit investigation materials? Is there a key to preserving thisexemption/privilege (i.e. involvement of counsel)?Pre-suit investigative materials, including an insurance company’s claim file, are notautomatically protected from discovery. See Scott v. Peterson, 2005 OK 84, 126 P.3d1232. However, a party may not discover documents and tangible things prepared inanticipation of litigation or for trial by or for another party or its representative, includingthe other party’s attorney, consultant, surety, indemnitor, insurer or agent except (i) ifthey are otherwise discoverable (i.e., relevant and not privileged) and (ii) the partyshows that it has substantial need for the materials to prepare its case and cannot,without undue hardship, obtain their substantial equivalent by other means. 12 O.S. §3226(B)(3)(a). Documents prepared in the ordinary course of business are not deemedgenerated in anticipation of litigation merely because litigation was a contingency. Hallv. Goodwin, 1989 OK 88, 775 P.2d 291. The key to preserving the privilege is ensuringthe primary motivating purpose behind creation of the document be in aid of possiblefuture litigation, though litigation need not be imminent at the time of the document'screation. Hall v. Goodwin, 1989 OK 88, 775 P.2d 291. Because deference is affordedto attorney work-product, involvement of counsel is recommended.2. What is your state’s rule with regard to the discoverability of written orrecorded statements taken during investigation of an incident?A party or witness is entitled to production of his or her own written or recordedstatements. 12 O.S. § 3226(B)(3)(c). Oklahoma case law has distinguished betweenthe discoverability of statements taken during an investigation of an incident dependingon whether the statements were taken by an attorney or layperson. See Cowen v.Hughes, 1973 OK 11, 509 P.2d 461; Carman v. Fishel, 1966 OK 130, 418 P.2d 963(overruled on other grounds). Unless a party can show that statements taken by nonattorneysin an investigation are taken in anticipation of litigation, they will likely not bedeemed to fall under the work-product doctrine and will be discoverable. Even if thework-product doctrine applies, the statements may be discoverable upon a propershowing under 12 O.S. § 3226(B)(3)(a).

3. Does your state recognize a self-critical analysis privilege?Oklahoma has not adopted the self-critical analysis privilege, but does recognizeprotection of “measures taken [after an event] that would have made the earlier injury orharm less likely to occur.” 12 O.S. § 2407. “[E]vidence of subsequent measures is notadmissible to prove negligence, culpable conduct, a defect in a product or its design ora need for a warning or instruction in connection with the event. 12 O.S. § 2407.

OREGONWalter H. SweekNicholas E. WheelerCOSGRAVE VERGEER KESTER, LLP500 Pioneer Tower888 SW Fifth AvenuePortland, OR 97204Phone (503) 323-9000www.cosgravelaw.comwsweek@cosgravelaw.com1. Does your state recognize an exemption from discovery (or a privilege) forpre-suit investigation materials? Is there a key to preserving thisexemption/privilege (i.e. involvement of counsel)?Oregon’s lawyer-client privilege and work product doctrine encompass pre-suitinvestigation materials. United Pac. Ins. Co. v. Trachsel, 83 Or. App. 401, 731 P.2d1059 (1987). Preserving the lawyer-client privilege requires a “confidentialcommunication” between: (1) clients/“client representatives” and their lawyer/“lawyerrepresentatives,” (2) lawyers and “lawyer representatives” of the same client, and (3)the client and/or lawyer to another’s lawyer “in a matter of common interest.” O.E.C.503(2). Preserving the work product doctrine requires a showing that the investigationmaterials were “prepared in anticipation of litigation.” O.R.C.P. 36 B(3). However, workproduct immunity can be overcome by a showing that “the party seeking discovery hassubstantial need of the materials in the preparation of such party’s case and is unablewithout undue hardship to obtain the substantial equivalent of the materials by othermeans.” Id. If that showing can be made, the court must nonetheless “protect againstdisclosure of the mental impressions, conclusions, opinions, or legal theories of anattorney or other representative of a party concerning the litigation.” Id.2. What is your state’s rule with regard to the discoverability of written orrecorded statements taken during investigation of an incident?Written or recorded statements taken during the investigation of an incident are typicallywork product. Although not a state-wide rule, Multnomah County (Portland) typicallypermits discovery of such statements taken during the first 24 hours following theincident, if there is an inability to obtain a substantial equivalent. Mult. Co. Motion PanelStatement of Consensus, Section 2.I.2 (February 1, 2013). Further, any person(whether or not a party), is entitled to a copy of his/her own statement. O.R.C.P. 36B(3).

3. Does your state recognize a self-critical analysis privilege?No.

PENNSYLVANIAGary H. HunterGERMAN, GALLAGHER & MURTAGH, P.C.The Bellevue200 S. Broad StreetSuite 500Philadelphia, PA 19102Phone (215) 545-7700www.ggmfirm.comhunterg@ggmfirm.com1. Does your state recognize an exemption from discovery (or a privilege) forpre-suit investigation materials? Is there a key to preserving thisexemption/privilege (i.e. involvement of counsel)?Pennsylvania does not recognize a specific exemption from discovery for pre-suitinvestigation materials. Pa. R.C.P. 4003.1. All facts from any such investigation wouldbe discoverable unless they fall within another privilege or exemption under the rules.Pa. R.C.P. 4003.3. For instance, all attorney client communications are privileged andtherefore non-discoverable. In addition, the mental impressions of a party’s attorney orhis or her conclusions, opinions, memoranda, notes or summaries, legal research orlegal theories are not discoverable. With respect to the representative of a party otherthan an attorney (this primarily applies to a claims representative of an insurancecarrier), discovery shall not include disclosure of his or her mental impressions,conclusions or opinions respecting the value or a merit of a claim or defense or withrespect to strategy or tactic. Further, expert discovery in Pennsylvania is extremelylimited. A party may only receive limited information regarding the opinions of an expertand the basis of his/her opinion so long as that expert is anticipated to be called at timeof trial. Pa. R.C.P 4003.5.2. What is your state’s rule with regard to the discoverability of written orrecorded statements taken during investigation of an incident?Under Pennsylvania Rule of Civil Procedure 4003.4, upon written request, a party isentitled to immediate receipt of a statement concerning the action or its subject matterpreviously made by that party, any other party or a witness. Statements under the ruleinclude a written statement signed or otherwise adopted or approved by the personmaking it or a stenographic, mechanical, electrical or other recording or its transcriptionthereof, which is a substantially verbatim recital of an oral statement by the personmaking it and contemporaneously recorded. Statements taken during an investigationof an incident are discoverable under this rule unless it is a privileged communicationbetween client and attorney or is attorney work product.3. Does your state recognize a self-critical analysis privilege?

Only for peer review for professionals. Not in the product liability or transportationcontext.

RHODE ISLANDStephen B. LangHIGGINS, CAVANAGH & COONEY, LLPThe Hay Building 123 Dyer StreetProvidence, RI 02903Phone (401) 272-3500www.hcc-law.comslang@hcc-law.com1. Does your state recognize an exemption from discovery (or a privilege) forpre-suit investigation materials? Is there a key to preserving thisexemption/privilege (i.e. involvement of counsel)?In Rhode Island, pre-suit investigation materials may be afforded qualified immunityfrom discovery if considered “factual” work product, with “the party asserting thedoctrine ha[ving] the burden of establishing that the document was prepared inanticipation of litigation.” State v. Lead Indus. Ass’n, Inc., 64 A.3d 1183, 1193 (R.I.2013) (citing Gaumond v. Trinity Reperatory Co., 909 A.2d 512, 517 (R.I. 2006)). Thisapplies to “any material gathered in anticipation of litigation,” even those materialsprepared by non-attorneys. Id. (quoting Henderson v. Newport Cnty. Reg’l YoungMen’s Christian Ass’n, 966 A.2d 1242, 1248 (R.I. 2009)). However, a party seekingsuch discovery may still overcome this qualified immunity by showing substantial needand an inability to obtain equivalent materials without undue hardship. See id. (citingCrowe Countrywide Realty Associates, Co. v. Novare Engineers, Inc., 891 A.2d 838,842 (R.I. 2006)); see also R.I. Super. R. Civ. P. 26(b)(3).2. What is your state’s rule with regard to the discoverability of written orrecorded statements taken during investigation of an incident?The qualified immunity provided to factual work product applies to all “documents andtangible things,” which would include written or recorded statements taken during aninvestigation provided that such statements were recorded “in anticipation of litigation.”R.I. Super. R. Civ. P. 26(b)(3).3. Does your state recognize a “self-critical analysis” privilege?Yes, Rhode Island recognizes a “self-critical analysis” privilege with regard to the“records” and “proceedings” of medical peer-review boards. See R.I.G.L. § 23-17-25(a).However, the privilege “does not render immune information otherwise available fromoriginal sources even if the information was presented at a peer-review committeemeeting.” Moretti v. Lowe, 592 A.2d 855, 858 (R.I. 1991).

SOUTH CAROLINADuke R. HighfieldVictoria L. AndersonYOUNG CLEMENT RIVERS, LLP25 Calhoun Street, Suite 400Charleston, SC 29401Phone (843) 720-5456www.ycrlaw.comdhighfield@ycrlaw.com1. Does your state recognize an exemption from discovery (or a privilege) forpre-suit investigation materials? Is there a key to preserving thisexemption/privilege (i.e. involvement of counsel)?South Carolina does not recognize a specific exemption from discovery for pre-suitinvestigation; rather, a party must assert attorney-client privilege or privilege under thework-product doctrine with regard to any materials it seeks to preserve in confidence.The essential elements giving rise to the [attorney-client] privilege [are]:“(1) Where legaladvice of any kind is sought (2) from a professional legal adviser in his capacity assuch, (3) the communications relating to that purpose (4) made in confidence (5) by theclient, (6) are at his instance permanently protected (7) from disclosure by himself or bythe legal adviser, (8) except the protection be waived.” State v. Doster, 276 S.C. 647,651, 284 S.E.2d 218, 219-20 (1981) (internal citations omitted). The attorney workproduct doctrine protects from discovery documents prepared in anticipation of litigation,unless a substantial need can be shown by the requesting party. See Rule 26(b)(3),SCRCP; Hickman v. Taylor, 329 U.S. 495, 67 S.Ct. 385, 91 L.Ed. 451 (1947).Generally, in determining whether a document has been prepared “in anticipation oflitigation,” most courts look to whether or not the document was prepared because ofthe prospect of litigation. Tobaccoville USA, Inc. v. McMaster, 387 S.C. 287, 294, 692S.E.2d 526, 530 (2010) (internal citation omitted).2. What is your state’s rule with regard to the discoverability of written orrecorded statements taken during investigation of an incident?The scope of discovery is very broad in South Carolina, in that “[p]arties may obtaindiscovery regarding any matter, not privileged, which is relevant to the subject matterinvolved in the pending action.” Rule 26(b)(1), SCRCP. Therefore, written or recordedstatements taken during accident investigation are discoverable unless such fall underthe category of privilege as discussed above.

3. Does your state recognize a self-critical analysis privilege?No. South Carolina does not recognize this privilege.

SOUTH DAKOTAW. Todd HaggartM. Daniel VogelVOGEL LAW FIRM218 NP AvenueFargo, ND 58102Phone (701) 237-6983thaggart@vogellaw.comwww.vogellaw.com1. Does your state recognize an exemption from discovery (or a privilege) forpre-suit investigation materials? Is there a key to preserving thisexemption/privilege (i.e. involvement of counsel)?Other than a previous statement, documents and tangible things produced by a party orits representative in anticipation of litigation are not discoverable unless the opposingparty shows a substantial need for the information that cannot otherwise be obtainedwithout undue hardship. SDCL 15-6-26(b)(3); but see, SDCL 15-6-26(b)(4) (substanceand subject matter of facts and opinions developed by expert in anticipation of litigationare discoverable through interrogatories and other means ordered by the court).However, if an insurer unequivocally delegates its claims function and relies exclusivelyon outside counsel to conduct an investigation and determination of coverage, theresulting documents and work product are not privileged. Dakota, Minnesota, & EasternR.R. Corp. v. Acuity, 2009 SD 69, 56, 771 N.W.2d 623.2. What is your state’s rule with regard to the discoverability of written orrecorded statements taken during investigation of an incident?Generally the same as above.3. Does your state recognize a self-critical analysis privilege?No.

TENNESSEEJohn R. TarpleyRichard W. KriegLEWIS, KING, KRIEG & WALDROP, P.C.One Centre Square 5 th Floor620 Market StreetKnoxville, TN 37902Phone (865) 546-4646www.lewisking.comdkrieg@lewisking.com1. Does your state recognize an exemption from discovery (or a privilege) forpre-suit investigation materials? Is there a key to preserving thisexemption/privilege (i.e. involvement of counsel)?Yes. Tennessee’s work product doctrine, codified in Tennessee Rule of Civil Procedure26.02, extends to any document prepared in anticipation of litigation by or for theattorney. The “key” to preserving the exemption is that the document be clearly notedas being prepared in anticipation of litigation by the attorney conducting theinvestigation. See State ex rel. Flowers v. Tennessee Trucking Ass’n Self-Ins. GroupTrust, 209 S.W.3d 602, 616 (Tenn. Ct. App. 2006) (perm. app. denied). It should benoted, however, that when this protection is invoked the claim must be made expresslyand describe the nature of the documents in such a manner that, while not revealing theprotected information, will allow the parties to assess the applicability of the protection.2. What is your state’s rule with regard to the discoverability of written orrecorded statements taken during investigation of an incident?So long as such writings or documents were prepared in anticipation of litigation, theyare protected by Tennessee’s work product doctrine, codified in Tennessee Rule of CivilProcedure 26.02. When invoking this protection, however, the rule requires that thisclaim be made expressly and describe the nature of the documents in such a mannerthat, while not revealing the protected information, will allow the parties to assess theapplicability of the protection.3. Does your state recognize a self-critical analysis privilege?No.

TEXASJ.K. LeonardWhitney BroadwaterNAMAN HOWELL SMITH & LEE, PLLC10001 Reunion Place, Suite 600San Antonio, TX 78216Phone (210) 731-6300www.namanhowell.comjkleonard@namanhowell.com1. Does your state recognize an exemption from discovery (or a privilege) forpre-suit investigation materials? Is there a key to preserving thisexemption/privilege (i.e. involvement of counsel)?Texas’ work product doctrine will exempt from discovery any “material prepared ormental impressions developed in anticipation of litigation or for trial” by or for a party orits representatives (which includes attorneys, consultants, sureties, indemnitors,insurers, employees, or agents). TEX. R. CIV. P. 192.5(a). Also protected arecommunications made in anticipation of litigation or for trial between a party and theparty's representatives or among a party's representatives (defined above). Id. “Corework product” - that which contains mental impressions, opinions, conclusions, or legaltheories - is not discoverable. TEX. R. CIV. P. 192.5(b)(1). Non-core work product isdiscoverable upon a showing that the party seeking discovery has substantial need ofthe materials for the preparation of the party's case and that the party is unable withoutundue hardship to obtain the substantial equivalent of the material by other means.TEX. R. CIV. P. 192.5(b)(2). Certain work product is never protected from discovery: “(1)information discoverable under Rule 192.3 concerning experts, trial witnesses, witnessstatements, and contentions; (2) trial exhibits ordered disclosed under Rule 166 or Rule190.4; (3) the name, address, and telephone number of any potential party or anyperson with knowledge of relevant facts; (4) any photograph or electronic image ofunderlying facts (e.g., a photograph of the accident scene) or a photograph or electronicimage of any sort that a party intends to offer into evidence; and (5) any work productcreated under circumstances within an exception to the attorney-client privilege in Rule503(d) of the Rules of Evidence.” Id. § 192.5(c).2. What is your state’s rule with regard to the discoverability of written orrecorded statements taken during investigation of an incident?A witness statement that is signed, adopted, or approved in writing by the personmaking it, or a recording or transcript of such recording of a witness statement arediscoverable under Texas Rule of Civil Procedure 192.3(h). However, notes taken byan individual during an interview or conversation with a witness are not discoverablestatements. See TEX. R. CIV. P. 192.3(h).

3. Does your state recognize a self-critical analysis privilege?No.

UTAHHeidi G. GoebelCHRISTENSEN & JENSEN, P.C.257 East 200 South. St. 1100Salt Lake City, UT 84111Phone (801) 323-5000www.chrisjen.comHeidi.goebel@chrisjen.com1. Does your state recognize an exemption from discovery (or a privilege) forpre-suit investigation materials? Is there a key to preserving thisexemption/privilege (i.e. involvement of counsel)?U.R.C.P. 26(b)(5) (2014) indicates that pre-suit investigation materials are exempt fromdiscovery (with some limited exceptions) where it can be shown that they are preparedin anticipation of litigation. In evaluating whether such materials are prepared inanticipation of litigation, factors to be considered include: whether the investigation wasdone solely at the insistence of management-level employees, Gold Standard v. Am.Barrick Resources Corp., 805 P.2d 164, 168 (Utah 1990); whether an attorneyrequested or was involved in the investigation, id.; and whether the primary motivatingpurpose behind the creation of the document was anticipation of litigation, id. at 170.Documents in an insurer’s claim file may be protected as work product if it can beshown, on a case by case basis, that the documents were prepared in anticipation oflitigation and not in the ordinary course of the insurer’s business. Askew v. Hardman,918 P.2d 469, 474-76 (Utah 1996).2. What is your state’s rule with regard to the discoverability of written orrecorded statements taken during investigation of an incident?U.R.C.P. 26.2(c)(4) (2014) requires that defendants produce “copies of all written orrecorded statements of individuals, in the possession of defendant, defendant’sinsurers, or counsel.” The rule recognizes, however, that such statements do not needto be produced where they are “protected by Rule 26(b)(5)” (the work product doctrine).Id. Written and recorded statements taken by an insurer may be protected as workproduct if it can be shown, on a case by case basis, that the documents were preparedin anticipation of litigation. Askew, 918 P.2d at 474-75.3. Does your state recognize a self-critical analysis privilege?Not in the Product Liability or Transportation context.

VERMONTMark F. WerleRYAN, SMITH & CARBINE, LTD98 Merchants RowP.O. Box 310Rutland, VT 05702-0310Phone (802) 786-1000www.rsclaw.commfw@rsclaw.com1. Does your state recognize an exemption from discovery (or a privilege) forpre-suit investigation materials? Is there a key to preserving thisexemption/privilege (i.e. involvement of counsel)?Vermont recognizes a qualified privilege protecting from discovery documents “preparedin anticipation of litigation by or for another party’s representative, including documentsprepared by or for the other party’s insurer or agent.” Pcolar v. Casella Waste Systems,Inc., 2012 VT 58, 17, 192 Vt. 343, 59 A.3d 702. The privilege can be overcome “upona showing that the party seeking discovery has substantial need of the materials in thepreparation of the party’s case and that the party is unable without undue hardship toobtain the substantial equivalent of the materials by any other means.” Vt.R.Civ.P.26(b)(3). When work-product is ordered to be disclosed, “the judge shall protect themental impressions, conclusions, opinions, or legal theories” of an attorney or otherrepresentative of the party concerning the litigation.” Id. One trial court has held that ifthe plaintiff and defendant share the same insurance carrier, any statement made froma party to the insurance carrier prior to litigation is not privileged. See Reposa v.Landon, Dkt. No. 1102-06 CnCiv (Vt. Sup’r Ct. Dec.24, 2007 [Katz, J.]) (finding that“[p]rior to litigation, an insurance company representing both parties is viewed as a dualagent . . . of the party making the statement and also of the potentialadversary”)(internal citations omitted).2. What is your state’s rule with regard to the discoverability of written orrecorded statements taken during investigation of an incident?Vermont’s qualified work-product privilege extends to protect written and recordedstatements taken during investigation as material developed in anticipation of litigation,but it may be overcome upon a showing of substantial need and an inability to obtainthe substantial equivalent without undue hardship. Pcolar v. Casella Waste Systems,Inc., 2012 VT 58, 18, 192 Vt. 343, 59 A.3d 702 (the recorded interview of defendant’struck driver conducted by an adjuster for defendant’s insurance company nineteen daysafter plaintiff contacted the defendant’s CEO about the accident at issue in the litigationis protected from discovery); see Vt.R.Civ.P. 26(b)(3).

Statements made by a party during an investigation are discoverable. Vermont’s rulesand trial courts recognize that a party’s statements to an agent of her opponent are notshielded from disclosure by the work-product privilege. See Vt.R.Civ.P. 26(b)(3)(“Aparty may obtain without the required showing a statement concerning the action or itssubject matter previously made by that party.”). In fact, a trial court has even extendedthe disclosure of “party statements” to include a party’s non-party relative. Hermann v.Hewitt, Dkt. No. 272-2-05 Bncv (Vt. Sup’r. Ct. Jan. 26, 2006)(plaintiff’s statement andplaintiff’s uncle’s witness statement to the defendant’s insurer following the car accidentthat was the subject of the suit were not protected from disclosure by the work-productdoctrine).3. Does your state recognize a self-critical analysis privilege?The self critical analysis privilege applies in medical peer review cases. Vt. Stat. Ann. tit.26, § 1443. No state courts have considered the privilege outside of the medical reviewcontext; the one reported Vermont federal court decision that considered the privilegedeclined to adopt the privilege outside of medical review. Lawson v. Fisher-Price, 191F.R.D. 381 (D. Vt. 1999). Lawson would be persuasive, but not binding, on Vermontstate courts.

VIRGINIAD. Cameron Beck, Jr.MORRIS & MORRIS, P.C.11 South 12 th Street, 5 th FloorRichmond, VA 23219Phone (804) 344-8300www.morrismorris.comcbeck@morrismorris.com1. Does your state recognize an exemption from discovery (or a privilege) forpre-suit investigation materials? Is there a key to preserving thisexemption/privilege (i.e. involvement of counsel)?Rule 4:1(b)(3) of the Supreme Court of Virginia provides that a party may obtaindiscovery of work product prepared by or on behalf of a party in anticipation of litigationonly by showing that “the party seeking discovery has substantial need of the materialsin the preparation of his case and that he is unable without undue hardship to obtain thesubstantial equivalent of the materials by other means.” The circuit courts are indisagreement as to the point at which documents or things are considered as havingbeen prepared in anticipation of litigation, but the majority of courts consider thetriggering event to be the retention or consultation of counsel. See McDougall v. Dunn,468 F.2d 468, 473 (4th Cir.1972). Other courts, however, allow for the possibility of anearlier claim to the privilege, and follow a case by case analysis. See State Farm v.Perrigan, 102 F.R.D. 235, 238 (W.D.Va.1984).2. What is your state’s rule with regard to the discoverability of written orrecorded statements taken during investigation of an incident?Virginia Code section 8.01-417(A) requires that any written or recorded statement takenfrom an injured person be turned over to the injured person at their request. Rule 4:1 ofthe Supreme Court of Virginia provides that statements made by a party concerning theaction be provided to the party at his or her request.3. Does your State recognize the self-critical analysis privilege?Virginia Code Section 8.01-581.17 recognizes this privilege in terms of peer reviews inmedical malpractice cases. The state has not recognized the privilege in a broadercontext.

WASHINGTONTamara K. NelsonSylvia J. HallMERRICK, HOFSTEDT & LINDSEY, P.S.3101 Western Avenue, Suite 200Seattle, Washington 98121Tel.: (206) 682-0610www.mhlseattle.comtnelson@mhlseattle.com1. Does your state recognize an exemption from discovery (or a privilege) forpre-suit investigation materials? Is there a key to preserving thisexemption/privilege (i.e. involvement of counsel)?Washington Superior Court Civil Rule 26(b)(4) provides a limited exemption for pre-suitinvestigation materials under the work-product doctrine. Washington Civil Rule 26(b)does not distinguish between the work product of attorneys and non-attorneys. Thedetermining factor for whether the materials are exempt from discovery is whether theyare created “in anticipation of litigation” as opposed to “the ordinary course of business”.If specific litigation can be reasonably anticipated from the outset of an incident, and thedominant purpose of the investigation is to prepare to defend the potential claim, theinvestigation materials will fall under the work product doctrine. Heidebrink v. Moriwaki,104 Wn.2d 392, 706 P.2d 212 (1985). If the investigation materials are created in theordinary course of business and not in anticipation of litigation, the materials will not beexempt from discovery. Even if created in anticipation of litigation, materials may bediscovered if the requesting party shows a substantial need of the materials in thepreparation of his case and that he is unable without undue hardship to obtain thesubstantial equivalent of the materials by other means. In ordering discovery of suchmaterials when the required showing has been made, the court shall protect againstdisclosure of the mental impressions, conclusions, opinions, or legal theories of anyattorney or other representative of a party concerning the litigation.2. What is your state’s rule with regard to the discoverability of written orrecorded statements taken during investigation of an incident?Washington Superior Court Civil Rule 26(b) governs the discoverability of written andrecorded statements taken during an investigation. A party or witness is entitled to acopy of his or her own statement without any requisite showing of good cause. Awritten or recorded statement of another person is only discoverable if the party seekingthe discovery has substantial need of the materials in the preparation of his case andthat he is unable without undue hardship to obtain the substantial equivalent of thematerials by other means. Courts will generally only require the disclosure of thestatement if the statement is made by a witness or a party whose testimony is relevantand the declarant is unavailable.

3. Does your state recognize a self-critical analysis privilege?No.

WEST VIRGINIAEdward J. GeorgeROBINSON & McELWEE, PLLC400 Fifth Third Center700 Virginia Street, EastCharleston, WV 25301Phone (304) 344-5800www.ramlaw.comejg@ramlaw.com1. Does your state recognize an exemption from discovery (or a privilege) forpre-suit investigation materials? Is there a key to preserving thisexemption/privilege (i.e. involvement of counsel)?Pre-suit investigations and related material may be exempt from discovery in WestVirginia under the work product doctrine. Whether or not this privilege applies dependson why the pre-suit investigation was performed. Documents prepared in theanticipation of litigation are subject to the work product doctrine. Documents preparedin the normal course of business are not protected as work product. “[T]he test shouldbe whether, in light of the nature of the document and the factual situation in theparticular case, the document can fairly be said to have been prepared or obtainedbecause of the prospect of litigation. But the converse of this is that even thoughlitigation is already in prospect, there is no work product immunity for documentsprepared in the regular course of business rather than for purposes of litigation.” Stateex rel. United Hosp. Ctr., Inc. v. Bedell, 199 W. Va. 316, 328, 484 S.E.2d 199, 211(1997). “[T]o determine whether a document was prepared in anticipation of litigationand, is therefore, protected from disclosure under the work product doctrine, the primarymotivating purpose behind the creation of the document must have been to assist inpending or probable future litigation.” State ex rel. United Hosp. Ctr., Inc. v. Bedell, 199W. Va. 316, 330, 484 S.E.2d 199, 213 (1997). Although a pre-suit investigationprepared in anticipation of litigation is protected by the work product doctrine, thatinformation may still be discoverable. West Virginia distinguishes between “fact workproduct” and “opinion work product.” “[F]act work product, ordinarily, may bediscovered upon a showing of ‘substantial need’ and ‘undue hardship to obtain thesubstantial equivalent by other means.’ W.Va.R.Civ.P. 26(b)(3). . . opinion work producthowever is discoverable only where ‘very rare and extraordinary circumstances’ arepresent.” State ex rel. United Hosp. Ctr., Inc v. Bedell, 199 W. Va. at 331, 484 S.E.2d at214 (citations omitted).2. What is your state’s rule with regard to the discoverability of written orrecorded statements taken during investigation of an incident?The same standard outlined above in United Hospital would seem to apply to all writtenor recorded statements. United Hospital involved an “Investigation Report” whichcontained a written statement from a hospital employee.

3. Does your state recognize a self-critical analysis privilege?No.

WISCONSINJohn J. LaffeyWilliam E. HughesAnthony J. AnzelmoWHYTE HIRSCHBOECK DUDEK S.C555 East Wells Street, Suite 1900Milwaukee, WI 53202-3819Phone (414) 978-5301www.whdlaw.comjlaffey@whdlaw.com1. Does your state recognize an exemption from discovery (or a privilege) forpre-suit investigation materials? Is there a key to preserving thisexemption/privilege (i.e. involvement of counsel)?Yes. The seminal case is State ex rel. Dudek v. Circuit Court for Milwaukee County, 34Wis.2d 559, 150 N.W.2d 387 (1967). The key is involving counsel, and having theinvestigation proceed at his or her direction “in anticipation of litigation” in order toinvoke the benefit of the privilege(s). See Id., 150 N.W.2d at 404-407; Wis. Stat.804.01(c).2. What is your state’s rule with regard to the discoverability of written orrecorded statements taken during investigation of an incident?For parties, there are two general rules compelling production. The first is set forth inWis. Stat. Wis. Stat. §804.01(2)(c)(2):a party may obtain without the required showing [(i.e., substantial need/unduehardship to obtain otherwise)] a statement concerning the action or its subjectmatter previously made by that party. Upon request, a person not a party mayobtain without the required showing a statement concerning the action or itssubject matter previously made by that person.Wisconsin also has a rule of evidence, Wis. Stat. § 904.12(2), which provides in relevantpart:Every person who takes a written statement from any injured person or personsustaining damage with respect to any accident or with respect to any injury toperson or property, shall, at the time of taking such statement, furnish to theperson making such statement, a true, correct and complete copy thereof. . .Recorded statements of non-party witnesses taken at the direction of attorneys aresubject to the Dudek analysis and work-product protections discussed above.3. Does Wisconsin recognize a "self critical analysis" ?

Wisconsin has not definitively ruled; however, a viable predictor is that the SeventhCircuit has “never recognized” the self-critical analysis privilege. Burden-Meeks v.Welch, 319 F.3d 897, 899 (7th Cir.2003).

WYOMINGJames WorthenMURANE & BOSTWICK, LLC201 North Wolcott St.Casper, WY 82601307-634-7500www.murane.comjcw@murane.com1. Does your state recognize an exemption from discovery (or a privilege) forpre-suit investigation materials? Is there a key to preserving thisexemption/privilege (i.e. involvement of counsel)?Other than “reports, findings, proceedings and data” presented to a medical reviewpanel organized pursuant to and acting under the provisions of W.S. §35-17-101 et.seq., and apart from the limited protections provided by Wyoming’s Rule 26 equivalentto F.R.C.P. 26(b)(3), there is no statue, rule or decision specifically providing an“exemption” or “privilege” for pre-suit investigation materials. Dependent upon the factsand the nature of a specific document, in state court there remains the possibility thatsuch reports will be protected from discovery. In the United States District Court for theDistrict of Wyoming there is a probability that such documents will be subject todiscovery.In a 34 year-old Wyoming Supreme Court decision, Thomas v. Harrison, 634 P.2d 328(Wyo. 1981), the Court held that statements and reports from the defendant physician tohis insurance carrier were prepared in anticipation of litigation and not discoverableabsent a showing of substantial need and the inability, without undue burden, to obtainthe substantial equivalent by other means. Thomas has been cited in later WyomingSupreme Court decisions, but only one of which addressed Rule 26(b)(3) provisions inthe context of this topic, and then only to raise questions as to the continuing influenceof the decision. First Wyoming Bank, N.A., Jackson Hole v. Continental Ins. Co. 860P.2d 1064, 1087-1088 (Wyo. 1993). It is also important to note that none of themembers of the court that decided Thomas v. Harrison remain on the bench.The interpretation and application of FRCP 26(b)(3) in Wyoming provide significantlyless protection to those seeking to limit discovery of accident and incident reports thanis provided by Thomas v. Harrison. If an insurer retains an adjuster or investigator, inthe absence of a letter, demand or other writing from claimant’s counsel advising that alawsuit will be filed, the chance of prevailing on a claim that adjuster/investigator reportswere prepared in anticipation of litigation will likely not prevail. If outside counsel retainsthe investigator and controls the investigation, the argument to protect the materialsbecomes more credible.

2. What is your state’s rule with regard to the discoverability of written orrecorded statements taken during investigation of an incident?The same principals discussed above would apply to statements taken during aninvestigation.3. Does your state recognize a self-critical analysis privilege?No.

ALFA INTERNATIONAL2015 INTERNATIONAL CLIENT SEMINARFAIRMONT SCOTTSDALE PRINCESS –SCOTTSDALE, ARIZONAMARCH 5–8, 2015Strategies For Avoiding Qui Tam Relator(Whistleblower) Controversies And ActionsPatrick CoffeyLeader, Corporate Compliance &White Collar Defense PracticeWHYTE HIRSCHBOECK DUDEK, S.C.Milwaukee, Wisconsin(414) 978-5538pcoffey@whdlaw.comChristopher E. KnightManaging ShareholderFOWLER WHITE BURNETT P.A.Miami, Florida(305) 789-9210cknight@fowler-white.comSteven K. CoveySenior Vice President, General Counsel & Chief Ethics OfficerNAVISTAR INTERNATIONALLisle, Illinoiswww.navistar.com

The Increasing Threat of Whistleblower Claims and RelatedEnforcement: Insights on Effective Risk Management 1Whistleblower claims and related enforcement actions continue to escalate across awide swath of industry sectors with the bulk of claims being directed at health careproviders, financial institutions, pharmaceutical and device companies, defensecontractors, and manufacturing concerns. Those who have experienced (some wouldsay endured) the costs, distraction and other consequences of enforcement or litigationinvolving whistleblowers will attest to the pain associated with these controversies.Again last year, blaring headlines accompanied reports of settlements and casesinstituted by whistleblowers. These controversies and the billions paid in settlementshave been widely touted by government enforcement authorities as well as the qui tamrelator bar, and they both continue efforts to increase claims and promote whistleblowerprograms. As the numbers and types of whistleblower claims being filed underwhistleblower laws continue to grow, there is growing acceptance that whistleblowerswill continue to confront company management teams with claims carrying significantrisk of enforcement and attendant legal, financial and business reputational costs anddamage.These cases have also prompted predictions that companies are going to have lessability to identify and correct problems using traditional compliance strategies and tools.As the government and whistleblower bar continue to encourage the filing of claims,1 Article prepared by Patrick Coffey, leader of the White Collar Defense and Compliance Practice at theAFLA International firm of Whyte Hirschboeck Dudek S.C., of Milwaukee, Wisconsin.1

there is mounting frustration over these efforts and the further resulting challenge ofgetting employees to work through internal channels to address problems. Regardless,savvy corporate managers for companies in the line of fire are moving expeditiously toimprove internal reporting mechanisms and ensure that they address employeeconcerns and complaints are properly addressed.This article will survey components of the growing arsenal of tools available towhistleblowers, and, more importantly, address what has become the predominanttrigger for whistleblower controversy. The article offers practical suggestions formanaging risk based on the hard lessons learned by companies who have beenexposed to enforcement as a result of whistleblowers. While by no means an easytask, the premise of this article is that there are practical measures that can beemployed to address this risk effectively and reduce whistleblower claims and theirconsequences.I. Overview of Notable Whistleblower LawsA. The False Claims ActThe False Claims Act (“FCA”) 2 was enacted during the Civil War in an effort to combatfraud by suppliers of goods and materials to the Union Army. 3The law has beenamended various times but generally prohibits the knowing making of false claims (orcausing false claims to be made) in order to get the government to pay claims for goods2 31 U.S.C. § 3729 et seq.3 The False Claims Act-Department of Justice, A Primer (April 22, 2011),http://www.justice.gov/sites/default/files/civil/legacy/2011/04/22/C-FRAUDS_FCA_Primer.pdf.2

or services. Although the FCA makes provision for the civil or criminal enforcement ofknowing false claims, the majority of FCA cases brought by the Department of Justice(“DOJ”) involve alleged civil violations and seek the recovery of actual damages andexemplary penalties. In addition, the FCA also makes provision for relief to individualswho are subjected to termination or other retaliation for reporting suspected FCAviolations, and there is growing use of that portion of law by whistleblowers who claimthey have been subject to retaliation for their reporting of false claims. 4The qui tam provisions of the FCA reward whistleblowers (also known as relators) withup to 30% of the funds recovered by the government, and provide a private right ofaction that allows relators to pursue cases even where the government after review andtypically a lengthy investigation declines to intervene and prosecute. 5While thenumbers of FCA cases in which the government elects to intervene have not grownsubstantially despite increasing numbers of qui tam filings, there is a growing ability andwillingness on the part of qui tam relator lawyers to invest in the continued prosecutionof whistleblower claims without regard to DOJ intervention decisions.While the FCA is arguably the most effective whistleblower statute in existence, it is farfrom the only false claims law being utilized by whistleblowers. For example, to dateapproximately 30 states have enacted false claims laws that are similar or evenmodeled on the FCA. 6 These state whistleblower laws contain similar reward provisionsas well as legal protections against retaliation. Claims under these statutes are being4 Id. at 3730(h).5 31 U.S.C. § 3730 et seq.6 See, e.g., Illinois False Claims Act, 740 ILCS 175/1 et seq. (including Illinois Whistleblower Reward andProtection Act), http://www.ilga.gov/legislation/ilcs/ilcs3.asp?ActID=2058&ChapterID=573

increasingly added to FCA complaints filed in federal court or filed alone in state courts,and there has been a fast developing capability on the part of state fraud enforcementauthorities to pursue these cases and share in the recoveries being driven bywhistleblower reporting.1. FCA Whistleblower Case Recoveries and Related IssuesIn November 2014, the DOJ announced a record setting $5.69 billion in recoveriesunder the FCA for fiscal year 2014, including nearly $3 billion in recoveries related toactions filed by whistleblowers under the FCA. 7 The government paid $435 million towhistleblowers who filed qui tam complaints under the FCA in FY 2014, and reported713 newly filed lawsuits under the qui tam provisions of the statute. As stated by theDOJ, “[t]he growing number of qui tam lawsuits filed since 2009 has led to increasedrecoveries, which exceeded $2 billion for the first time in fiscal year 2010, and hasapproached or exceeded $3 billion ever since.” 8It is apparent to practitioners handling FCA cases that the DOJ has come toincreasingly rely on whistleblowers to assist in the detection and reporting of fraud.While the numbers of FCA cases accepted for intervention by the government have notgrown substantially, whistleblowers are viewed by the government as important sourcesof reported fraud in connection with government contract and other regulated activityand are expressly encouraged. In response to the typical lament of FCA targets thatfalse claims allegations are the product of “disgruntled former employees,” the7 Press Release, U.S. Department of Justice, Justice Department Recovers Nearly $6 Billion from FalseClaims Act Cases in Fiscal Year 2014 (Nov. 20, 2014), http://www.justice.gov/opa/pr/justicedepartment-recovers-nearly-6-billion-false-claims-act-cases-fiscal-year-2014.8 Id.4

government scrutinizes whistleblower motivation but operates with the fundamentalperspective that the only real issue is whether a relator is able to provide cogentevidence of wrongdoing.In addition to recognizing the value represented bywhistleblowers as internal sources of information about potentially fraudulent conduct,the government is also keenly interested in understanding a target company and itsmanagement’s actions in response to reported problems. The DOJ carefully evaluatesmanagement’s response to whistleblower complaints and related company efforts toensure compliance with the law.At the end of the day, whistleblowers and their relator counsel are increasingly beingrelied upon and used by DOJ and its investigators to assist in the identification anddevelopment of these cases. This circumstance offers the government the furtherbenefit of assisting in the attainment of its fraud enforcement agenda without theinvestment of the government’s own investigative time and resources that wouldotherwise be required.2. Recent FCA Whistleblower Case SettlementsA sampling of reported FCA settlements and cases last year includes the following:Bank of America Corporation (Countrywide) – $1.85 billion to resolve formerexecutive’s FCA complaint relating to the origination and sale of mortgages to FannieMae and Freddie Mac. Relator awarded $58 million. 9Johnson & Johnson (Janssen Pharmaceuticals and Scios subsidiaries) – $1.1billion settlement in resolution of FCA claims relating to the promotion of drugs forunapproved uses. Multiple whistleblowers paid rewards over $167 million. 109 Id.5

Supreme Foodservice A.G. – Criminal fraud conviction and False Claims Actsettlement for former executive’s complaint of overcharges under contract to supplyfood and water to U.S. troops. Criminal penalties of $288 million, and FCA settlementof whistleblower action for $101 million, with $16 million to relator and $1.1 million infees to relator counsel. 11The Boeing Company – $23 million settlement under FCA for alleged false claimsrelating to labor charges under maintenance contract with U.S. Air Force. Current andformer employee whistleblowers paid $3.9 million. 12CA Inc. – DOJ intervention in FCA qui tam suit alleging knowing overcharges forsoftware licenses and maintenance services under GSA contract. Qui tam action filedby former employee of foreign subsidiary. 13Community Health Systems, Inc. – One of the largest acute care systems in thecountry agreed to pay over $98 million to resolve multiple qui tam lawsuits filed underthe FCA alleging the fraudulent billing of unnecessary inpatient admissions.Whistleblower awards not yet determined for former director, nurses, and physicianrelators. 14 3. New DOJ Enforcement Policy on Whistleblower ClaimsThe DOJ recently announced a new policy calling for the review of all civil qui tamcomplaints filed under the FCA. Leslie R. Caldwell, Assistant Attorney General for theDOJ’s Criminal Division, announced at a conference sponsored by Taxpayers Against10 Press Release, U.S. Department of Justice, Johnson & Johnson to Pay More Than $2.2 Billion toResolve Criminal & Civil Investigations (Nov. 4, 2013), http://www.justice.gov/opa/pr/johnson-johnsonpay-more-22-billion-resolve-criminal-and-civil-investigations.11 Press Release, U.S. Department of Justice, Defense Contractor Pleads Guilty to Major Fraud inProvision of Supplies to U.S. Troops in Afghanistan (Dec. 8, 2014),http://www.justice.gov/opa/pr/defense-contractor-pleads-guilty-major-fraud-provision-supplies-ustroops-afghanistan.12 Press Release, U.S. Department of Justice, Boeing Pays $23 Million to Resolve False Claims ActAllegations (Oct. 10, 2014), http://www.justice.gov/opa/pr/boeing-pays-23-million-resolve-false-claimsact-allegations.13 Press Release, U.S. Department of Justice, Government Files Complaint Against CA Inc. for FalseClaims on GSA Contract (May 29, 2014), http://www.justice.gov/opa/pr/government-files-complaintagainst-ca-inc-false-claims-gsa-contract.14 Press Release, U.S. Department of Justice, Community Health Systems Inc. to Pay $98.15 Million toResolve False Claims Act Allegations (Aug. 4, 2014), http://www.justice.gov/opa/pr/community-healthsystems-inc-pay-9815-million-resolve-false-claims-act-allegations.6

Fraud 15 that the DOJ’s Criminal Division Fraud Section would begin to review filed civilFCA actions for purposes of potential parallel criminal investigation and enforcement.In her reported remarks, Assistant Attorney General Caldwell stated “[q]ui tam casesare a vital part of the Criminal Division’s future efforts” to combat fraud on thegovernment. 16 Accordingly, DOJ will now require all newly filed qui tam cases to beshared with criminal enforcers for evaluation for potential criminal investigation andprosecution. While this new policy is certainly consistent with the high priority beingassigned to enforcement of whistleblower and other claims under the FCA, there issubstantial question whether the policy will translate to even more aggravated civil andcriminal investigation of cases filed by relators. The fact that whistleblower cases will besubject to an additional level of review by experienced criminal fraud prosecutors shouldat least give pause to companies and officials who may not have taken the threat ofwhistleblower cases under the FCA as seriously as they should have in the past. Whilethere is a stark difference between cases that are accepted for civil prosecution underthe FCA and those satisfying the much more exacting standards required to support acriminal action, experience would suggest that more DOJ eyes on the same reportedclaims may pose at least some additional risk to targets of whistleblower filings.15 Press Release, U.S. Department of Justice, Remarks by Assistant Attorney General for the CriminalDivision Leslie R. Caldwell at the Taxpayers Against Fraud Education Fund Conference (Sept. 17,2014), http://www.justice.gov/opa/speech/remarks-assistant-attorney-general-criminal-division-leslie-rcaldwell-taxpayers-against.16 Id.7

B. The Dodd-Frank Act Whistleblower ProvisionsThe Dodd-Frank Act Wall Street Reform and Consumer Protection Act (“Dodd-FrankAct”) 17amended the Securities Exchange Act of 1934 to add Section 21F, entitled“Securities Whistleblower Incentives and Protections.” 18 Section 922 requires that theSecurities and Exchange Commission (“SEC”) pay awards to whistleblowers who“voluntarily” report “original information” relating to violations of the securities laws thatresult in “successful enforcement” and monetary sanctions in excess of $1 million. 19 TheDodd-Frank Act requires awards ranging from 10% up to a maximum of 30% of themonetary sanctions collected in qualifying cases.The Dodd-Frank Act also prohibits termination, demotion or retaliation “because of anylawful act done by the whistleblower” in providing information to the SEC, assisting inthe SEC investigation or enforcement action relating to the reported matters, or for“making disclosures that are required or protected” under the securities laws. 20 UnderDodd-Frank, whistleblowers who are subjected to retaliation for reporting are entitled todouble back pay plus interest, reinstatement, costs of litigation and attorney fees.The SEC created an Office of the Whistleblower and reporting program and adoptedfinal rules in May 2011 to implement the whistleblower provisions of Dodd-Frank. 2117 See Pub. L. No. 111-203, section (use symbol) 922(a), 124 Stat. 1841 (2010).18 15 U.S.C. § 78a et seq.19 See Id. at § 78u-6.20 Id.21 See Final Rule, 17 CFR Parts 240 and 249, Securities Act Release No. 34-64545, Implementation ofthe Whistleblower Provisions of Section 21F of the Securities Exchange Act of 1934 (Aug. 12, 2011),http://www.sec.gov/rules/final/2011/34-64545.pdf.8

Those rules have served to greatly increase reporting of potential corporate wrongdoingto the SEC with approximately 3000 tips being made a year.The Dodd-Frank whistleblower program, operated by SEC for three years, hasgenerated thousands of tips or reports of suspected wrongdoing but only 14 awardsthrough the end of 2014, suggesting that the SEC enforcement staff is being cautiousand selective in connection with the whistleblower reports they elect to investigate. 22 Onthe other hand, considering the time typically required for the investigation of significantviolations of the securities laws, the handful of awards made to date may be just the tipof a coming wave of whistleblower inspired SEC enforcement actions. Indeed, SECand other governmental representatives (speaking at conferences and only on their ownbehalf) continue to suggest that is the case. 23 Given that the SEC’s Investor ProtectionFund, the fund containing monies available for award to qualifying whistleblowers,contains nearly $440 million as of the end of fiscal 2014, there may be something tothese predictions. 24The Dodd-Frank whistleblower program has been criticized for encouraging employeesto report suspected violations without first resorting to internal reporting and relatedcompliance procedures. The SEC has attempted to address this concern by indicatingthat it will award credit to whistleblowers who previously or simultaneously reported theirconcerns to company authorities. However, SEC whistleblower awards are not22 See SEC Whistleblower Program Information at https://www.sec.gov/whistleblower; See SEC StaffAnnual Report to Congress on the Dodd-Frank Whistleblower Program (Nov. 17, 2014), available athttp://www.sec.gov/about/offices/owb/annual-report-2014.pdf.23 See e.g., Remarks at 31st International Conference on the Foreign Corrupt Practices Act, AndrewCeresney, Director, SEC Division of Enforcement (Nov. 19, 2014).24 SEC Staff Annual Report to Congress on the Dodd-Frank Whistleblower Program (Nov. 17, 2014),available at http://www.sec.gov/about/offices/owb/annual-report-2014.pdf.9

conditioned upon parallel internal reporting or even cooperation by the whistleblower inconnection with internal investigations of the reported matter. In an amicus filing lastyear, the SEC asserted that the term “whistleblower” encompasses individuals whoreport suspected securities violations through internal reporting mechanisms or to theSEC itself. 25 The additional protections against retaliation offered by the Dodd-Frankwhistleblower provisions are arguably viewed as offering further encouragement toemployees to bypass internal reporting and compliance mechanisms.1. Notable Whistleblower Awards Under Dodd-FrankSignificant and telling whistleblower awards to date include the following:SEC Press Release (September 30, 2013) 26 – SEC award of more than $14 million tounidentified whistleblower whose original information led to successful enforcementaction and the recovery of “substantial investor funds.” SEC Chair Mary Jo Whitecommented that the SEC “hope[s] an award like this encourages more individuals withinformation to come forward.”SEC Release No. 72947 (August 29, 2014) 27 – SEC announces whistleblower awardof $300,000 to unnamed employee “who performed audit and compliance functions andreported wrongdoing to the SEC after the company failed to take action when theemployee reported it internally.”SEC Release No. 73174 (September 22, 2014) 28 – SEC reports largest award to dateof $30 million to whistleblower residing outside the U.S. that led to a successfulenforcement action. SEC noted this is “the fourth award to a whistleblower living in aforeign country, demonstrating the program’s international reach.”25 Brief of the SEC, Amicus Curiae In Support of the Appellant, Meng-Lin v. Siemens AG (No. 13-4385),2014 WL 3953672 (2d Cir. Feb. 20, 2014), https://www.sec.gov/litigation/briefs/2014/liu-siemens-0214.pdf.26 Order Determining Whistleblower Award Claim, Securities Act Release No. 70554, File No. 2013-4(Sept. 30, 2013), https://www.sec.gov/rules/other/2013/34-70554.pdf.27 Order Determining Whistleblower Award Claim, Securities Act Release No. 72947, File No. 2014-9(Aug. 29, 2014), https://www.sec.gov/rules/other/2014/34-72947.pdf.28 Order Determining Whistleblower Award Claim, Securities Act Release No. 73174, File No. 2014-10(Sept. 22, 2014), http://www.sec.gov/rules/other/2014/34-73174.pdf.10

Despite the controversy over the SEC program and issue of whether employees arebeing encouraged to bypass internal reporting mechanisms, the SEC 2014 AnnualReport on the whistleblower program, SEC press releases on whistleblower awards,and SEC representatives speaking at conferences have emphasized that a significantnumber of awards to date involve instances where suspected wrongdoing was initiallyreported internally by individuals who ultimately became whistleblowers.Thiscircumstance comports with the experience of many counsel involved in theinvestigation and defense of whistleblower claims, and suggests again that somecorporate compliance programs and mechanisms intended to allow for the identificationand correction of problems are not working.While the SEC whistleblower program under Dodd-Frank is still in its infancy, andprogram rewards are only available for reported violations of federal securities laws, thelevel of reporting to SEC and the SEC’s stated intention to further intensify itsenforcement efforts suggest that there will be more Dodd-Frank whistleblower actiongoing forward.C. Internal Revenue Service Whistleblower ProgramThe Internal Revenue Service (“IRS”) also has a whistleblower program which wasestablished in 2007 and operates under the IRS Whistleblower Office which wascreated by the Tax Relief and Health Care Act of 2006. 2929Whistleblower Office At-a-Glance, http://www.irs.gov/uac/Whistleblower-Office-At-a-Glance (LastReviewed or Updated Mar. 7, 2014).11

Title 26, Internal Revenue Code section 7623(b) sets forth the rules attendant to the IRSwhistleblower program, including the provision for awards ranging between 15% and30% of proceeds collected by the IRS as a result of information provided. 30 Awardsrequire that the unpaid tax amounts identified and reported by the whistleblower exceed$2 million (inclusive of taxes, penalties, and interest). 31In fiscal year 2013, the last year for which information about the IRS program isavailable, 32the IRS reported paying $53 million to 122 whistleblowers in 2013, amarked decrease from the $125 million paid out to 128 whistleblowers in 2012. TheIRS program has been dogged by slow evaluation and processing of whistleblowerclaims, with over 3000 claims reported as remaining open from 2012, and significantnumbers of open claims remaining from years dating back to 2007. 33The single largest and important whistleblower award to date was the $104 million paidin 2012 to Bradley Birkenfeld, a former UBS bank executive convicted in 2009 for hisrole in the tax evasion scheme that he reported. 34 Birkenfeld provided information onUBS’s assistance to U.S. taxpayers with undeclared accounts held overseas and hasbeen credited for driving a 2009 settlement between the DOJ and UBS which imposednearly $8oo million in penalties and required the disclosure of account information forthousands of U.S. clients of UBS.30 I.R.C. § 7623(b) (2006), http://www.irs.gov/uac/Internal-Revenue-Code-(IRC)-7623(b).31 Id.32 IRS Fiscal Year 2013 Report to the Congress on the Use of Section 7623, (Apr. 10, 2013), available athttp://www.irs.gov/pub/whistleblower/Whistleblower_Annual_report_FY_13_3_7_14_52549.pdf.33 Id.34 David Kocieniewski, Whistle-Blower Awarded $104 Million by I.R.S., N.Y. Times, Sept. 11, 2012,http://www.nytimes.com/2012/09/12/business/whistle-blower-awarded-104-million-by-irs.html?_r=0.12

As the awards made under the IRS whistleblower program have dipped, and relator’scounsel and even members of Congress have expressed concerns over the interestand ability of the IRS to administer the program effectively, it is unclear whether thisprogram will continue to generate significant numbers of whistleblower reports andawards in the coming years.II.Proactive Management of Whistleblower RiskUnderstanding the array of laws and programs available to whistleblowers, it issimplistic to offer the old saw that companies exposed to risk need to ensure they haveeffective ethics and compliance programs. Everyone knows that. The challenge is toaddress the peculiar area of whistleblowers with the benefit of meaningful and practicalinsights on what will really serve to reduce risk of whistleblower claims and attendantexposure to penalties and other adverse consequences.There is a legion of guidance and other information available on the definition ofeffective corporate compliance 35 , and the basic elements of good compliance arebeyond the subject of this article.In any case, the problem exposed by companies subjected to whistleblower controversyis typically not that the organization lacked a corporate ethics and compliance program.Indeed, it is now a rare event for a significant company to lack an operating complianceprogram that generally satisfies the Sentencing Guidelines and other key complianceguidance. So what is it that tends to be missing as the ongoing wave of whistleblower35See e.g., Federal Principles of Prosecution of Organizations athttp://www.justice.gov/opa/documents/corp-charging-guidelines.pdf; Federal Sentencing Guidelines athttp://www.ussc.gov/Legal/Amendments/Reader- Friendly/20130430_RF_Amendments.pdf; FCPAGuidance at http://www.justice.gov/criminal/fraud/fcpa/guide.pdf.13

cases continue to generate controversy? The reality is that what is missing tends to fallwithin a fairly narrow set of common factors or circumstances that serve to allowsignificant problems to go without appropriate response or resolution.The following are suggestions based on experience in the handling or evaluation of alarge number of whistleblower cases. The attention paid to each of these subjects willoffer real and meaningful benefit to companies and responsible officers who arecommitted to avoiding these difficult claims.A. The Failure to Understand What Prompts WhistleblowersThe cases noted above, and decades of experience with the investigation and defenseof cases involving whistleblowers across a wide span of industry segments, support theposition that the nearly constant reason for the ultimate resort to qui tam filings orwhistleblowing stems from an employee’s actual or perceived inability to report a matterof concern internally and obtain feedback and attention that comports with theirexpectations of fairness and non-retaliation.Without question, some buddingwhistleblowers cannot or will not work with the company to address and resolve aperceived problem. Everyone has encountered the “disgruntled” current or formeremployee situation. However, experience and research in the field suggests that manywhistleblowers, if not most, resort to FCA qui tam filings and related external reportingonly after they attempted to raise problems internally and were rebuffed or ignored orsubjected to even worse treatment. 3636 Aaron S. Kesselheim, David M. Studdert & Michelle M. Milla, Whistle-Blowers’ Experiences in FraudLitigation against Pharmaceutical Companies, 362 NEW ENG. J. OF MED. 1832 (2010).14

Notwithstanding corporate attention and commitment to compliance, there are levels ofmanagement who do not pay proper attention to the proper handling of concerns orissues raised by their reporting personnel. In many instances this stems from a lack ofsensitivity or training about the risks associated with improperly handled compliancereports. In many more instances there is a failure by managers and others tocommunicate reported concerns to other appropriate company officials for furtherevaluation and response. The company management team looking to successfullyreduce risk in this field is devoting more attention to ensuring that potentialwhistleblowers are effectively encouraged to bring forward concerns and ensure thatthose matters, reported at any level within a company, are appropriately received andaddressed. A major emphasis in this effort is ensuring that the reporting employee issatisfied that their concern has been heard and taken seriously, regardless of whetherthe report reflects a valid problem requiring corrective action or further response. Afurther emphasis is on ensuring that employees are not dissuaded or fearful of reportingto their immediate superiors, a recurring problem that is aggravated by many caseswhere the superiors themselves are the subject of the employee concern.Again, identifying the principal problem that propels employees to resort to becomewhistleblowing is far easier than offering practical and effective solutions. That said, weoffer the following additional thoughts on managing the risk of the whistleblowerdynamic.15

B. Fleshing Out Potential Problems and WhistleblowersAs discussed above, the growing numbers of enforcement programs relying on andseeking to reward whistleblowers is making it ever more difficult to convince employeesto report problems internally. Without an advertised commitment to compliance asshown from the top company officials down, and a supporting environment that actuallyconvinces employees that the reporting of concerns is welcome and expected, there isnot a chance of success. Companies should consider facilitating the internal reportingof problems through means including the following:• Internal promotion of the compliance commitment and openness of thecompany to receiving reports of concerns at all levels.• Creation of incentives for the reporting of compliance related concerns orproblems, including the addition of compliance reporting to performanceand compensation review criteria for managers.• Internal messaging, from the top of the company, emphasizing thecommitment to ensuring that reported concerns will be addressed properlyand reporters will be protected from retaliation of any kind from any levelof the company.• Tracking and documentation of hotline and other reporting by employeesand monitoring of internal reporting mechanisms to ensure reporting isactually working at levels in line with the company size and risk profile.16

• Education of managers to ensure there is an understanding of the reasonsemployees are reluctant to report matters and training to assist managersin the proper handling and appropriate further internal communication ofreported concerns.• Institution of compliance related employee reporting review processes toensure that matters that are raised are appropriately considered andaddressed by qualified company officers.• Expansion of reporting mechanisms and features, including externallyhosted hotlines, to ensure that employees have multiple options andplaces to lodge concerns, on an anonymous basis if desired, and withoptions allowing for responses to reports of concerns or problems.These types of efforts have been successful in encouraging employees to come forwardand increase reporting.But there is still more that can be done. Management needs to do more to ensure thatall appropriate steps are taken to generate reports of problems regardless of whetheremployees desire to come forward or feel comfortable doing so. For example, ratherthan soliciting the typical one-time orientation certification that an employee hasreceived and agrees to comply with the corporate compliance program and code ofconduct, consider implementing an annual recertification process. In that process,employees are required to affirmatively confirm (by checking off on the form) that thatthey are not aware of any problems or conduct that is not in conformance with the17

company’s commitment to compliance or has not previously been brought to theattention of management. The form also provides for other options in cases where anindividual has concerns or information that has not been reported internally, andrequires the disclosure of any such matters.These additional compliance checks and certifications have been found to be veryeffective in ferreting out additional unreported concerns that could develop intowhistleblower claims or problems.All of these types of efforts have been proven to help reduce instances whereemployees resort to the external reporting of matters that may be ultimately successfullyresolved, but only after prolonged and costly enforcement review.C. Evaluating the Whistleblower and Enforcement RiskEnvironmentIn many ways, the risk of enforcement is growing for all businesses as whistleblowersand the government pursue cases in a wider variety of fields, under laws including theFCA but extending to anti-corruption laws, tax laws, securities laws, and consumerfraud and environmental laws. Determining the effective compliance measures that willtruly reduce exposure to whistleblowers and related investigation and enforcementaction is another daunting task. And not all risks warrant the same level of concern orattention. The current enforcement climate, however, offers little comfort from the factthat one is a smaller company, operating only domestically, and with fewer resourcesthan the companies in the headlines. Today, we see companies expending more timeand attention to the evaluation of risk associated with their business and practices, with18

a keener eye on ensuring that risks falling into priority enforcement areas are properlyidentified, evaluated, and tracked. This proactive identification of risks, ongoingreassessment of risks and tailoring of compliance efforts serves to protect againstwhistleblowers and related risks by allowing key risk areas and problems to be identifiedand corrective action taken as necessary to avoid problems before they can ripen intocontroversy.In evaluating compliance programs, we observe the lack of appropriate riskidentification and response to be a factor that significantly hampers companies’ ability tohead off whistleblower and related allegations of misconduct. The troubles befallingmany of these companies relate to risks that were reported but not effectively evaluated,risks that were not understood, or situations where risk was downplayed or discounted.The ability to demonstrate that a company has devoted appropriate effort to thehandling of reported problems and identification of key risks offers huge benefits inconnection with the effort to convince the government that the whistleblower case underreview is not tied to systemic problems or disregard of the law. As the governmentunderstands that no compliance program or company is perfect, well developed recordsreflecting robust internal reporting process, risk identification and compliancemanagement of those risks are critical to success in heading off or resolvingwhistleblower and enforcement matters.D. Making Compliance a Priority“Tone at the Top” and “Culture of Compliance” may be overused phrases but theyremain quite relevant to efforts to encourage internal reporting of problems. In the past,19

too many management teams considered compliance a non-revenue generating and, atbest, tolerated function. The role that compliance plays in assisting management insourcing and resolving potential whistleblower claims is changing rapidly. Companieslooking to reduce risk of exposure to risks in this arena must ensure that they havequalified compliance personnel on board and give them the resources and authorityneeded to do their job. Understand that compliance is viewed by employees as atrusted and unbiased resource where concerns can be aired. In addition, topexecutives and board members need to do more to assist compliance in promoting thecommitment to doing what is right and correcting issues of concern. Top levelassistance to compliance is particularly valuable in connection with communications thatallow employees to better understand they are encouraged, if not expected, to reportconcerns and can do so without fear of repercussions.E. Adopting the Lessons of Whistleblower and Other RelevantEnforcementsReported cases and settlements offer valuable information that assist managers inunderstanding the reasons whistleblower claims arise in similar settings and how thoseproblems could have been averted. These materials also help management to betterunderstand the compliance expectations of enforcement authorities involved in thereview of problems brought forward by whistleblowers. Understanding what cases arebeing pursued, how they are resolved, and what sanctions follow when compliancemechanisms are deficient, in particular the mishandling of internal compliance reporting,help similar companies take steps to avoid similar fates. Settlements often address thecompliance program elements found lacking, such as deficiencies in or the absence of20

internal reporting mechanisms. These problems help drive whistleblowers and moreonerous and costly settlement terms. The compliance requirements being imposed bythe government enforcers in whistleblower cases tell responsible managers what isexpected. Documented action of relevant changes to a company’s compliance effortsbased on reported cases send an important message to enforcers that can greatlyassist in driving a more favorable outcome to an investigation triggered by awhistleblower.F. Focusing Audits and MonitoringEffective management of whistleblower risk includes focused audit and monitoring ofthe priority risks faced by a given business. This documented activity, tied to theevaluation of internal reports, and annual compliance work plans, helps demonstrategood faith efforts to operate in accordance with applicable law. In the competition forthe resources available today for compliance, audit, and monitoring must focus on redflag issues identified internally and through other sources. Success in avoidingwhistleblower claims and enforcement requires the correct prioritizing and monitoring ofkey risk areas.G. Using Disclosures to Preempt WhistleblowersIn every business setting, it is expected that compliance problems will be uncovered.Many problems will be caught early enough to head off a potential whistleblower andenforcement risk. In some cases, for example, when claims or certifications have beenincorrectly but unintentionally submitted, the company is able to make corrective filingsor disclosures that cut off risk. In other cases, such as when possible bribery or other21

issues are identified in due diligence on a transaction, disclosures may be necessary toavoid subsequent litigation or enforcement risk. Disclosures in these and othercircumstances are markedly increasing as companies strive to identify and remediateproblems before they tempt reporting by whistleblowers or become the subject ofenforcement.H. Preparing for Internal and External InvestigationsIn companies confronting whistleblower and enforcement risk, risk managers areincreasingly working to establish plans and mechanisms that allow for the prompt andeffective review and evaluation of internally reported or discovered issues of concern.These plans ensure that internal reporters are engaged appropriately, and providefeedback on the evaluation of the reported concern and its ultimate handling. Plans forthe internal investigation of significant matters include readying resources that allow forthe quick assessment of compliance problems, evaluations of credibility, preparation forpotential enforcement response, and identification of any appropriate or necessarycorrective actions. A competent plan will also protect the organization and its managersfrom claims of improper internal investigation and issues such as bias. As thewhistleblower and related enforcement stakes increase, these activities protect thecompany and allow it to better defend against matters that may become the subject ofenforcement attention.22

III.ConclusionThe sky is not falling on companies that revisit and invigorate processes aimed atheading off whistleblower and enforcement risk. Indeed, notwithstanding the headlinereports of whistleblower cases and settlements, there are growing numbers of caseswhere companies have avoided or mitigated enforcement risk and consequencesthrough intensified internal reporting review processes and related compliancemeasures as addressed by this article. In cases where more effective and sophisticatedapproaches are taken to encourage internal reporting by employees, and reportedproblems are properly evaluated, documented and addressed, we are seeingcompanies reap substantial benefits. Here is to hoping that you and your companyenjoy the same success in this difficult and challenging area.23

-2015 INTERNATIONAL CLIENT SEMINARFAIRMONT SCOTTSDALE PRINCESSSCOTTSDALE, ARIZONAMARCH 5 – 8, 2015Tribalism in the Courtroom:What Neuroscience Has to Say about Bias, Loyalty, andGroup BehaviorT. Thomas SingerAXILON LAW GROUP, PLLCBillings, Montana(406) 294-9466tsinger@axilonlaw.comStanley E. SiegelNILAN JOHNSON LEWIS PAMinneapolis, Minnesota(612) 305-7527ssiegel@nilanjohnson.comDina M. CoxLEWIS WAGNER, LLPIndianapolis, Indiana(317) 237-0500dcox@lewiswagner.comScott BarrettGeneral CounselCRITICAL PROCESS SYSTEMS GROUPBurlington, Vermontwww.cpsgrp.comRon PeppeVice President Legal & Human ResourcesCANAM STEEL CORPORATIONPoint of Rocks, Marylandwww.canamgroupinc.com1

Tribalism in the Courtroom:What Neuroscience Has to Say about Bias, Loyalty,and Group BehaviorAs parties in litigation and lawyers, we tend to assume, or at least hope, that the judges,jurors, and arbitrators who will decide the facts and apply the law in our cases have nottaken sides. We want them to view our disputes not as Us v. Them or Them v. Us, butas Them v. Them – as battles in which they have no interest, between tribes for whichthey harbor no enmity and may even feel some affinity. Of course, the judges, jurors,and arbitrators know they are supposed to be neutral and, with rare exceptions, willinsist that they are not for or against any of the tribes doing battle before them.Science suggests otherwise. Studies conducted by social psychologists,neuroscientists, and others over more than 50 years tell us that human beings areprogrammed to join tribes, and to protect and defend whatever tribe they have joined,regardless of evidence, logic, or good sense. If that is true – if jurors (or other decisionmakers)are aligning with a tribe, whether they know it or not – then the parties whodepend on the justice system for a fair hearing, and the attorneys who represent thoseparties, need to know how to draw the decision-makers into their tribe.Fortunately, science offers some help. Using imaging technology and other techniques,neuroscientists have been able to identify the kinds of stimuli that we – lawyers andlitigants – should and should not use when our goal is to encourage jurors and judges toalign with “Us” instead of the opposing tribe, “Them.” Some of the scientific findingsseem like common sense, while others can be difficult to comprehend, especially for2

people schooled in law or science and, therefore, inclined to think that evidence andlogic are tools of persuasion. In fact, for most people, they aren’t.In the 17 th century, Sir Edward Coke asserted that, “Reason is the life of the law.” 1Inthe 19 th century, Coke’s assertion was qualified by Oliver Wendell Holmes, Jr.: “The lifeof the law has not been logic; it has been experience….” 2Today, neurosciencesuggests the life of the law is neither logic nor experience, but is essentially tribalempathy and antipathy. That means success in court depends principally on making anemotional connection with jurors and judges and on telling a compelling story that drawsthe jury into the litigant’s tribe.I. A World Divided – Them v. UsWe are pre-wired, if not hard-wired, to be tribal. 3“[O]ur ancestors faced the adaptivechallenge of forming and maintaining coalitions that could fend off challenges andattacks from rival groups. We are the descendants of successful tribalists, not theirmore individualistic cousins.” 4“Back in the days of our ancestors, membership of groupconstituted the very first life insurance policy. And, boy, did we need one. We’ve beenrenewing that ancient premium ever since.” 51 E Coke, Commentary Upon Littleton 97b (1628).2 Oliver Wendell Holmes, Jr., The Common Law (1881).3 Jonathan Haidt, The Righteous Mind: Why Good People Are Divided by Politics and Religion 152(2012).4 Id. at 163.5 Kevin Dutton, Split-Second Persuasion: The Ancient Art & New Science of Changing Minds 87 (2011).3

As a result, “in-group bias and ethnocentrism [are] universal.” 6“For millions of years,human beings have been part of one tribe or another.” 7“While there are some rareindividuals who treat strangers like family, there are no human societies in which this isthe norm….” 8II.Our Tribe May Be Our Family or Race, But Maybe NotFor most of us, our first tribe was the one we are born into, our birth family. Of course,membership in that tribe also makes us part of our parents’ families and extendedfamilies, and part of the clans, ethnic groups, religious traditions, and other tribes towhich they belong. A few of us may be separated from our birth families immediately,but even those folks usually find themselves in foster families or orphanages, or on thestreet, where they become part of tribes, too.In fact, wherever we go and whatever we do, we are constantly aligning with tribes,whether or not we use that label. When we gather with our siblings and cousins; or eatand drink with our friends, neighborhood, clique, circle, peers, fraternity, or sorority; orcheer for our favorite teams or our alma mater; or defend our political caucus or party;or rehearse with our band, choir, or team; or contribute to a charity, church, or club; orexpound on our tastes in wine, music, food, art, movies or books; or flaunt the brands ofour beer, cars, clothes, purses, or smartphones, we are identifying ourselves as6 Joshua Greene, Moral Tribes: Emotion, Reason, and the Gap Between Us and Them 49 (2013).7 Seth Godin, Tribes: We Need You to Lead Us 1 (2008).8 Greene, supra note 6 at 48.4

members of a tribe as much as we do with our accents or the colors of our skin andhair. We are aligning ourselves with a group – creating kinship outside our kinfolk.We seek communities because our friends really are like family to us -- in aneurochemical way. Tribalism is in our neurons, and our hormones. 9The primaryneurochemicals are oxytocin and vasopressin, two related neuropeptide hormones thatare produced by the pituitary gland and “act throughout the brain and body to integratemany processes including social behaviors, emotional feelings and responses, and theautonomic nervous system.” 10Oxytocin is better known than vasopressin, perhaps because it facilitates maternal laborcontractions and lactation. 11In those and other ways, oxytocin plays an important rolein the formation of mother/infant bonds, not only in humans, but also across mammalianspecies. 12Oxytocin also is known to strengthen the bonds in male/female pairs: “Among humans,couples who are administered oxytocin (versus a placebo) have fewer intense fights,and the men rate their partners as more attractive and spend less time looking at otherwomen.” 13But the “love hormone,” as some scientists have dubbed oxytocin, doesmore than make us want to cuddle with our children and spouses; it also “fosters trust,cooperation, forgiveness and generosity; and makes people more attuned to …9 Greene, supra note 6 at 54.10 C. Sue Carter, James Harris & Stephen W. Porges, “Neural and Evolutionary Perspectives onEmpathy,” in Jean Decety & William Ickes, The Social Neuroscience of Empathy 175 (2011).11 Id. at 176.12 Robert M. Sapolsky, “A ‘Love Hormone’ With a Nasty Little Secret,” Wall Street Journal (June 27,2014); Greene, supra note 6 at 54.13 Sapolsky, supra note 12.5

emotions” of others, including strangers. 14Oxytocin seems to be one of the keys toempathy. 15And it plays a role in reducing fear and “calming sympathetic responses tostressful stimuli.” 16Vasopressin, on the other hand, seems to be associated with the active responses tostress that are more often associated with male behavior. 17 More on that later. 18A. We Take Care of Our OwnAs our oxytocin levels rise, we are more inclined to engage in behaviors that have beendescribed as parochial altruism - behaviors intended to nurture and support the folkswith whom we feel a shared bond. 19Our parochial altruism is a powerful force. It willconsistently prompt us to remain loyal to our tribe, even when that seems unreasonableor irrational. In one study, self-described liberals and conservatives were asked toevaluate competing proposals regarding welfare benefits. When the sources of theproposals were not identified, the liberals preferred a plan providing generous benefitsand the conservatives preferred a plan providing meager benefits. However, when theliberals were told the proposal for meager benefits was developed by Democrats, theypreferred that plan, and the conservatives who were told the proposal for generous14 Id.15 Carter, et al., supra note 10 at 179.16 Id. at 178.17 Id. at 180.18 See subsection II.B, below.19 Greene, supra note 6 at 50.6

enefits was presented by Republicans preferred that plan. 20For both liberals andconservatives in the study, staying true to their party was more important than thesubstance of the proposals. Tellingly, most members of both groups denied that thepartisan labels had affected their judgment. 21It may seem reasonable that people will be loyal to their political parties and overlooksome incongruities about their parties’ positions on issues. After all, there are only twomajor parties in America, so unanimity within a party on every issue is unattainable andcompromise is required. Also, we may feel tied to a party because of a patronage job,family history, or other factors. Those arguments may sound reasonable to you. If theydo, that is probably because you, like most people, have a talent for finding creativeexplanations for our emotional reactions. People are incredibly good at rationalizing ourirrational loyalty to virtually any tribe, even one to which we are assigned randomly andhave no personal connections.To illustrate, look at the lines below, and identify the perpendicular line on the left that isthe same length as the perpendicular line on the right.A B C20 Id. at 89, citing Geoffrey L. Cohen, Party over policy: The dominating impact of group influence onpolitical beliefs, 85 Journal of Personality and Social Psychology 808 (2003).21 Id.7

It seems obvious, or should, that the correct answer is B. Yet three quarters of thesubjects in a classic study gave a wrong answer. In the study, they were asked torespond to a series of 18 line-judgment tasks like the one you just took, but they didn’tget to respond until they heard the responses of eight other people, all shills who hadbeen instructed to respond to 6 of the 18 comparisons with pre-determined wronganswers. The subjects and shills had never met before the study, but even in a groupof strangers, the subjects felt enough pressure to fit in with their peers that 76% of themactually agreed with a patently wrong answer at least once during the session. 22The subjects in that study did not receive oxytocin, but many studies have confirmedthat oxytocin is what triggers us to engage in the behaviors that demonstrate loyalty toour tribes. 23Apparently, oxytocin can trump our powers of reasoning, and when it does,we won’t have a clue that our loyalty can make us take stands that are irrational.B. We Turn on OutsidersUnfortunately, as much as oxytocin prompts pro-social behaviors toward groups we arein or want to join; it also prompts anti-social behaviors to a comparable or greaterdegree toward people outside our group. 24In a University of Amsterdam study,oxytocin was administered to Dutch students before they were asked to resolve thismoral quandary: Would they push one person under a runaway trolley in order to save22 Dutton, supra note 5 at 88-89, citing Solomon E. Asch, “Opinions and Social Pressure,” 193 ScientificAmerican 31-35 (1955).23 Carsten K.W. De Dreu, Lindred L. Greer, Gerben A Van Kleef, Shaul Shalvi, & Michel J.J. Handgraff,“Oxytocin promotes human ethnocentrism,” 108 Proceedings of the National Academy of Sciences ofthe United States of America 1262-1266 (January 25, 2011).24 Id.8

five other people? For some students, the hypothetical victim was assigned a typicalDutch name, while other students heard a German or Arab name that evokes prejudiceamong the Dutch. The students who received oxytocin were far more likely to throwArabs and Germans under the train than they were to sacrifice their Dutch brethren. Onthe other hand, a control group that received no oxytocin treated the groups the same. 25A follow-up study at the same university looked at the effect oxytocin has on cheatingwhen people were assigned to ad hoc tribes. 26Robert Sapolsky summarizes the studyand its results:Subjects were told that they were part of a team of three volunteers (withno further information about teammates). Then each person played avirtual coin-toss game, with winnings to be divided among the three. Thegame was a great chance to lie: Players only had to report whether theyhad correctly guessed outcomes beforehand. Of course, guessing yieldsa 50% success rate, so the higher someone scored above 50%, the morelikely it was that they were cheating.Control subjects cheated plenty, claiming an average success rate of66%. With oxytocin, cheating rose to 79%. Moreover, oxytocindramatically increased the number of outrageous liars. Among controlsubjects, 23% reported an outcome with only a one-in-a hundred chance25 Id.26 Carsten K.W. De Dreu, Steven Scholte, Frans A.A.M. Van Winden & K. Richard Ridderinkhof, Oxytocintempers calculated greed but not impulsive defense in predator-prey contests, Social Cognitive andAffective Neuroscience, August 19, 2014.9

of occurring—a success rate of more than 90%. And subjects onoxytocin? The majority made this absurd claim.What's going on? Maybe the subjects on oxytocin anticipated that theirteammates would cheat more and followed suit. But oxytocin didn't affectpeople's estimates of their teammates' cheating rates.Maybe they cheated more out of self-interest. After all, more money forthe team meant more for the individual. But no—when people played thegame solely for their own gain, oxytocin had no effect. It was about thegroup, stealing from the outsider who was supplying the money. In thefield's jargon, oxytocin enhances "parochial altruism." 27Does parochial altruism happen in the real world? As Dan Ariely of Duke University hasnoted, one reason we cheat is “because we are good people who care about thewelfare of those around us.” 28Think of Robin Hood, and others who rationalize theirbad behavior – theft masquerading as charity for a group they believe to be deserving.If parochial altruism were only about lies and petty theft, it would be bad enough, but ourtribal instincts can turn far uglier than that. Kevin Dutton notes there is an “insidiousconnection between group identity and violence,” and he illustrates the point with a story27 Sapolsky, supra note 12.28 Daniel Ariely, The (Honest) Truth About Dishonesty 232 (2012).10

about a sex offender Dutton interviewed in prison about gang rape. The rapistcompared his gang crime to buying a round of drinks, saying it provided a sense “ofgroup camaraderie.” 29Of course, rape isn’t the only example of violence perpetrated by groups. The Naziassault on Jews known as Kristallnacht, the “Night of Broken Glass,” may seem likeancient history to some, but ethnic cleansing, terrorist attacks, stonings, lynch mobs,race riots, and torture are current world events, all fueled by tribalism. Tribalmembership actually dictates what people regard as torture. When told that membersof our own tribe have carried out torture, our first response is often to deny it occurred,usually by changing our own criteria for defining torture. 30When acting in groups, people regularly subject members of other groups to horrorsthey would never inflict when acting alone. What is it about being part of a gang thatmakes people feel they have a license to cause harm to members of other tribes? Theanswer is drugs. Not meth or pot or other street drugs, but the two hormones oftribalism, oxytocin and vasopressin.The two hormones are structurally similar, so they can influence each other’s receptors,but they often act in opposite directions. “Oxytocin tends to reduce behavioral andautonomic reactivity to stressful experiences, whereas vasopressin is associated witharousal and vigilance.” 31So vasopressin may be the culprit in Schadenfreude (the29 Dutton, supra note 5 at 95.30 What Is Torture? Our Beliefs Depend In Part On Who's Doing It, interview of Shankar Vedantam bySteve Inskeep on NPR, 12/11/2014, accessible at http://www.npr.org/2014/12/11/370022493/what-istorture-our-beliefs-depend-in-part-on-whos-doing-it(last accessed 1/6/2015).31 Carter, et al., supra note 10 at 176-77.11

pleasure we experience at witnessing the misfortunes suffered by members of rivaltribes) and in Glückschmerz (the displeasure we experience at witnessing good fortuneenjoyed by members of rival tribes). Recent studies of diehard sports fans led by MinaCikara of Harvard show that the ventral striatum, which is the pleasure center of thebrain, lights up not only when the fan’s team does well, but also when a rival team lostto another team. Worse, it also lit up when players on the rival team were injured. Infact, the fans who experienced greater Schadenfreude at seeing a rival injured werealso more disappointed at news that the injury was not serious. Moreover, fans whoseventral striatum are active in response to a rival team’s suffering are actually morewilling to harm rival fans, and less willing to relieve the pain of rival fans. 32No one who has witnessed melees at major sporting events can be too surprised bythose findings, but the results apply in contexts other than long-standing sports rivalries.The same neural responses that show up in the brains of die-hard fans also appear intest subjects who have been assigned randomly to groups that are asked to competewith other groups. And those neural responses apparently are not driven by empathyfor the subject’s group, but by antipathy toward the competing group. 33In other words,we are wired to wish ill toward other groups and to enjoy their suffering, even whenmembership in the groups was assigned randomly and recently. And our ill-will isn’tdiminished by winning. 34No wonder pick-up basketball games sometimes turn bloody.32 M. Cikara, E. Bruneau, J.J. Van Bavel & R. Saxe, Their pain gives us pleasure: How intergroupdynamics shape empathic failures and counter-empathic responses, 55 Journal of Experimental SocialPsychology 110-12 (2014).33 Id. at 122.34 Id. at 119.12

III.We Identify Ourselves by Our TribesImagine you are entering a room full of people. What do you do? First, you scan theroom for threats. Having evolved in jungles and wilderness, we are vigilant about ourown safety.We depend on two areas in the temporal cortex of our brain, the fusiform gyrus and thesuperior temporal sulcus, to evaluate the movements, vocalizations, and facialexpressions of people (and other animals). If those areas perceive serious threats, twoprimitive neural circuits in our brain trigger a defensive reflex – either fight/flight orfreeze behavior – and our capacity for social behavior and communication essentiallyevaporates.Fortunately, the amygdala, a part of our brain that evolved more recently, is usually incharge. So for most perceived threats, we are less apt to run than to look for socialsupport. 35We respond as a human, rather than as a lizard, because our reactions areregulated by oxytocin and vasopressin. 36As Amy Cuddy of Harvard says, we arelooking for friend or foe, evaluating everyone in the room on two scales: warmth andcompetence. 37Warmth is perceived first and matters more than competence, unlesswe perceive someone to be a highly competent threat. Once we decide a person is35 C. Sue Carter, et al., supra note 10.36 Id. at 175.37 Craig Lambert, “The Psyche on Automatic: Amy Cuddy probes snap judgments, warm feelings, andhow to become an ‘alpha dog,’” Harvard Magazine 48-49 (November-December 2010), hereinaftercited as “Cuddy.” Many of the same ideas are also presented by Cuddy in a Ted Talk that can beaccessed at https://www.ted.com/talks/amy_cuddy_your_body_language_shapes_who_you_are (lastaccess on 1/6/2015) and in this article: Amy J.C. Cuddy, Matthew Kohut & John Neffinger, “Connect,Then Lead,” Harvard Business Review (July 2013), available at https://hbr.org/2013/07/connect-thenlead/ar/1(last accessed on 1/6/2015).13

friendly, our vigilance subsides a bit, but “a single instance of negative-warmth behavior– kicking a dog, say – is likely to irredeemably categorize the perpetrator as a coldperson. 38Interestingly, “People tend to see warmth and competence as inverselyrelated. If there’s a surplus of one trait, they infer a deficit of the other.” 39Ourhormones are active as we continue to scan the room, listening for accents, looking athairstyles and clothing, glancing at jewelry, and not incidentally, making mental notesabout genders, skin colors, heights, weights, physiques, facial features, body language,and other clues about the tribes that the people around us were born into, have joined,or would like to join. We use those clues to sort the crowd between potential friendsand likely foes. “How people dress, wash, eat, work, dance, sing, joke, court, have sex,et cetera – all the rules that govern daily life – can serve the nonarbitrary function ofmaking strangers seem strange, thus separating Us from Them.” 40There are some factors we use to separate Us from Them that many people think canor should be abandoned in civilized societies, but like it or not, research shows thatracism and sexism persist. For example, the mere presence of Mexicans on acommuter train platform in an Anglo neighborhood changed the views of the Anglos onthe platform concerning issues such as immigration; their views became moreexclusionary. 4138 Cuddy, supra note 36 at 49.39 Id. at 50 (quoting Cuddy).40 Greene, supra note 6 at 5141 Robert Sapolsky, “An Experiment Shows Bias Against Strangers on a Train,” Wall Street Journal(August 9-10, 2014).14

At the same time we are identifying Them, we are also looking for Us, the potentialallies we think we can recruit into our tribe. We try to form bonds by asking questionsthat will identify commonalities. Many of the questions may be intended to elicitinformation about tribal affiliations. We may ask for last names or the spelling of a firstname as a clue to heritage. We may mention politics or religion, or try to identifycommon friends or shared experiences. We may inquire about sports, of course, orhobbies, books, or television shows. We may want to know if our potential friends havechildren, and parents or siblings who are living. And we will almost always ask aboutwork – how and where they earn a living.If we find commonalities, we may form a temporary tribe, by “breaking bread,” sharing adrink, or perhaps many drinks. Alcohol seems to break down barriers and help peopleform new tribal affiliations.As we invest more time, and share experiences that are more intense, our bonds growstronger. The strongest bonds are formed in battling a common threat, whether it is anillness, a rival team, a terrorist regime, or the villain in a video game. Such bonds canfeel, and may be, stronger than kinship, as the title of Stephen Ambrose’s book “Band ofBrothers” suggests.But the bonds also can be fleeting. When traveling alone in a foreign country, we mayfeel a powerful connection to another tourist from our home country. When we meetthat same person in our home country, the connection may have evaporated. 4242 Robert Ariely, Predictably Irrational: The Hidden Forces that Shape Our Decisions 22-23 (2010).15

People aren’t likely to describe their gaming buddies or book club or church as tribes.But there is little doubt we look to the people with whom we spend time in such groupsfor support – whether emotional or financial or moral – just as our ancestors counted onmembers of their tribes to protect them and share the burdens of surviving ininhospitable environments.Jonathan Haidt of New York University asserts there are five moral foundations of ourtribal behavior:• Care (we put pins on our lapels and bumper stickers on our cars to identifyourselves with group goals);• Fairness (we don’t expect to be cheated by members of our groups andexpect to treat others in the group fairly);• Loyalty (we hate traitors);• Authority (even if we do not establish formal hierarchies and identifyleaders, there are pecking orders in every group); and• Sanctity (we share some sense of what is sacred and what isdisgusting). 43Seth Godin makes the point more succinctly, defining atribe as any “group of people connected to one another, connected to aleader, and connected to an idea.” 44•43 Haidt, supra note 3 at 150-79.44 Godin, supra note 7 at 1.16

IV.Tribes in the CourtroomSince humans are tribal, it follows that tribes are present wherever humans gather.That includes the courtrooms where lawsuits are tried. Many of the tribes inside acourtroom are like the ones you would find walking through a shopping mall or grocerystore, but some of the courthouse tribes are unique.A. The Insiders – Lawyers and StaffRide the elevator in a busy courthouse, and you won’t have any trouble knowing whichof the riders has been there before. The judges, court staff, and lawyers are at ease,making conversation with one another, knowing exactly where they need to be andwhen. The building is their turf. They dress the part. They understand the lingo, andspeak it. They know the American judicial system can’t function without them, and theyare proud of that. You can tell when you look at them.B. The Us and the Them – PartiesWalking with the lawyers, feigning their air of confidence, are the clients, the haplesssouls who have been forced to seek their definition of justice from the court system.They are probably dressed in clothes that make them feel uncomfortable. They are,without a doubt, in a situation that makes them extremely uncomfortable.They watch their lawyer, and if they are lucky to have a lawyer they admire and trust,they try to think of themselves as part of their lawyer’s tribe. Of course, they reallyhaven’t been accepted into the lawyer’s tribe, and they know that. They don’t know17

where they are going and aren’t sure what is happening. They don’t know any of therules – when to stand up, when to sit down, when to talk, or when to shut up. Theyhave been told to tell the truth, which seemed simple enough when it was said, butbecame complicated as they laid awake last night imagining all the devious questionsthe opposing attorney will ask. And now, people around them are speaking in gibberish,using words that sound familiar, but don’t have any meaning in this context.In feeling discomfort and longing for an ally, a party has something in common withanother person roaming the courthouse – their adversary. But they feel no bond withtheir opponent. Quite the opposite. Just as Red Sox fans will chortle when a Yankee’srunner sprains an ankle, the parties in a lawsuit would watch with glee as theiradversary burned in hell.But that pleasure, if it comes at all, will have to wait. At least on the first day of trial, andmaybe for much longer, a party is likely to feel alone, a wallflower lurking enviouslyoutside her or his attorney’s circle, hoping for an invitation that may never come.C. The Outsiders -- JurorsThe jurors also are alone. They are summoned to the courthouse individually. Theydon’t get to bring their tribe for support – no spouses or significant others, or co-workersor friends. Except in small towns, they aren’t likely to know any of the court staff or theattorneys, or anyone else on the jury panel. They walk into a room of strangers, identifythemselves to the clerk checking attendance, and sit down to wait.18

And then they do the same thing people always do when put in strange oruncomfortable surroundings. They scan for threats and try to find their tribe. Theirsocial instincts will take over. By the time the judge enters the courtroom, they mayalready have formed coalitions that could alter the outcome of the case. And none ofthe attorneys, or their clients, will have a clue about what has been going on.V. Narrowing the Choices for Our TribeIn 1936, when Clarence Darrow was 79 years of age, he summed up his thoughtsregarding jury selection in an article published in Esquire magazine. Though he was achampion of liberal causes in his day, his comments would outrage today’s politicallycorrect sensibilities. His approach was tribal, pure and simple.• Let us assume that we represent one of "the underdogs" because ofinjuries received, or because of an indictment brought by what theprosecutors name themselves, "the state." Then what sort of men will weseek? An Irishman is called into the box for examination. There is noreason for asking about his religion; he is Irish; that is enough. We maynot agree with his religion, but it matters not, his feelings go deeper thanany religion. You should be aware that he is emotional, kindly andsympathetic. If he is chosen as a juror, his imagination will place him inthe dock; really, he is trying himself. You would be guilty of malpractice ifyou got rid of him, except for the strongest reasons.19

• An Englishman is not so good as an Irishman, but still, he has comethrough a long tradition of individual rights, and is not afraid to standalone; in fact, he is never sure that he is right unless the great majority isagainst him. The German is not so keen about individual rights exceptwhere they concern his own way of life; liberty is not a theory, it is a way ofliving. Still, he wants to do what is right, and he is not afraid. He has notbeen among us long, his ways are fixed by his race, his habits are still inthe making. We need inquire no further. If he is a Catholic, then he lovesmusic and art; he must be emotional, and will want to help you; give him achance.• If a Presbyterian enters the jury box and carefully rolls up his umbrella,and calmly and critically sits down, let him go. ….• If possible, the Baptists are more hopeless than the Presbyterians. …. TheMethodists are worth considering; they are nearer the soil. …. If chancesets you down between a Methodist and a Baptist, you will move towardthe Methodist to keep warm.• Beware of the Lutherans, especially the Scandinavians; they are almostalways sure to convict. …. A person who disobeys must be sent to hell; hehas God's word for that. …. It is best to inspect a Unitarian, or aUniversalist, or a Congregationalist with some care, for they may beprohibitionists; but never the Jews and the real agnostics! And do not,please, accept a prohibitionist; he is too solemn and holy and dyspeptic.He knows your client would not have been indicted unless he were adrinking man, and anyone who drinks is guilty of something, probablymuch worse than he is charged with, although it is not set out in theindictment. Neither would he have employed you as his lawyer had he notbeen guilty.20

• I have never experimented with Christian Scientists; they are much tooserious for me. … You may defy all the rest of the rules if you can get aman who laughs. Few things in this world are of enough importance towarrant considering them seriously. So, by all means, choose a man wholaughs. A juror who laughs hates to find anyone guilty. Never take awealthy man on a jury. He will convict, unless the defendant is accused ofviolating the anti-trust law, selling worthless stocks or bonds, or somethingof that kind. …. If you are defending, you want imaginative individuals.You are not interested in the morals of the juror. If a man is instinctivelykind and sympathetic, take him.• Then, too, there are the women. These are now in the jury box. ….Womenstill take their new privilege seriously. They are all puffed up with theimportance of the part they feel they play, and are sure they represent agreat step forward in the world. They believe that the sex is co-operatingin a great cause. Like the rest of us, they do not know which way isforward and which is backward, or whether either one is any way at all.Luckily, as I feel, my services were almost over when women invaded thejury box. 45Darrow’s approach must have worked for him a century ago, but it may be difficult toimagine how it could work in a courtroom today. We may think the American meltingpot has blurred and combined our ancestries, religions, and even our genders. Butmaybe not. Religion continues to divide and unite us. A research poll by the Pew4545 Clarence Darrow, "How to Pick A Jury" (1936) (accessed on 12/06/2014 athttp://law2.umkc.edu/faculty/projects/ftrials/DAR_JURY.HTM).21

Research Center found that 65% of Americans believe the Christmas story is literallytrue, while 14% believe none of it is. The other 20% believe some parts and notothers. 46Furthermore, Darrow’s skill as a litigator is legend, so there must be more wisdom thanfirst meets the eye. And there is. If we get past the tribal-typing that may offend currentsensibilities, what Darrow was talking about is empathy, specifically the empathy thatarises from tribal connections.Darrow describes his clients as “the underdogs.” We understand he is referring topeople who are somehow fighting against the odds. It is likely he used the termbecause he knew, at least subconsciously, that people empathize with underdogs. Wecheer for underdogs. That may be because most of us feel we are underdogs. We feelwe are being ignored, or we are fighting uphill battles against prejudice or injustice, orwe are facing rivals that are stronger, richer, better looking, smarter or less scrupulousthan us. So we empathize with underdogs. We want to run with their pack.But wait, if all of us empathize with underdogs, then who are the big dogs we detest?That is where it gets tricky. Darrow was looking for jurors who would empathize with hisunderdogs, people who were criminals and injured plaintiffs. The attorneys whoopposed Darrow wanted jurors who would empathize with their underdogs, people who46 William Galston, “The Christian Heart of American Exceptionalism,” Wall Street Journal, December 30,2014, referring to David Masci, “Most Americans believe in Jesus’ virgin birth, Pew Research Center,December 25, 2013 (accessed on 1/6/2015 at http://www.pewresearch.org/fact-tank/2013/12/25/mostmericans-believe-in-jesus-virgin-birth/).22

were victims of crime or had been sued on a frivolous claim. Darrow and his opponentsboth needed jurors who were empathetic, and both recognized that jurors are mostlikely to empathize with their own tribes and the tribes with which they have somethingin common. And in their time, Darrow and others felt comfortable identifying thosetribes based on racial and religious stereotypes.Darrow recognized that, as a trial lawyer, he should identify and strike potential jurorswho couldn’t or wouldn’t empathize with his clients. When we do select juries today, westill depend on stereotypes, perhaps not the racial, religious, and sexual stereotypesDarrow used, but stereotypes nonetheless. We deselect jurors based on assumptionsthat are essentially tribal.We assign the potential jurors to groups we think may empathize with our clients, or not:he is married to a doctor and lives in a wealthy neighborhood, so he will not empathizewith a thief; she is unemployed and in chronic pain, so she will not empathize with acorporate defendant. We also deselect jurors based on instinct. We read non-verbalcues, often unconsciously, to separate friend from foe, Them from Us, our tribe fromother tribes. The instincts that kept our ancestors safe are still pretty good at warningus away from people who aren’t likely to become members of our tribe, and that really isour goal in choosing a jury.23

Bringing the Jury into Our TribeOnce the jury is seated, the job of the lawyers and litigants gets harder because,regardless of what each juror brings to the courtroom in terms of history, knowledge,and prejudice, we have to find a way to draw him or her into our client’s tribe if possible,or at least to keep them from joining the tribe of the opposing party.Trial lawyers learn to persuade jurors by trial and error, literally. Where doctors andengineers are expected to rely on controlled studies and scientific principles whenmaking recommendations, trial lawyers rely mostly on anecdotal evidence – war stories.Our clients regularly ask us to estimate the odds of success at trial, and we generallyprovide an estimate to them, although the numbers we provide are not based onresearch or controlled studies. No one has devised a way to predict trial outcomesbased on science.But science can identify techniques we can use to recruit jurors into our tribe, or ourclient’s tribe. We will offer six techniques suggested by neuroscience here. Some aretechniques you already know and may practice. Others may surprise you.A. Open a New ChannelShakespeare was telling us how to get the audience to listen to an uncomfortable truthwhen he said, “the play's the thing [w]herein I'll catch the conscience of the King.” 47Before we can persuade people, we first have to get them to listen.47 William Shakespeare, Hamlet Act 2, scene 2.24

Researchers at the University of Arkansas found that door-to-door salespeople can selltwice as many Christmas cards by quoting a price in pennies rather than dollars, andthat a street vendor sells more cupcakes by calling them “half-cakes,” but only if atagline -- describing the cards as a bargain or the cupcakes as delicious – is insertedimmediately after the anomaly. 48Why? Unusual events activate the amygdala and thetemporoparietal junction in our brains, which makes us more receptive to newexperiences. The effect on our brain is similar to what happens when we hear a babycry or listen to a Blues singer bend a note. Jokes do the same thing. 49“They ambushexpectations and take our emotions hostage.” 50Presenting facts at the outset doesn’t change people’s minds. Brains scans showDemocrat and Republican partisans have an initial burst of negative emotion whenexposed to contradictory statements by leaders of their own party, but the neural circuitsthat regulate emotion soon take over and somehow turn lemons into lemonade. Thepartisans not only manage to reconcile the statements, using only their emotionalcircuitry, but they then feel very good about doing it. 51The parts of their brains thatcontrol logic and rational thought take a siesta, while the emotional parts take control,pledge continued fealty to their tribe, and congratulate themselves for having chosen sowell.48 Dutton, supra note 5 at 176, citing Barbara P. Davis & Eric S. Knowles, “A Disrupt Then ReframeTechnique of Social Influence,” 76 Journal of Personality and Social Psychology 192-199 (1999).49 Id. at 177 (and at 39).50 Id. at 177-78.51 Id. at 178-79.25

If facts won’t open juror’s minds, we need to try something else, something aimed atwhat we call the heart, which is actually the portions of the brain dedicated to emotions.The ideal tool for opening a channel to that part of the brain is something unusual oreye- or ear-catching, an incongruity: a joke, a surprise, a gaffe – real or intended.Think of the two opening statements for the defendants in the movie My Cousin Vinny,one hopelessly inarticulate because of a stutter, the other a simple, “Everything he justsaid, it’s bullshit.” Both opening statements worked dramatically in the film, and bothalso could have potential in a courtroom. Odd as it may seem, a stutter or lisp canactually help a lawyer connect with jurors. 52And an unexpectedly short openingstatement is one way to pique jurors’ interest.If we aren’t blessed with a speech impediment, or the courage to give a one-sentenceopening, we still should be able to think of some way to convince the jury that whateverthey may think of our client, or its lawyers, isn’t the whole story, so they will be receptiveto our evidence. Just as Avis’s ad campaign about being No. 2 managed to portray amultinational company as an underdog, we need to find creative ways to let jurors putour clients in a different, positive light.B. Appeal to Self-InterestFormer Australian Prime Minister Gough Whitlam is credited with saying, “The puntersknow that the horse named Morality rarely gets past the post, whereas the nag named52 See Debra Cassens Weiss, “BigLaw Partner’s Stuttering Brought Tears from Moot Court Judge,Respect from Real Jurors,” ABA Journal post on March 7, 2011(http://www.abajournal.com/news/article/biglaw_partners_stuttering_brought_tears_from_moot_court_judge_respect_from/, last accessed December 7, 2014.)26

Self-interest always runs a good race.” 53You might think self-interest would take aback seat to morality among students at the Princeton Theological Seminary, especiallythose who had been preparing to videotape a presentation about the story of the GoodSamaritan. If so, you would be disappointed. Told that they were late for thevideotaping session, most of the students walked right past a man who was slumped inan alleyway, coughing and groaning. 54Their own agenda, presenting a speech in theirrole as a member of the tribe of academia, had become more important than offering tohelp a stranger who seemed to be injured, even when the speech they were going topresent was about charity for the less fortunate.As the Princeton study illustrates, self-interest isn’t triggered only by money or materialgoods. We also can play on juror’s self-interest by framing our arguments in ways thatconfirm their views. For example, Harry Plotkin, a jury consultant from Los Angeles,notes that self-interest can motivate a safety-conscious juror to overlook evidence that aproduct may be unsafe. The juror may be uncomfortable thinking that manufacturersare distributing dangerous products, so assigning fault to the user makes the juror feelthe world works the way they would prefer. 55Bob Cialdini, a professor at Arizona State, has identified six evolutionary persuasionprinciples that can trigger self-interest. They are:• scarcity (the less there is of something, the more we want it),53 Dutton, supra note 5 at 169.54 Id.55 Harry Plotkin, “Leveraging you jurors’ self-interest,” August 2008(http://www.yournextjury.com/jt0808.htm, last accessed on 12/8/2014).27

• reciprocity (we feel obligated to return favors),• commitment and consistency (we want to be true to our word),• authority (we defer to those in power),• liking (we say yes to those we like), and• social proof (if we aren’t sure what to do, we see what others are doing). 56To apply those principles when we are addressing jurors, we should ask questions:• Scarcity: What will jurors think is scarce as they deliberate? Perhaps theopportunity to make the world safer, or do justice, or send a message.Standing up for what is “right” in the face of pressure may provide selfsatisfaction.Or delivering an unusually large verdict may give jurors aspecial and rare distinction, a measure of notoriety, which is scarce andvaluable in our fame-obsessed culture. Or maybe not, a $186 millionverdict against Autozone in November barely registered in the news. 57• Reciprocity: What favor can we offer that would make jurors feel obligatedto reciprocate? Simple gestures of kindness or acknowledgement, suchas opening a door or smiling, may be enough. The urge to reciprocatecan be triggered by giving a complete stranger something as trivial as apostage stamp or a dime, or by asking for a large favor, and thenretreating to a smaller one. 58 So suggesting an outsized verdict (large orsmall), and then offering to compromise could trigger a willingness toreciprocate.56 Dutton, supra note 5 at 167.57 Jacob Greshman, “AutoZone Hit With $186 Million Verdict,” Wall Street Journal, November 18, 2014(accessed on 1/6/2015 at http://www.wsj.com/articles/autozone-hit-with-186-million-verdict-1416359038).58 Dutton, supra note 5 at 114.28

• Commitment and consistency: How can we ask jurors to be true to theirword? We can ask them to make a promise, such as to listen to all of theevidence, or to award a verdict that is consistent with the evidence. Wearen’t likely to get much further than that with any judge.• Authority: Who in the courtroom can assert the power to which we wantjurors to defer? The highest the power in the courtroom is supposed toreside with the judge. That is why she sits above everyone else andwears a robe. But power may be shared with, or in some instances, cooptedby others. Jurors will defer to lawyers, clients, and witnesses –particularly expert witnesses – who appear knowledgeable and confident.Confidence is important enough we need to address it separately below.• Liking: How do we get the jury to want to say yes to our client? By beinglikable. Good lawyers know, and teach their clients and witnesses toremember, that the jury is watching constantly, evaluating everyone in thecourtroom with a focus on those who are courteous and show respect forothers. Liking is close to empathy, which will get more attention in a fewpages.• Social proof: How can we get the jury as a group going our client’s way?This is tribalism, pure and simple. During deliberations, if not before,jurors will be looking to the judge, the court staff, the attorneys and parties,and eventually each other for guidance first on how to behaveappropriately in court and then on how to assess the case. No juror islikely to stand up against a consensus view, any more than test subjectswere likely to disagree when everyone else in the room identified a linethat was longer or shorter than the correct answer in the study describedin Section II.A.These six evolutionary principles can help us frame our cases to appeal to jurors’ selfinterest.If you review them once more, you may see they have something in common.29

They all are associated with the same hormones that trigger tribal behavior, oxytocinand vasopressin. Offering jurors an opportunity that is rare or a chance to reciprocateor follow a strong leader or be part of a group triggers the hormones that make themwant to be on our team.C. Be ConfidentThe power of confidence to persuade can hardly be overstated.Political scientists have shown that one of the best ways to predict election outcomes isto compare the candidates on “approach behaviors,” such as the tendency to movetoward the audience when answering questions, exuding openness and confidence,instead of standing still, thereby signifying defensiveness. 59Psychologists at the University of Chicago led by Paul Zarnoth conducted a study inwhich volunteers first solved math, analogy and other types of problems, and then wereasked how confident they were about their answers, first as individuals, and then againin small groups. The group responses tended to mirror the individual responses of themost confident member of the group, regardless of whether the answers were right orwrong. The individuals who seemed most confident were also perceived to be the mostcompetent. 60And another group of psychologists looked at whether student’s initial perceptions aboutlecturers on traits such as confidence, optimism, likability, and enthusiasm were59 Dutton, supra note 5 at 184.60 Id. at 183-84.30

correlated with the evaluations given at the end of the semester. They found a strongcorrelation, much stronger than might be expected since the students based their initialevaluations only on watching a thirty-second video clip of the lecturer, with the soundturned off. 61A half-minute watching body language apparently told the studentseverything they would ever need to evaluate their teachers.Recognizing that confidence is important in the courtroom is one thing; instillingconfidence is another. A person who feels confident should have little trouble exudingconfidence, but a person who is shy or racked with self-doubt usually can’t changecharacter overnight. An obvious lack of self-confidence is most likely to be seen inwitnesses who tend to be perfectionists or very insecure and have become convincedthat there was something they could have done to prevent something that went terriblywrong. Facts won’t change their mind, as we’ve already noted.What the introverts need is a shot of testosterone, and less cortisol. Both are hormonesthat are present in humans and other primates. Testosterone is associated withdominance and power (in both males and females), while cortisol is associated withstress. The levels of those hormones change in individuals as their roles change.When a person assumes a leadership position, her testosterone level will rise and hercortisol level will fall in just a few days. 62A leadership position is what we want our witness to assume, but she is assigned to arole that is inherently powerless. She has no control over the court’s agenda, the date61 Id. at 184.62 Cuddy, supra note 36 at 51.31

or time she will testify, or the questions she will be asked. She may be forced to listento days of tedious testimony that upsets her or to sit in an empty hallway on a hardbench until she is called into a room as foreign as the moon and forced to explainherself, using a microphone, to a group of total strangers. She is a stranger in a strangeland unless we help her, first by taking the time to help her get comfortable with thespace in advance of the trial, and then by helping build her confidence.How do you give someone else confidence about the positions that person needs toassert? Our first inclination is often to lecture the person about the strengths of herarguments. While support can be important, it won’t convince a person of somethingshe doesn’t believe. It is a better idea to make her present her own defense, either inwriting or aloud. Forcing her to articulate the arguments for herself will actually openher mind to ideas she may not otherwise see. Of course, it will take time and practice,and some coaching.There are easier and quicker techniques. Clothes can make a difference, for example.You can encourage your witness to dress presidentially, in a dark business suit with awhite shirt or blouse and a tie or scarf in a primary color. Clothes that convey power willmake the wearer more powerful.Another technique is asking your witness to stand and sit taller and bigger, to adoptpostures that are more assertive and confident. As silly as it may sound, Amy Cuddy ofHarvard has shown that “a mere two minutes in high- or low-power poses causedtestosterone to rise and cortisol to decrease – or the reverse.” 63So sending your63 Id.32

witness into a private space in the last few minutes before court convenes withinstructions to stand with her feet spread and her arms raised over her head to makeherself as big as possible will raise her confidence. Much as cats arch their backs andraise their fur to enlarge their power, people who adopt powerful postures look morepowerful and become more powerful. They are more willing to take risks, they speak upmore in class, and they are more successful in selling venture capital projects. 64Theybecome leaders the tribe will follow.We project confidence in other behaviors as well. Studies show that success in sellingventure capital projects is strongly predicted by “calmness,” “passion,” “eye contact,”and “lack of awkwardness.” 65Eye contact may be the most compelling indicator ofconfidence, and of sincerity and trustworthiness. When we listen to people, most of uslook directly at them about 75 percent of the time. When we are talking, most of us lookat our audience only about 40 percent of the time. Upping the percentage when we talkjust a bit, to around 50 percent, can make a significant difference in how the audienceresponds. Getting our witness, or ourselves, to make eye contact 50 percent of the timepresents an air of authority. (But don’t get carried away; staring can be creepy.) 66Another way to increase our influence is to modulate our speech patterns – not thewords we choose, but the harmonics of pitch, frequency, and timbre. Researchers havefound that business leaders and successful politicians around the world “all share keyvocal qualities that strongly affect how people respond to them, independent of the64 Id. at 52.65 Id.66 Dutton, supra note 5 at 55.33

meaning of the words they say or the ideas they express.” 67While some people areborn with charismatic voice qualities that inspire trust, UCLA acoustic scientist RosarioSinorello says, “You have the capacity to shape your voice in a way that makes peopleperceive you a leader.” 68You can learn to speak like the men whose voices arecharismatic, who tend to use lower-pitches and, when speaking to crowds, a wide rangeof frequency variation. They stretch their voices less when speaking to other leaders.Whether woman can use the same techniques to alter how audiences perceive themhasn’t been studied yet. 69Through practice, we can alter our voice patterns, increase the amount of eye contactwe make with the audience, and alter our levels of testosterone and cortisol before apresentation. By doing those things, we can exude confidence, which is far moreimportant to persuasion than the words we use or the facts we present. A cautionthough: confidence isn’t a synonym for arrogance. Empathy matters, too.D. EmpathizeWe respond positively to people we think are like us. When students read that theyhappened to have been born on the birthdate of Rasputin, the Mad Monk of Russia,they thought of him more positively than did the students who read Rasputin’s actualbirthdate. 70Readers process messages containing sports metaphors more carefully67 Robert Lee Hotz, “Hear, Hear! Scientists Map What Charisma Sounds Like,” Wall Street Journal D1(December 2, 2014).68 Id.69 Id. at D2.70 Dutton, supra note 5 at 188.34

than neutral messages, and those messages have a greater impact on attitudes, butonly for readers who are sports fans. For other readers, the sports metaphorsbackfired, attenuating interest and considerably reducing persuasion. 71Fortunately, we don’t have to depend on metaphors of any kind to establish empathywith an audience. A smile often will do. People tend to mirror each other. In fact, thereare “dedicated ‘mirror neurons’ in the brain.” 72Smiling at someone will prompt them tosmile back, that is unless they have concluded that our smile is insincere or our motivesare questionable. 73“We are probably not able consciously to mimic others very effectively; the process issimply too complex and too fast.” 74Trying to mimic others probably makes us lookphony. 75But when we mimic the facial expressions of another person, flexing ourmuscles into characteristic emotional expressions actually produces the effects on theautonomic nervous system that accompany the emotion. “Thus, facial expressionsseem[] to be capable of generating appropriate [autonomic nervous system] arousal.” 76In that way and others, “people do in fact catch one another’s emotions….” 77Theprocess has been called “emotional contagion.” 7871 Id. at 191.72 Cuddy, supra note 36 at 52.73 Id.74 E. Hatfield, R.L. Rapson, and Y-C.L. Le, “Emotional Contagion and Empathy,” in Jean Decety & WilliamIckes, The Social Neuroscience of Empathy 19, 21 (2011).75 Id.76 Id. at 23.77 Id. at 25.78 Id. at 19.35

Not all emotions are contagious. In fact, we are essentially immune to the influence ofthe emotions of rival or disfavored tribes. We can easily ignore the suffering of the poor,for example. Recent imaging research showed no activation of the medial prefrontalcortex, an area of the brain that is necessary to social perception, in response topictures of homeless people. Professor Cuddy notes, “People are not even recognizingthem as human.” 79That would seem to explain how public hangings could drawenormous crowds in bygone days, and any number of other examples of the crueltypeople can perpetrate against human beings who we see as being outside our owntribes.It may also help explain why so many people were incensed when the Supreme Courtinsisted that corporations are “people” that enjoy a right to freedom of speech. For mostpeople, it is hard to empathize with an abstraction, whether it is a corporation, thegovernment, or any group other than our own tribes. As a result, “[p]eople trust groupsless than individuals and expect interactions with groups to be more hostile thanperson-to-person interactions. People also act less cooperatively toward groups thanthey do toward individuals and behave more aggressively in intergroup as compared tointerpersonal interactions, holding all other factors constant.” 80People distrust large organizations. In one study, a team led by Dan Ariely askedpeople to affirm or deny the truth of statements such as “the sun is yellow” and “a camelis bigger than a dog.” When the team provided the statements without attributing themto anyone, participants affirmed the statements as true every time. But when the79 Cuddy, supra note 36 at 51.80 Cikara, supra note 31 at 121 (citations omitted).36

statements were attributed to one of the two major political parties, or to Proctor &Gamble, participants got suspicious; they wondered whether the sun has red spots andisn’t “really just yellow,” and they wondered if a newborn camel really would be biggerthan a bull mastiff. Ariely’s team also found that consumers were far less suspicious ofproduct claims attributed to neutral sources, such as Consumer Reports, thanstatements made by companies, even ones with well-respected brand names. 81For businesses and large organizations, and for the lawyers who represent them, thoseresults present an obvious problem. Most jurors are inclined to be suspicious abouteverything such parties say concerning their products or their actions.How do we deal with that? We have to talk about people, rather than the company orthe government agency or the union that is our client. We have to let the jury see realpeople, people they like and trust and respect, sitting in the courtroom and explainingwhat they did and why.The lawyers who defend businesses have long believed that having a good corporaterepresentative sitting at counsel table was essential. It still is, and probably always willbe, even though it may be losing some of its effectiveness. Studies from the Universityof Michigan and San Diego State University reveal that “college students’ self-reportedempathy has declined since 1980, with an especially steep drop in the past 10 years”and “during the same period students’ self-reported narcissism has reached newheights.” 82If the next generations of jurors will be narcissistic and lack empathy, that81 Ariely, supra note 42 at 262-64.82 Jamil Zaki, “What, Me Care?” Scientific American Mind 14 (January/February 2011).37

makes it all that much more important for lawyers representing businesses to engagethem in other ways.And clearly, there are ways to engage them, as Apple has proven. Apple’s business isbased on the high tech devices that are so often accused of being dehumanizing, butApple is one of the most popular companies in the world, particularly among that samegeneration that may be more narcissistic and less empathic than older generations. IfSteve Jobs and Tim Cook can inspire empathy and enthusiasm for Apple, there isreason to think we can find a representative who will do it for the businesses werepresent as well.E. Tell a StoryOne of the best ways we engage people is by telling a story. The Bible is filled withparables for a reason. Most of us understand the power of stories intuitively, butlawyers too often forget about that power as we get absorbed in the details of ourcases. We shouldn’t. Uri Hasson, a neuroscientist at Princeton University, has beenusing brain scans to confirm how people respond to stories. In one study, his team“recorded the pattern of one person’s brain activity as she told a vivid personal story.Then someone else listened to the story on tape, and they recorded his brain activity.”They found “the two brain patterns showed a remarkable degree of correlation. Thestory teller … had literally gotten into the listener’s brain and … made [it] match herown.” 8383 Alison Gopnik, “Want a Mind Meld? Tell a Compelling Story,” Wall Street Journal (April 5-6, 2014).38

“The more tightly coupled the brains became, the more the listener said that heunderstood the story. This coupling effect disappeared if you scrambled the sentencesin the story. Something about the literary coherence of the tale seemed to do the work.”Id. A good narrative story is a kind of magnet that pulls people into the storyteller’stribe.To win a jury, the best opening statement is good story. Lawyers who bristle when thejudge admonishes them for arguing in their openings ought to thank the judge instead.She is doing them a favor, perhaps unintentionally. The lawyer who argues in openingis less persuasive than the one who brings the jurors into his and his client’s world,helping them feel, for example, the enthusiasm the client has about offering a productthat makes life a little safer, warmer, or better for customers, and their personaldisappointment and frustration when their product is maligned unfairly. A good story willput the jurors right into our client’s shoes, ready for a long walk with our client’s tribe.As British barrister Michael Mansfield has said, “The first thing members of a jury get ina courtroom is a gut instinct. They make up their minds with their hearts. The trick thenis to present the evidence in such a way that it corroborates that initial gut instinct. It’sjust like in everyday life. It’s much easier to convince someone that they were right allalong than that they were wrong all along.” 84F. Make It Simple84 Dutton, supra note 5 at 100.39

Finally, jurors will always respond more favorably if our story and our theme are easy tounderstand. “Research has indicated time and time again that our brains have a biasfor simplicity.” 85It is good if our case is simple; it is better if it seems simple. Simplicityisn’t as simple as you might think.Johnny Cochran demonstrated how simplicity sells with a ditty about a glove that didn’tfit. He could have said, “If the glove is too small, OJ is not guilty.” Instead, he used arhyme – “If the glove doesn’t fit, you must acquit.” That was a great choice based onthe outcome of the trial, and also on what we know from research. In a study conductedat the University of Texas, participants read pairs of aphorisms. The pairs had thesame meanings, but one aphorism rhymed and the other didn’t. Participants wereasked to rate the aphorisms for accuracy – that is, how well “the proverbs stacked upagainst real life?” 86Participants perceived the aphorisms that rhymed as “less cutesyand more genuine.” 87 Participants apparently thought the rhyming versions provided “atruer, more accurate reflection of the way things really are” because they could be“swallow[ed] whole” and digested more quickly. 88So it isn’t enough to keep it simple, and the critics who disparage speeches and writingthat incorporates rhyme and alliteration and similar techniques are overlooking thebenefits of making our words simpler for people to understand and remember. Findinga simple, catchy way to summarize a difficult idea, now that is complicated.85 Dutton, supra note 5 at 162.86 Id. at 164.87 Id.88 Id.40

VI.ConclusionBefore we present any evidence or argument, we have to draw the jurors into ourclient’s tribe with a story, one that catches their interest with something unexpected orintriguing, serves their own interests in some way, makes them empathize with ourclient, and provides a theme that summarizes the evidence simply and memorably. Ifwe can find such a story, and tell it well and with confidence, we have done the best thatmodern science suggests we can do to advance our client’s cause at trial. Theselessons come from the burgeoning science of tribalism, but that science can help uswhen we are preparing for trial or in the heat of a courtroom battle only insofar as weabsorb it and apply it. That isn’t easy. There are too many studies, too many ideas, toomany hormones, too many techniques to remember them all. What we can remember,and it is the most important thing to remember, is where our focus should not be. Weneed to remember that law, logic, and evidence aren’t the tools we use to enlarge ourtribe.41

The science of tribalism says jurors don’t attend to the content of scientific evidence, orof any evidence or argument, as much as they do to who is presenting it and how it ispresented. As Amy Cuddy says, people giving a speech tend to exaggerate theimportance of words. They “care too much about content and delivering it withprecision. That makes them sound scripted.” It is far better, she says, to “come into aroom, be trusting, connect with the audience whoever they are, and then move themwith you.” 89So remember this: tribalism trumps thought!89 Cuddy, supra note 36 at 52 (emphasis in original).42

2015 INTERNATIONAL CLIENT SEMINARFAIRMONT SCOTTSDALE PRINCESS | SCOTTSDALE,ARIZONAMARCH 5 – 8, 2015Catastrophic Litigation:Lessons from Defending Headline CasesBenton J. BartonHALL & EVANS, LLCDenver, Colorado(303) 628-3403bartonb@hallevans.comP. Clark AspyNAMAN, HOWELL, SMITH & LEE, PLLCAustin, Texas(512).807-2453aspy@namanhowell.comCynthia StevensCorporate CounselJACOBS ENGINEERING GROUP, INC.Pasadena, Californiawww.jacobs.comDianna Baker ShewAssistant General CounselCORRECTIONS CORPORATION OFAMERICANashville, Tennesseewww.cca.comJoseph BuczSenior Claim ConsultantXL InsuranceChicago, Illinoiswww.xlgroup.com

Catastrophic Litigation:Lessons from Defending Headline Cases 1I. What is “Catastrophic Litigation?”The term “catastrophic litigation” refers to complex claims that arise from a tragic,publicized disaster. Catastrophic litigation is intense, and will unleash a frenzy ofaccusations and responses, threatening to eclipse your business focus and monopolizeyour time and legal resources. Catastrophic litigation presents a significant risk ofexposure to your company, and could threaten its very survival. While specificcatastrophes and litigation that follows will differ in significant ways, they raisecompelling issues, and this panel and these materials offer recommendations on bestpractices and lessons learned that your business can draw on when needed.II.IntroductionIncreasingly in modern times, there is no such a thing as “just an accident” or an “act ofGod.” When something dramatic happens – when many people are injured and there isextensive damage and publicity – we now assume that high-stakes litigation againstsomebody will follow. This will happen in most places across the globe, and it does notmatter if you may be just a small actor in the tragedy. This will happen even if youbelieve you have strong defenses to both liability and causation. Victims will hirelawyers immediately, and quite often they will bring claims before the tragedy and its1 We are grateful for the panelists’ contributions to this topic and paper, written and edited by BentonBarton of the ALFA International firm of Hall and Evans, LLC of Denver, Colorado and Clark Asp of theALFA International firm of Naman, Howell, Smith & Lee, PLLC of Austin, Texas.

impacts are fully felt, much less the legal theories fully developed. No matter what yourcompany’s role may have been in arguably contributing to the catastrophe, plaintiffs’lawyers will find a way to assert that nearly everyone involved should shareresponsibility.These concerns are heightened when a garden variety accident rises to the level of atrue catastrophe.While there is no universally accepted legal definition of“catastrophic,” the word has been defined thusly: “extremely harmful;” or, “bringingphysical or financial ruin;” or, “involving or causing sudden great damage or suffering.” 2Catastrophes are rare, and thankfully so are the lawsuits that spring from them. Youmight only experience one in your career. But when one arises, it is better to be readywith a plan, and not make things worse for you and your company by not beingprepared.Catastrophic litigation presents unique issues and special considerations for yourbusiness. It could also be described as “bet-the-company litigation.” 3The pressures ofcatastrophic litigation are exacerbated by saturation coverage in the news, and arefurther ratcheted up by social media. Here, we offer ideas for immediate discussion and2 These definitions are found in on-line versions of dictionaries published by Google, The Free Dictionary,and Merriam-Webster.3 Notably, this topic is gaining traction as a defined legal practice area. Mealey’s Litigation Report nowdedicates a monthly journal on claims, lawsuits, and insurance coverage disputes triggered by“Catastrophic Loss.” “The Report tracks coverage liability arising from Hurricanes Irene, Katrina, Rita… the September 11 terrorist attacks; the Gulf Oil Spill; tropical storms; tornados; rainstorms; poweroutages; data breaches; and much more.” Mealey’s Litigation Report: Catastrophic Loss, available athttp://www.lexisnexis.com/litigationspotlight/pdfs/CatastrophicLoss.pdf (last visited January 7, 2015).

implementation when your company is embroiled in a tragedy that triggers unwelcomescrutiny and potentially devastating claims. 4III.Anatomy of a CatastropheTo frame our discussion, the following paragraphs summarize a real tragedy that led tocatastrophic litigation.In the middle of the night on August 6, 2007, in a remote Rocky Mountain site, amassive pillar of coal being mined suddenly collapsed. The implosive failure occurredduring the controversial practice of “retreat mining.” Six miners were working on thenight shift 2,000 feet underground – over four miles from the mine’s entrance – andwere instantly entombed. The collapse was felt as a 3.9-magnitude earthquake.This extremely remote site quickly developed into a 24-hour international news andcrisis management center. Since it was possible that the miners were still alive, fellowworkers, family members, engineers, equipment operators, healthcare providers,government investigators, investigative reporters and curiosity seekers arrived tosupport, protest, pray, and report on the search-and-rescue efforts. Plaintiffs’ lawyersappeared soon after.The mine company’s CEO took personal charge at the site and quickly became thepublic face of the tragedy. He personally led grieving families, reporters, government4 These materials were written to benefit a national audience. The authorities cited are representativediscussions of important legal issues that arise in catastrophic litigation. Please consult your ownjurisdiction’s law for more specific guidance.

investigators, scientists and politicians on underground tours, discussed the rescueefforts in great detail, and held emotional press conferences each day. The CEOinitially blamed the collapse on natural causes and refused to entertain the possibilitythat mining the coal pillars might have triggered the event.As the days dragged on without contact from the trapped miners, criticisms of themine’s past design and operations came to light. Then, things went from bad to worse.On August 16, ten days after the initial collapse, a second burst occurred while rescuerswere tunneling towards the suspected location of the first group. The second tragedymore than doubled the number of victims, adding more deaths and serious injuries.The media spotlight’s glare had already been intense, but then it became simplyoverwhelming.The pressures increased as family members, co-workers, andneighbors staged round-the-clock vigils, the Governor and other elected officials took tothe airwaves, and federal, state, and local government agencies asked hard questionsand uncovered troubling documents about the mine’s efforts to recover “support pillars”that had served as structural support for the mine’s roof. Warnings from old agency andconsultant reports were highlighted on the news and before government agencies.Opinions on the causes of the two collapses were offered from international miningexperts on nightly news programs.Within just a few days, the mine’s executives, employees, consultants, and contractorswere subpoenaed to provide documents and witness statements to the United StatesSenate, House of Representatives, Department of Labor, Mine Safety & HealthAdministration, and the State, among others. The agencies separately sent out

hundreds of written questions, and also requested documents, interviews, anddepositions. Criminal charges were discussed. Televised hearings were set.To complicate matters further, most of the victims came from large families. Over 100plaintiffs, mostly close relatives represented piecemeal by a dozen different plaintiffs’firms, filed cases in federal and state courts. There were different judges and potentialjury pools; nothing about the lawsuits was coordinated. The scores of plaintiffs includedwives and ex-wives, minors and adult children, and undocumented foreign relatives.Some plaintiffs were bystanders who felt the coal bursts and suffered emotionaldistress. Others were related to one miner who escaped the first collapse, but thencommitted suicide after being ordered to go back to work. The involvement of foreignplaintiffs triggered thorny questions of legal standing, immigration status, andinternational law, and caused many procedural entanglements.There were also collateral administrative proceedings such as workers’ compensationclaims. There were property damage claims for damaged and destroyed miningequipment. Suddenly, hundreds of coal miners were out of work and seeking financialassistance. Just as suddenly, a mine that had yielded over 50,000 tons of coal permonth was completely shut down. Customers complained. Inevitably, insurancecarriers filed declaratory judgment actions to sort out the difficult coverage questions,along with subrogation claims. Hundreds of insurance policies were implicated.

One defendant 5 , Company X for this discussion, was a small engineering company thatfor decades had provided the mine with recommendations for harvesting the remainingcoal pillars. The media, government investigators, and plaintiffs’ lawyers accused thecompany of misconduct and criminal offenses. There were only a handful of experts inthe world who could understand the complex engineering and operations, thus a“standard of care” was difficult to define.The government investigations proceeded simultaneously with the lawsuits, and theofficial inquiries were haphazard and inconsistent. Lawyers raised concerns thatwitnesses could incriminate themselves by answering questions. For a while, CompanyX and defense counsel received daily messages from CNN and other national mediaoutlets, seeking comment on the latest developments. The mine CEO’s rambling,combative press conferences enraged victims’ family members, who still held out hopefor a rescue.For Company X and many others, these events raised extremely sensitive business andlegal concerns, including the impacts of unfavorable press, the wisdom of cooperationwith oversight agencies, damage to reputations and commercial relationships, the needto preserve documents and evidence, potential insolvency from fees, costs anduncovered damages, insurance coverage questions, tainting of the jury pool, and theterrifying specter of criminal prosecution. In the lawsuits themselves, unique issuesincluded applying a standard of care to cutting-edge engineering services, sufficiency of5 Hall & Evans represented Company X in this matter, and it has granted permission for the panel togenerally discuss the public aspects of the claims and litigation.

expert opinions, retaining and producing old documents and electronic information, thelogistics of dealing with over 100 plaintiffs bringing wrongful death and survivorshipclaims, defending serious (and higher-value) bodily injury claims, ensuring that allstakeholders were accounted for in settlement discussions, and responding to theunyielding demands of the investigating governmental agencies.Ultimately, the lawsuits and most ancillary claims settled, but spin-off litigation continuedfor several more years. This catastrophe implicated nearly every conceivable issue thatmight be involved in “catastrophic litigation.” At the end of the discussion, it is thepanel’s hope that attendees and readers will benefit from the following “lessonslearned.”IV.Before the Storm: Is it Possible to Prepare for a Catastrophe?Even though catastrophes may be completely unforeseeable, companies who work onhigh-risk projects can be prudently proactive when things are quiet.A. Choosing Work CarefullyAll transactions of any complexity present a risk of serious future exposure that will befar in excess of what the work was worth. Since companies that take no risk do nowork, it is unrealistic to expect lawyers to advise clients to turn down attractiveopportunities, especially in a competitive economy.Instead, it would be ourrecommendation that your company would at least conduct a careful, up-front business

and legal review of significant engagements (including the reputations of the partiesinvolved) that may contain heightened risk.In the above-described case, the mine’s ownership had turned over several timesduring the mine’s long operating life. With the benefit of hindsight, Company X learnedof concerns involving the mine’s operations that definitely would have raised “red flags”years before had a proper risk assessment been done. If properly assessed, thisinformation might have led Company X to make different decisions relating to theproject, its role, the preparation of design documents and, most importantly, theissuance of warnings and other helpful documentation. The post-accident investigationalso revealed problems relating to methods of harvesting coal, safety violations, anddeviations from Company X’s design recommendations.The awareness and understanding of red flags at the beginning of a new relationshipwill, at the very least, guide your team to act more cautiously than usual in executing itswork. It will also help reinforce the need for careful documentation. If an accident lateroccurs, your company will be in a better position to defend itself amid the scrutiny.B. Reviewing the Adequacy of Your InsuranceAt least annually, a well-managed company should undertake a complete top-to-bottomreview of its insurance program. The company should consult not only with its broker,but also with in-house and outside counsel, to spotlight any potential gaps or new lawthat may impact coverage. Prominent items to study include levels of deductibles andself-insured retentions, total policy limits, whether limits erode, the availability of excess

or project-specific policies to supplement limits, and generally whether damages causedby your work might not be covered. If the company later faces catastrophic litigation,these proactive efforts will pay obvious dividends.Some companies tactically obtain lower levels of insurance, higher deductibles, or mighteven “go bare” so as to present less of a target to future claimants. This choice mightwork out sometimes, but it is enormously risky and is not recommended.Catastrophic litigation is expensive. All too often outside counsel are presented withdefensible cases, but are hamstrung by a lack of resources with which to zealouslydefend the case. In the mine case discussed above, Company X maintained only a $2million professional liability policy with eroding limits. It had not substantively reviewedits insurance needs for several years, nor had the owner requested higher limits.Company X had no other insurance for its professional services. Initial settlementdemands exceeded $100 million. Counsel simply could not mount a thorough, effectivedefense through trial without exhausting most of the limits, and this would havesignificantly harmed Company X’s ability to stay in business.The “reality” Company X faced – insufficient insurance limits v. exorbitant damages –impacted all of the defense decisions and limited Company X’s ability to hire experts, e-discovery vendors, and other consultants. No company wants to be economicallyhamstrung when facing catastrophic litigation.Moreover, sometimes higher-tier parties will focus more on the insurance obtained bytheir lower-tier counterparts, rather than taking a careful look at their own portfolios.

Relying upon the insurance of others is risky, since additional insured (“A/I”) coverage isinherently tenuous.Because catastrophic litigation could put your company out of business, considerrevisiting the question of whether insurance coverages are commensurate with thepotential exposure arising from complex projects or transactions. When the value ofclaims dwarfs the available insurance limits, a policy-limits demand will arrive quickly.This will stress the insurer-insured relationship. This will also negatively impact acompany’s ability to clear its name through the litigation process when it may not wantto settle.Insufficient insurance limits will mandate a fast, unsatisfactory settlement (assuming theplaintiffs will accept the limits). In another recent case, a company worked on amassive minerals project and faced over $20 million in claims from the owner, most ofwhich were completely meritless. However, to defend itself, the company had only a $1million professional liability policy with eroding limits. It never occurred to the owner orthe company to obtain more coverage before the project began. Without the client andcounsel undertaking significant defense efforts, the matter settled quickly for policylimits to avoid the risk of spending the limits fighting the dubious claims, and then stillfacing the possibility of an excess judgment. 66 A good resource on the benefits of a healthy insured-insurer relationship is: John Degroote and WendyTolin Breau, Bet the Company Litigation from a Policyholder’s Perspective, 2009 ACC Docket 25. Theauthors advise on what an insured should be doing with its carriers before and after catastrophe strikes,distilling their recommendations down to four rules: “1) Always act like a reasonably prudent insured; 2)Never try to outsmart yourself; 3) Apply an age-old rule (an insured cannot sue for bad faith withoutacting in good faith); [and] 4) Remember – insurers hate surprises.”

C. Conducting a Crisis Management ReviewNumerous brokers, carriers, and consultants now offer crisis preparedness training.While a business might question the value of these efforts in quiet periods, certainlysomething positive can always be gained through these proactive efforts. Theseservices are not limited to “public relations coaching.”As an example, Marsh USA advertises its ability to “implement an effective crisismanagement program before a crisis ever occurs.” 7Marsh claims that its training will“enhance an organization’s preparedness capability and culture of prevention…” Suchservices may be expensive and time-consuming, but the benefits in terms of avoidingcatastrophic litigation (through the culture of prevention), or in having a heightened levelof readiness when a catastrophe erupts, will pay off.D. Considering Specialty InsuranceInsurance carriers are always interested in selling new products and distinguishingthemselves from competitors. These factors, along with demand, have led to theoffering of many types of specialty products that could assist in defending catastrophiclitigation.For example, RLI Design Professionals offers “Crisis Management Coverage” to itsinsureds. 8When a well-publicized accident occurs, the insurer and insured will decidehow best to implement it to protect the insured’s business and legal positions. In a7 Available at http://usa.marsh.com/RiskIssues/CrisisManagement.aspx (last visited January 7, 2015).8 Available at http://www.rlidesignpros.com/prof-liability.asp (last visited January 7, 2015).

more fearful context, Beazley offers Kidnap & Ransom (“K&R”) Insurance for companieswho send employees abroad to unstable countries. Beazley “will provide both crisismanagement and personal security guidance that is tailored to each client’s specificneeds … [including] evacuation planning, risk mitigation measures and what to do in theevent of an incident.” 9Since September 11, 2001, insurance for terrorism has become a sought-out coverage,now offered by many carriers. In addition, “many governments have introduced statefundedterrorism insurance and reinsurance facilities...” 10When conducting a regularinsurance review, each company must determine whether it faces any unusual risk, andwhether these exotic, but potentially critical, coverages are warranted.E. Ensuring Your Contracts Properly Shift Risk and LimitExposureIt is often said that “good risk management starts with a good contract.” In litigation,defense counsel often face avoidable hurdles arising from poorly drafted agreements;this is extremely frustrating when a case is otherwise defensible. Litigation is difficultenough without having to go to battle with one hand tied behind your back. Poorcontracts are often drafted – or accepted – by sophisticated businesses.9 Available at https://www.beazley.com/our_business/political_risks_contingency/kidnap_and_ransom.html(last visited January 7, 2015).10 A discussion of available terrorism insurance products is published in a report by Airmic Technical andWillis in the “Terrorism Insurance Review 2013,” available athttp://www.willis.com/Documents/Publications/Services/Political_Risk/Terrorism_2013_FINAL_web.pdf(last visited January 7, 2015).

A discussion of the myriad ways to shift risk and limit exposure through contracts isbeyond the scope of this paper. 11However, at a minimum, your scope of servicesshould be governed by a written agreement that clearly sets forth what you are going todo, and perhaps more importantly what you are not going to do. The agreement shouldalso contemplate indemnity, A/I coverage, and also less common situations such asforce majeure, statute of limitations accrual, waiver of consequential damages andforum selection. While these provisions may not always be of benefit against claims byvictims of catastrophes, they are absolutely helpful in litigation positioning andsettlement discussions amongst co-defendants.V. In the Heat of the Moment: First Reactions to a CatastropheWhether or not you have taken any precautionary steps, there is no time to waste afterreceiving news of a catastrophe that implicates your company. You must startprotecting your business by preserving its reputation, relationships and, mostimportantly, future litigation defenses immediately. The following recommendations areimportant when facing any complex claim; they are essential when responding to adisaster. 1211 Author Benton Barton previously prepared a paper titled, “Shifting Risk and Limiting Exposure ThroughContract Language: A Litigator’s Perspective,” presented at a previous ALFA International ClientSeminar. That paper provides examples and analyses of twenty-one contractual provisions thatbusinesses can use in written agreements to help minimize claims and limit exposure, and is availablefrom the author.12 Degroote and Breau, supra at 27. The authors raise the threshold question of whether or not yourecognize a “bet the company” case when confronted with it. The authors note that “catastrophiccases often involve: competitors; regulators with political ambitions; novel legal theories;counterclaims (so be careful who you sue); injunctive or equitable relief; patents and business modelchallenges; aggressive settlement stances; and very good lawyers.” (Emphasis added).

A. Assembling the Company TeamWhen a catastrophic event occurs, immediately, but carefully assemble a responseteam. Take all steps to ensure that legal privileges are protected, and that a “litigationhold” on company documents and emails is painstakingly implemented. The team mustalso include management-level persons with sufficient technical expertise to grasp (andexplain to others) precisely what happened. The team should also have a single persontasked with providing information to outsiders (such as inquiring customers and mediaoutlets).There are numerous court opinions and articles discussing how to protect privilegeswith in-house counsel. 13Most corporate attorneys receive training on these issues. Foreach jurisdiction in which you are headquartered, where the accident happened, andwhere you could be sued, it is essential to be up to speed on the current law of in-houseprotections, as these areas are constantly evolving. 1413 ALFA International regularly offers webinars and written materials on these topics. Additionally, theAssociation of Corporate Counsel provides excellent resources. We recommend: William A. Ruskin,Preserving the Attorney-Client Privilege for In-House Counsel, available athttp://www.lexology.com/library/detail.aspx (last visited May 30, 2014), which summarizes work byattorneys Thomas E. Zeno and Emily E. Root, and distills tips to assist companies in preservingprivileges. The discussion focuses on court rulings in In re Vioxx Products Liability Litigation, 501F.Supp. 2d 789 (E.D.La. 2007).14 It is also wise to study actual court opinions from time to time to get a flavor for what to do (or what notto do) to preserve in-house privileges. E.g., U.S. ex rel. Baklid-Kunz v. Halifax Hospital MedicalCenter, U.S. Dist. LEXIS 158944 (M.D.Fla. Nov. 6, 2012) (ruling that hundreds of emails to and fromin-house counsel and compliance personnel were not protected because they were not solely relatedto legal advice).

B. Tendering to Insurance Carriers and IndemnitorsPerhaps you have a significant self-insured retention. Or, you think a claim is meritless,or not covered by insurance. Nevertheless, in the wake of a disaster it is no time to be“penny wise and pound foolish” by simply hoping a claim will not be pursued. Any“circumstance” or “occurrence” that might lead to a claim, even if the possibility isremote, should be reported immediately to your broker and all potential carriers. Thisincludes tendering to your indemnitors and A/I carriers. When in doubt, you shouldreport the potential claim. If you have questions, consult an insurance coverageattorney immediately.There is no limit on court decisions highlighting the terribly adverse consequences of aninsured’s late reporting of a claim. 15Moreover, insurance carriers prefer to receivenotice of a claim as early as possible, for obvious reasons.Many policies also offer “pre-claims assistance” to insureds who may need legal advicebefore formal claims are asserted. This is an excellent resource for a company to drawupon after a dramatic event, without the worry of having to limit the scope of thelawyer’s services or pay a large legal bill.After reporting the event to all potentially involved carriers, follow-up efforts are critical.Set up a series of scheduled conference calls with the claims professionals to ask andanswer each other’s questions, and to develop a game plan for exchanging key15 “Circumstance” is a term used in claims-made insurance policies as an alternative to “occurrence.” A“notice of circumstance” provision is often included in these policies to extend coverage for events thatmay later produce a claim, so long as the circumstance is timely reported. Please see, IRMI Online:Glossary of Insurance & Risk Management Terms, available at http://www.irmi.com/online/insuranceglossary/terms/c/circumstance.aspx(last visited January 7, 2015).

information (in a privileged setting) at regular intervals after a catastrophe, whether ornot actual claims are pending.C. Assembling Your Outside Legal TeamA catastrophe can happen anywhere, and it might occur in a far-flung venue where youhave no reliable legal contacts. Your insurance carrier will have input into the selectionand retention of defense counsel. When facing a particularly large and complex matter,insurer and insured should work together to identify and retain the best possiblecandidate to serve as lead defense counsel. Insurers generally will accept more of theinsured’s input on choice-of-counsel decisions when a claim is large and complex. Thedefense counsel’s experience in handling catastrophic litigation should be a criticalfactor in the hiring decision.Some companies will want to vet defense counsel candidates through a formal requestfor proposal (“RFP”) process. While this may lead to an excellent hire, it will also wasteprecious time. You may not realize until the end of the RFP process that the lawyer hasa conflict or is not the right fit. This is also not the right time to shop around on price. Ifyou are in an unfamiliar jurisdiction, ask for recommendations from lawyers you alreadyknow and trust.D. Retaining Experts QuicklyThe step of retaining experts quickly is often overlooked early in the process and somewould consider it premature before a lawsuit has been filed. It is not. Catastrophes

arise from incredibly complex underlying decisions, transactions, conduct, and events.Issues of liability and causation will be hotly contested. There is not a deep pool ofqualified expert witnesses who can excel in catastrophic litigation, no matter the area ofexpertise. Ultimately, these experts must be able to write stellar reports and stand up toaggressive cross-examination by A-list opposing counsel.In the case described above, the subject matter of the mine’s design and operations –impacting the crucial issues of liability and causation – was so incredibly specializedthat only a handful of experts worldwide had the knowledge and sophistication to read,understand, and comment on the company’s work. Although the search for expertsbegan within weeks of the tragedy and before litigation was filed, most of the top-tiercandidates had already been contacted by government agencies, media outlets, andother potential parties. This factor definitely impacted the evaluation of the case andcreated a great deal of stress. Everyone on the team will sleep better knowing that youhave the right experts on board.E. Executing the Internal InvestigationAfter a catastrophe, the most fleeting information is that contained within a witness’memory. It is crucial to gather and document the recollections of key witnesses quickly.These efforts could be complicated because company employees may be emotionallyor physically injured, disenchanted with the company, facing termination or criminalcharges, or perhaps they already gave statements to law enforcement or investigatingagencies. All due care should be taken – with input from in-house counsel, outside

counsel, investigators, and experts – to conduct employee interviews ethically andeffectively and maintain privilege on appropriate portions of the internal investigation.F. Retaining Other Litigation VendorsBeyond experts, there are numerous non-legal professionals that can assist incatastrophic litigation. Most importantly, you must immediately consult IT specialistsand consider retaining an e-discovery vendor for preserving electronic information.Vendors engaged early in the process provide the most value. 16In-house and outside counsel who handle complex lawsuits are bombarded with noticesfor blogs, articles and seminars dedicated to issues of evidence preservation and e-discovery. These subjects continue to evolve at a breakneck pace, with littlestandardization other than in some high-profile federal courts. Notably, the State Bar ofCalifornia issued its Interim Opinion on “ethical duties in the handling of discovery ofelectronically stored information.” 17Other seemingly “landmark” cases arises severaltimes per year from other jurisdictions. 1816 Another sometimes overlooked effort involves capturing all photographs and videos of events before,during, and after the catastrophe. Cameras are ubiquitous. Surveillance cameras at nearbybusinesses must be identified, and the images contained requested, along with news helicopter andcell phone videos. For instance, random cameras (installed for other purposes) captured criticalevidence used in the Minneapolis I-35 bridge collapse and the Boston Marathon bombinginvestigations.17 Formal Opinion Interim No. 11-0004 (ESI and Discovery Requests), State Bar of California (2014). “Anattorney’s obligations under the ethical duty of competence evolve as new technologies develop andthen become integrated with the practice of law. Attorney competence related to litigation generallyrequires, at a minimum, a basic understanding of, and facility with, issues relating to e-discovery, i.e.,the discovery of electronically stored information (‘ESI’). … Lack of competence in e-discovery issuescan also result, in certain circumstances, in ethical violations of an attorney’s duty of confidentiality, theduty of candor, and/or the ethical duty not to suppress evidence.” (Emphasis added).18 E.g., Procaps, S.A. v. Patheon, Inc., 2014 WL 800468 (S.D.Fla.).

Beyond the realm of e-discovery, you should consider hiring a public relations or crisismanagement firm to assist you in shaping the company’s response to the tragedyamidst the onslaught of publicity. Defense attorneys are poorly suited for this role.Defense attorneys are innately and reflexively cautious, and will consider all the risks ofmaking public statements without appreciating any potential benefits. Today, with theway news is reported – and then repeated and amplified on social media – simplysaying “no comment” is not helpful and could actually be harmful, especially if othersare talking.Certainly, there is wisdom in the avoidance of offering speculative opinions that mayhave to be “walked back” later in an investigation. However, this consideration must beweighed against the benefits offered by the opportunity to influence “hearts and minds”through the affirmative telling of your own side of the story.Also consider the need for a forensic accountant. Such an expert could help on anumber of fronts. In the case discussed above, because Company X was insufficientlyinsured relative to the exposure, the forensic accountant developed reports on thecompany’s financial status. The information was disclosed in the strictest confidence ofsettlement discussions to convince the plaintiffs that the insurance limits were all thatcould be conceivably recovered. These efforts helped get the case resolved quickly,and without a lengthy due diligence process.Finally, many private investigators and independent adjusters excel in documentingaccident scenes and taking witness statements. Witnesses will often talk more freelywith non-lawyers or persons outside the company. Sometimes, investigators are

connected with certain communities and can trade on personal favors with lawenforcement and other officials. Your company and its carriers should carefullyconsider the benefits that these additional specialists could bring to your team.G. Preserving All EvidenceIn addition to documents, electronic information, photographs, and videos, care must betaken to preserve the status quo at the accident scene itself, lock down physicalevidence such as equipment and parts, and ensure a legally sufficient chain of custodyfor all evidence. Often, investigating agencies such as OSHA will gather and retainmaterials from the site, which can present challenges later when it is time forinspections and testing.Experts should have input into developing evidencepreservation recommendations.State and federal courts will impose substantial penalties against companies that arefound to have spoliated evidence. Most of the time spoliation is unintentional, but thisfactor may not matter when opposing parties seek sanctions. Spoliation orders can alsoinclude “adverse inference” jury instructions.H. Adding Legal FirepowerThe case discussed above took many twists and turns, some of which were unique andunforeseeable. Beyond retention of many of the non-legal consultants discussedabove, defense counsel also eventually vetted and retained several different attorneys –legal specialists – to round out the outside counsel team. Though the larger legal team

was a bit unwieldy and expensive, the diverse perspectives offered by these legalspecialists were invaluable in shaping the client’s defenses and overall strategy.From the time of the catastrophe through case resolution, Company X sought out thefollowing additional legal specialists to supplement the main defense team:• Local counsel. Provided insider knowledge of venues, judges, and jurypools. Enhanced the credibility of Company X and its counsel with thecourt, opposing attorneys and mediator.• Insurance coverage counsel. Provided expertise on Company X’scoverages in place, and assisted in coverage demands and settlementnegotiations.• Bankruptcy counsel. Advised Company X on ethical, proactive behaviorto enhance the company’s future viability.• Criminal counsel. Analyzed the merits of criminal allegations bygovernment officials, the likelihood of follow-up action by prosecutors, andadvised on steps to avoid incriminating conduct.• Separate employee counsel. Dealt with conflicts between the companyand employees, especially when employees were threatened with criminalprosecution, or acted outside the course and scope of their employment.• Administrative law counsel. Specialized attorneys who routinely didbattle with particular government agencies (e.g., OSHA, MSHA, etc.),advised on how to respond to investigations, document requests,depositions and public hearings.• Washington, DC counsel. Specialized in responding to publicizedCongressional investigations.

VI.THE BATTLE BEGINS: RECOMMENDATIONS FOR LITIGATIONThousands of decisions – many of them judgment calls – will come into play in anycomplex lawsuit arising from a catastrophe. Because all cases are unique, no paper ortreatise can provide a one-size-fits-all litigation roadmap. Here, though, the panel offerssome recommendations that could help your company effectively defend and resolvecatastrophic litigation.A. Reaching Across to the Other SideBeyond the stresses of time and money, catastrophic litigation will exact other businessand emotional tolls on all those involved. Every company facing catastrophic litigationeventually will become worn down and express a strong desire to get the matterresolved quickly so that everyone can focus on productive and less-taxing endeavors.While catastrophic litigation can be overwhelming for defendants, it is also challengingand stressful for the victims and plaintiffs’ attorneys. Beyond the factual and legalissues, plaintiffs’ attorneys are juggling the challenging logistics of multiple clients,outsized recovery expectations, familial and legal status of claimants, and variable claimvalues. Understanding the pressure points that the other side must deal with is helpfulfor defendants in the context of shaping defense strategies and approaching settlement.Some might counsel against this, but consider reaching out to plaintiffs’ attorneys earlyfor face-to-face meetings. Couched as confidential settlement discussions, themeetings would include candid exchanges about what each side is dealing with, and

how each side can assist the other with informal disclosures of documents andinsurance information in an attempt to expedite resolution, or at least plan for it. 19While there is some risk that these overtures could be interpreted as signs of worry orweakness, this risk is low if your legal team is respected and has a reputation fordefending difficult cases. Even if the meetings do not materially advance the balltowards settlement, they are never a waste of time. You will at least learn somethingimportant about the facts and the other side’s perspective. You will be able to get a feelfor the strengths, weaknesses, and reasonableness of the other attorneys and theirclients. At the very least, you will have “broken the ice” with the other parties – bothplaintiffs and codefendants – and hopefully enhanced your credibility. This will lead tosmoother and more efficient dealings later in the litigation or at mediation (when thingsget more heated).In the case discussed above, early meetings with the plaintiffs’ attorneys, and also withother defense attorneys and insurance professionals, allowed Company X to lay helpfulgroundwork for a joint defense, and this also assisted future settlement negotiationswhere representations and credibility were in play.B. Locking Down Your MediatorAs with expert witnesses, the skillfulness of mediators varies greatly, and there are fewneutrals with significant experience in shepherding catastrophic cases to resolution. It19 See Rule 408, Federal Rules of Evidence (2014), Compromise Offers and Negotiations. This Rule andits state equivalents are routinely used as “cover” for plaintiffs’ and defense attorneys – and theirclients and carriers – to have more frank conversations and information exchanges early in a lawsuit.

is essential to retain an excellent mediator who will be accepted by the main litigationstakeholders, and who has unquestioned credibility with plaintiffs, defendants andinsurance professionals. Since all good mediators are busy, it is essential to vetmediators and secure their availability early.For larger cases especially, mediators should be proactive. In complex cases,“managed mediation” is becoming more common. In this approach, parties meetseparately, request documents, exchange specific information in particular formats, andthen hold multi-day settlement conferences.Good mediators also understandinsurance coverage issues, and can talk to claims professionals on their level.In an incredibly complicated construction case involving a high-profile public projectmediated in late 2013, the parties agreed to an out-of-state mediator who specialized indesign, construction and insurance coverage disputes. The mediator called several inpersonmeetings with the main parties and their legal teams, toured the site tounderstand the design and construction issues, requested shorter mediation letters,summaries and bullet-point research memoranda, and eventually scheduled seven fulldays of discussions occurring over a four-month period. The mediation efforts weretime-consuming and complex for all involved, and many parties complained. Ultimately,the efforts were beneficial and caused all the attorneys, parties, and insurers to maintainfocus on resolving the case, even during periods of frenetic litigation activity.Even if the case is ultimately headed for trial, there is little to lose by mediating early.

C. Reaching Out to Co-DefendantsWe also recommend scheduling early meetings with co-defendants and their legalteams, and also with key witnesses if they are not affiliated with a party. Your interestsmay be aligned or divergent, but the meetings will still yield benefits. These meetings,which can also be governed by evidentiary Rule 408 (relating to compromise offers andnegotiations) allow the parties to understand each other’s key factual and legalpositions, willingness to stay in the fight or settle, and insurance availability.D. Considering Joint Defense and TollingResearch the applicable jurisdiction’s law on the “joint defense” or “common interest”doctrine, and also the enforceability of tolling agreements. With respect to the former,some type of common interest doctrine is recognized in nearly all states and federalcourts, but the contours of the privilege are surprisingly variable. The common interestdoctrine is addressed in the Restatement (Third), “The Law Governing Lawyers,” atSection 76. A common interest agreement does not mean that one has to defend thecase in lockstep with other defendants. It simply means that the parties can shareinformation with each other that will be protected from discovery. 2020 The common interest doctrine is a popular topic at legal seminars, and getting it wrong can exposeyour company to significant risk. At the ABA’s National Conference on Professional Responsibility in2012, a prominent California attorney and professor presented: Mark L. Tuft and Brandon Lawrence,What’s Uncommon About the ‘Common Interest’ Doctrine, available athttp://www.americanbar.org/content/dam/aba/administrative/professional_responsibility/38th_conf_session8_whats_uncommon_about_the_common_interest_doctrine.authcheckdam.pdf (last visitedJanuary 7, 2015). The authors provide an excellent discussion of the privilege’s history and contours.

A tolling agreement is also very useful between co-defendants. It is “an agreement towaive a right to claim that litigation should be dismissed due to the expiration of astatute of limitations.” 21 There are few downsides to executing these agreements. Onecan always withdraw from such an arrangement if it is no longer useful or relevant.The most obvious benefit of a tolling agreement is to allow defendants to avoid feelingas if they have to assert claims against each other early in a case. Seeing cross-claimscan embolden plaintiffs’ attorneys and lead to defendants being forced to prove upcases against each other to the plaintiffs’ ultimate benefit.Another use for tolling agreements involves putting off coverage disputes andapportionment actions between insurers. As with cross-claims, plaintiffs could usecollateral insurance litigation to gain leverage in the main case. A tolling agreement willkeep these issues in the background.E. Streamlining the Litigation as Much as PossibleThere are many legal tactics that can be considered to consolidate claims and cases.Carefully research the availability of these methods in the relevant jurisdiction as earlyas possible. In the case discussed above, there were numerous court and governmentactions filed by different claimants, proceeding against different defendants,simultaneously. Beyond the logistical challenges of coordinating these matters, the riskof self-incrimination and inconsistent rulings may compromise your defense.21 This is a very basic definition, available at http://definitions.uslegal.com/t/tolling-agreement/ (last visitedJanuary 7, 2015). Tolling agreements are particularly useful in deferring potential cross-claimsbetween defendants, and also forestalling ancillary litigation involving insurance coverage.

Assuming jurisdiction, most parties will first look to removing a case filed in state courtto federal court. Federal court also offers multidistrict litigation (“MDL”). The procedureis codified at 28 U.S.C. § 1407. One of the goals of MDL is to foster consistent judicialrulings. MDL proceedings have been in place in the federal courts since the late1960s. 22Some states (such as Texas) have their own MDL procedures. Using a state court’s“mini-MDL” procedure where catastrophic litigation is pending may be a preferablealternative to federal MDL (or litigating in multiple courts). 23Another procedural streamlining method is known as the “Colorado River Doctrine.”The Doctrine is a rule of abstention arising from considerations of judicial economy. Itallows a federal court to abstain from resolving a pending lawsuit in deference to a statecourt action. 24The Colorado River Doctrine can sometimes be strategically used toconsolidate all claims into a single court.Some trial court judges will also consider staying civil litigation during pendingadministrative, criminal or grand jury proceedings. 25When a party can demonstrate a22 28 U.S.C. § 1407 (a): “When civil actions involving one or more common questions of fact are pendingin different districts, such actions may be transferred to any district for coordinated or consolidatedpretrial proceedings.” Please also note subsection (c): “Proceedings for the transfer of an actionunder this section may be initiated by: (i) the judicial panel on multidistrict litigation upon its owninitiative, or (ii) motion filed with the panel by a party in any action in which transfer for coordinated orconsolidated pretrial proceedings under this section may be appropriate.”23 Chapter 74, Texas Government Code, Subchapter H (1995).24 Colorado River Water Conservation Dist. v. United States, 424 U.S. 800, 96 S.Ct. 1236 (1976). Thefederal court must weigh five specified factors in deciding whether to abstain and defer to state courtproceedings.25 Catastrophic litigation can present great challenges in responding to government agency investigations.In the mine case, there were simultaneous requests for documents and statements from MSHA, theDepartment of Labor, the Department of the Interior, the State of Utah, the House of Representatives,

isk of inconsistent results or, worse, irreparable prejudice that may come from taking aposition in an action (such as self-incrimination), a trial court may seriously entertainstaying a lawsuit until the tangential actions are played out. 26Stay rulings are typicallysubject to the court’s discretion.Another judicial doctrine that may impact your decision whether to fight in multiplevenues, or consolidate, is collateral estoppel. Collateral estoppel prevents the relitigationof a contested issue, and it can apply to both determinations of fact and law.This can cut for or against you as a defendant. Thus, it is possible that a ruling orverdict in one case may apply in another. Even if the second court does not actuallyadopt the issue as fully resolved, it may be persuaded by the reasoning used by the firsttribunal. This consideration is especially important when the group of victims includesminors who have not yet brought claims, and will not be forced to do so until reachingtheir age of majority. 27the Senate, and criminal prosecutors. In other catastrophic contexts, it is not unusual to have torespond at the same time to OSHA, FEMA, the EPA, the NTSB and other regulatory agencies.26 Streamlining litigation will increase efficiency and limit defense fees and costs. Additionally, it willreduce the risk of inconsistent factual and legal determinations, and possibly prevent witnesses andthe company from facing criminal exposure. Another key issue involves what impact evidencedeveloped in administrative and criminal proceedings will have in the civil case. For instance, sometypes of standards and findings by government agencies (e.g., the NTSB) are excluded from civillitigation. Others are admissible. For instance, the California Supreme Court has ruled that OSHAregulations are admissible to support proof of negligence. Elsener v. Uveges, 34 Cal.4 th 915 (2004).27 States have different limitations periods for minors, which do not begin to run until the age or eighteenor twenty-one. Defense counsel handled a Montana case involving severe injuries to a young motherand infant. The mother proceeded with her lawsuit, but the infant’s prognosis was uncertain. Giventhe questionable liability facts, the client was determined to try the case. After a fortunate defenseverdict against the mother’s claim, counsel is now armed with arguments that the jury’s finding of “noliability” in the mother’s case should bar the infant’s case, if it is ever brought.

F. Considering Challenges to Jurisdiction and VenueWhether your company is subject to the court’s jurisdiction is a threshold question thatyou should quickly analyze. Challenges to jurisdiction are common, well-codified andaddressed in numerous cases in most federal circuits and states.Whether you are in the proper venue is often a more difficult question. Plaintiffs’attorneys will purposely file an action in the most favorable venue possible. Especiallyin catastrophic litigation, great care must be taken – immediately, before you file ananswer – to determine whether or not the plaintiffs’ chosen forum is appropriate. Inaddition to mandatory and permissive venue rules and statutes in all states, considerbringing a motion to transfer venue based upon forum non conveniens by consultingfederal law and its state equivalents. 28You must also be very careful not to waivevenue challenges through missed deadlines or active participation in the pending case.You must also consider that an unsuccessful challenge to jurisdiction or venue mayalienate the presiding judicial officer.G. Hiring a Jury ConsultantCases with significant exposure are often “mock tried” with the assistance ofprofessional psychologists and jury consultants. These confidential proceedingsprovide valuable insight into what facts, legal arguments, and themes may have tractionwith a real jury. When defending catastrophic litigation, we have sometimes found it28 See 28 U.S.C. § 1404. When faced with a timely motion, there are numerous factors courts willconsider in deciding whether a more convenient venue exists for hosting a pending action. Moststates, including Colorado, also offer procedures for changing venue for “the convenience of witnessesand the ends of justice…” E.g., Rule 98(f)(2), Colorado Rules of Civil Procedure (2014).

useful to retain this type of consultant early in the case. The consultant will force thelegal team to focus on core issues, distill and simplify themes and arguments, andprovide guidance as to how to present complicated evidence at trial. These efforts willalso assist the defense team in the discovery phase.Hiring a consultant should not be limited to cases that are surely headed for trial. Theinformation derived from these efforts will also help you determine whether the caseshould be settled, and at what level. If it is still to be tried, the mock findings will helpyou prepare a better defense.H. Understanding Punitive DamagesCatastrophic litigation involves dramatic, aggravated facts. Victims often argue thatfraudulent or criminal conduct was a factor in causing the disaster. Plaintiffs’ attorneyswill therefore include claims for punitive (or exemplary) damages, which increasepressure on all involved.The law governing punitive damages varies greatly across jurisdictions. Manyinsurance policies do not cover punitive damages. Because punitive damages presentanother source of exposure for your company and its key employees, and because thedemand for punitive damages will complicate the insurance analysis and settlementnegotiations, it is imperative for the company and its legal team to have a firm grasp onhow punitive damages are treated in that court, the likelihood of an award, and whetherthat exposure is insured. 2929 Every few years, the Supreme Court issues a substantive pronouncement on the purpose of punitivedamages, when they are appropriate to be assessed, and limitations on their recovery. E.g., Exxon

I. Discussing the Release in AdvanceAlthough some catastrophic cases go to trial, most will settle. As discussed above,early involvement by an active mediator can be helpful. Moreover, do not wait until themediation to think about the anticipated release and its scope. Too often, productivesettlement talks suddenly go south over release disagreements.A release following catastrophic litigation should contain many tailored provisions. Inaddition to provisions for indemnification in the event of future reimbursement claims bythird parties, the release should also provide a waiver of subrogation. It is mostbeneficial to get mutual releases, and also releases among co-defendants and insurers.Discussing these issues up front will help all the attorneys, parties and claimsprofessionals – assisted by a forceful mediator – understand that “this is it” in terms ofresolution, and nobody should expect future claims to come out of the woodwork later.J. Acknowledging the MicroscopeCatastrophic litigation is complex, expensive, and stressful; it can bring out the worsttype of litigation conduct by both sides. Always remember that a tragedy occurred fromwhich people have yet to recover, or may never recover. Moreover, catastrophiclitigation will receive media attention. Thus, taking aggressive or novel positions inlitigation, especially in publicly filed pleadings, can backfire. So, too, can beingShipping Co. v. Baker, 128 S.Ct. 2605 (2008). See also, Douglas E. Motzenbocker, Supreme CourtCurbs Punitive Damages Again, Litigation News (American Bar Association), August 13, 2008,available at http://apps.americanbar.org/litigation/litigationnews/top_stories/article_punitive.html (lastvisited January 7, 2015), noting that: “Exxon represents the fifth consecutive case in which the Courthas found a punitive damage award excessive, unconstitutional, or both.”

obstructive in discovery, especially in videotaped depositions. Extra care should betaken to couch litigation positions sensitively, with the understanding that every moveyou make is under a microscope.K. Seeking a Judicial Gag OrderMost publicity surrounding catastrophic litigation is sensationalist and bad fordefendants. Defensive positions are complicated to explain and usually not worthy ofsound bites. Consider asking the court to impose a gag order to prevent lawyers,parties, and witnesses from talking to the media.The U.S. Supreme Court first approved the use of gag orders on trial participants in1966. Since then, there have been several notable cases involving these orders andthe scope and standards for issuing them. Generally, if a party can show that publicitymay taint the jury pool or otherwise interfere with the right to a fair trial, the trial court willserious consider issuing a gag order. 30L. Considering Surgical Dispositive MotionsIt is too easy for experienced defense counsel to look at a complicated lawsuit andconclude at the outset that “this is not a summary judgment case.” However,catastrophic litigation often involves aggressively postured, but perhaps tenuous, factualand legal arguments. At the earliest possible moment, consider filing a motion for30 Sheppard v. Maxwell, 384 U.S. 333 (1966). Attorneys must also be aware of their state barassociation’s disciplinary rules to the extent this subject is addressed.

partial dismissal under F.R.C.P. 12(b) and its state equivalents. At the very least, sucha motion will cause the other side to show more of its cards early in the process andcould buy you valuable time to get your legal house in order. As catastrophic litigationproceeds further, motions for partial summary judgment brought under F.R.C.P. 56 arealso helpful to streamline litigation or get a better handle on plaintiffs’ claims andsupporting evidence.VII.DEALING WITH CONGRESSCongressional investigations often parallel catastrophic litigation. Hopefully, yourcompany will never face such an investigation, but if it is caught up in a situation thathas gotten Congress’ attention, the following discussion will provide insight.Responding to a Congressional investigation must be considered as important, if notmore so, than any “bet-the-company” litigation. Given the pitfalls and collateral impacts,assembling a team that can implement a successful damage control strategy will helpyou live to fight another day. The mine case was the “next big thing” to dominate newsheadlines at that time, and it set off a veritable “feeding frenzy” in Washington. Everyfew months, a dramatic scandal or disaster triggers new investigations by Congress.Before and since, we have witnessed high-profile investigations involving federalcontractors, steroids in baseball, Toyota vehicle safety, Wall Street bonuses, the BP oilspill, and the VA hospital operations.

A. Congressional Power to InvestigateThe rules and law surrounding this type of federal litigation are vague. If your client issubpoenaed by the House or Senate to provide documents or testimony, you cannotrely upon your knowledge of standards, rules, and laws that govern traditional litigation.It is a dead end to argue that a House or Senate committee is overstepping its power torequest information on an issue of public concern. Others have tried to advance thisargument without success. The source of Congress’ investigative power can be tracedto the Constitution. Congress’ power “to make all Laws which shall be necessary andproper” extends to investigations because Congress must gather facts before it candraft legislation. So long as an investigation is “related to, and in furtherance of, alegitimate task of the Congress,” then it will be upheld under pursuit of “the legislativefunction.” 31Specific committees have developed their own procedural rules for conductinginvestigations, issuing subpoenas, and holding public hearings. These rules have slightdifferences between the House and Senate and even from committee to committee.You should obtain the rules from the specific committee immediately upon learning of apending investigation. Committees can subpoena documents and testimony, butgenerally most investigations start by seeking voluntary cooperation via a letterrequest. 3231 McGrain v. Dougherty, 273 U.S. 135 (1927); Watkins v. United States, 354 U.S. 178 (1957).32 Eastland v. United Servicemen’s Fund, 421 U.S. 491 (1975); Exxon Corp. v. FTC, 589 F.2d 582 (D.C.Cir. 1978), cert. denied, 441 U.S. 943 (1979).

The resources of specific committees and their ability to focus on an investigation canvary markedly. All committees have staffers and lawyers on both sides of the politicalaisle to do the heavy lifting. As with other forms of litigation, the competence andexperience of these lawyers will impact what unfolds.B. Congressional Subpoena PowerIf a committee does not get cooperation, it can issue subpoenas for documents andtestimony. Committees often ask for documents first, then telephone interviews anddepositions. Also different from traditional litigation, Congress will make little effort toaccommodate a party’s or lawyer’s schedules. Deadlines can be extraordinarily short,such as a subpoena to produce thousands of documents within a week, or a subpoenato appear for a deposition or televised hearing in Washington just days away. Congresswill also ask your client to provide documents in an organized, searchable format, oftenat great expense.Since Watergate, the House has increasingly used its power of criminal contempt tosecure cooperation from targeted individuals and entities. The Senate most often reliesupon civil contempt proceedings initiated in the U.S. District Court sitting in Washington,D.C. 3333 2 U.S.C. §§ 192, 194 (2008); 28 U.S.C. § 1365 (2008). See also Louis Fisher, CongressionalInvestigations: Subpoenas and Contempt Power, Congressional Research Service (April 2, 2003).

C. Privileges in CongressThere are no governing rules of evidence in Congressional investigations and hearings.The most commonly cited privilege is the Fifth Amendment protection against selfincriminationin response to a question. For maximum impact, Congress will oftenrequire that a witness invoke the privilege in person. Alternatively, government lawyersmight accept an affidavit in lieu of testimony to establish: “If I am asked questions about[subject matter], for each such question I intend to invoke my Fifth Amendment right notto testify on the grounds that answering the question may be used to incriminate me.”(A corporation does not have a Fifth Amendment right against self-incrimination, but theright can be asserted by individual witnesses.)Many committees will recognize traditional litigation privileges. Prudent counsel willnegotiate and reach agreement on these issues up front before turning over clientdocuments and testimony. If not, a committee has discretion to refuse to recognizebasic privileges and protections, and sometimes a waiver can result. 34D. Responding to a Congressional InvestigationMost commentators agree that a Congressional investigation is not about getting to thetruth. Sometimes, the investigation is fueled by an agenda which steers theproceedings toward a predetermined outcome. The best a target can hope for is tocome out relatively unscathed, without having impacted the civil litigation. The white-hotspotlight will eventually cool down when Congress finds another target to focus on in34 Frederick M. Kaiser, Walter J. Oleszek and Todd B. Tatelman, Congressional Oversight Manual,Congressional Research Service (2011).

another investigation. 35The following list of general tips may help when facing aCongressional investigation:• Hire specialty counsel. Many lawyers in Washington haveCongressional experience as a member, staffer or lawyer. They maintainfriendships with key staffers and decision-makers.• Be careful with informal requests. In the case discussed above,Company X wanted to tell its side of the story “to clear its name” and fullycooperate with agencies in its heavily regulated industry. Specialtycounsel advised against extensive cooperation because of criminalexposure. Additionally, even voluntary interviews offered without takingan oath are subject to perjury laws. 36• Consider civil and criminal impacts. Witnesses will need carefulcounsel on whether and how to invoke Fifth Amendment protection.Additionally, subpoenaed documents have a tendency to leak out; informalinterviews and depositions can be recorded; and, hearing testimony isoften televised. A very important goal of surviving this process must alsobe for your client to maintain consistency.• Consider hiring a media professional: Targets of investigations willrespond to questions from investigators and potentially appear in front ofcameras. A single misstep can be disastrous. The legal team mustconsider bringing on a professional to synthesize themes, project empathyand defuse the impact of problematic information. There are well-35 Some commentators advise targets to “run out the clock” on federal investigators as a defensestrategy. We have all seen how the news cycle will dictate the level of focus that Congress will give toa particular matter. It is thus possible that another scandal can spark a new investigation and divertresources from the current one. One must also be mindful of the impact of elections and other humanevents, and their effects on deadlines and officials’ conduct.36 18 U.S.C. § 1001(2). It is a crime to make “any materially false, fictitious or fraudulent statement orrepresentation” in any matter within the jurisdiction of the Congress.

egarded media firms (many headed by former government officials) whocan provide guidance to present your honest, consistent message.• Use “turf battles” to your advantage. Often, a rivalry simmers betweendifferent officials or agencies. Sometimes, the putative search for truth issubverted by an instinct to claim credit or rush to judgment. There is alsoa natural rivalry between committees in the legislative branch, versusenforcement agencies in the executive branch. After the catastrophediscussed above, federal working groups from different committees andagencies each sent questions and requests for documents. Each grouprushed to get the first major report on the tragedy published, and theiraccuracy suffered greatly. By working with counsel, the company wasable to streamline this process by providing one set of key documentssimultaneously and exploiting the different motives of the investigators.• Use criminal threats to your advantage: Officials do not like to seeother agencies threaten criminal prosecutions, because then it will causethe target to stop talking. If testimony is critical, a witness can seek partialor full immunity from Congress. With a majority vote in the House or twothirdsvote in a committee, Congress can petition a federal court to compela witness to give testimony under either “use” or “transactional” immunity,which can be used to leverage help for your client. 37Dealing with Congress is unusual and stressful. It presents unique legal and publicrelations pitfalls. No matter how prepared you are to handle and defend catastrophiclitigation, this area requires assistance from insiders.37 Louis Fisher, CONGRESSIONAL SUBPOENAS: THE POLITICS OF EXECUTIVE PRIVILEGE (Carolina AcademicPress 2004).

VIII. CONCLUSIONWhile catastrophic litigation may at times feel overwhelming, it will not last forever.Understanding the ebbs and flows of catastrophic litigation will help your company be ina better position to deal with sudden and dramatic events when they erupt. Very rarelydoes catastrophic litigation present a true threat to the future existence of yourcompany. With the right professionals assisting you, your business can resolvecatastrophic litigation on favorable terms, while learning, surviving, and thriving in thefuture.

2015InternationalClientSeminarALFAINTERNATIONAL2015INTERNATIONALCLIENTSEMINARFIRSTWORLDCHALLENGES:FINDINGPRACTICALSOLUTIONSIN ASHRINKINGGLOBALECONOMYTRACK2:VIRTUALREALITY

2015 INTERNATIONAL CLIENT SEMINARFAIRMONT SCOTTSDALE PRINCESSSCOTTSDALE, ARIZONAMARCH 5-8, 2015Hackers Anonymous—Risk Mitigation Strategiesfor Handling Ever-Changing Threats to DataSecurityChristopher C. GenoveseNELSON MULLINS RILEY & SCARBOROUGH,LLPColumbia, South Carolina803-255-9543chris.genovese@nelsonmullins.comMadison RobertsCorporate CounselFOCUS BRANDS, INC.Atlanta, Georgiawww.focusbrands.comDavid G. HymerBRADLEY ARANT BOULT CUMMINGSBirmingham, Alabama205-521-8289dhymer@babc.comG. Edward Cassady, IIISenior Vice President, Chief FinancialOfficer, and Corporate SecretaryROBINS & MORTONBirmingham, Alabamawww.robins.morton.comMarch 6, 2015 1 © 3-6-2015 ALFA International Business Litigation P.G.

Hackers Anonymous—Risk Mitigation Strategies forHandling Ever-Changing Threats to Data Security 1I. Not If, But When?Former FBI Director Robert Mueller once said, “There are only two types of companies:those that have been hacked and those that will be. And even they are converging intoone category: and that is companies that have been hacked and will be again.” And so,the question has turned into not “if” but “when” a company will face a data breach.From Target and Home Depot to JP Morgan Chase and PF Chang’s, data security is inthe news on a daily basis. And while the constant barrage of stories about databreaches can have a desensitizing effect, a lot of the hype is real. Data breaches andcyber attacks are not just an IT issue, they are everyone’s issue, in all industries. Andthey are here to stay. To avoid the pitfalls of being caught unprepared, companies mustknow what data they have a duty to protect, have defensible data management andsecurity policies, and have a data breach response plan. What if tomorrow you learnthat:• Over the last two months, hackers have stolen contact information for anunknown number of households and small businesses that dealt with yourcompany by using offshore servers to hack your business after they1 Article prepared by Christopher C. Genovese and Rachel M. Flynn of the ALFA Interntaional firm ofNelson Mullins Riley & Scarborough, LLP, Columbia, South Carolina.March 6, 2015 2 © 3-6-2015 ALFA International Business Litigation P.G.

compromised the computer of an employee with special privileges. 2• A hospital employee inadvertently left a stack of papers containingpatient and healthcare information on a subway train. The loss of paperfiles affected 192 of the hospital’s infectious disease practice patients. 3• A company executive with stock market-moving information received anemail purportedly from another executive urging her to open an attacheddocument. The executive opened the document, entered her credentials,and gave hackers access to information to play the stock market. 4This article provides an overview of some of the most common threats to data security,best practices for protecting data and preparing for a data breach, key tips forresponding to a data breach, and several related litigation and enforcement trends.II.What Needs Protecting?Companies may have massive amounts of data, both electronic and paper, containingfinancial information, customer information, patient information, vendor information,employee information, intellectual property and patents, mergers and acquisitions2 Emily Glazer and Danny Yadron, J.P. Morgan Says About 76 Million Households Affected By CyberBreach, The Wall Street Journal (Oct. 2, 2014, 9:32 p.m.), http://online.wj.com/articles/j-p-morganfound-hackers-after-finding-breach-of-race-website-1414766443(last visited Jan. 13, 2015).3 Pamela Lewis Dolan, Carelessness behind many health data breaches, American Medical News (March21, 2011), http://www.amednews.com/article/20110321/business/303219968/2/ (last visited Jan. 13,2015).4 The Associated Press, FireEye details cybersecurity threat that appears to help hackers play themarkets (Dec. 1, 2014 9:30 a.m.), http://www.startribune.com/lifestyle/284326251.html (last visited Jan.13, 2015).March 6, 2015 3 © 3-6-2015 ALFA International Business Litigation P.G.

information, marketing information, Personally Identifiable Information, Protected HealthInformation, confidential information, and other sensitive, federally-protected, stateprotected,or competitive information. All of this data and information is capable ofbeing compromised in a number of ways, whether by the bad guys, by a carelessemployee, or through a third party vendor. Company management and leadership mustfully assess what paper and electronic company data needs protecting.III.Identify the Threats and Vulnerabilities.A. Who: Your Own Backyard vs. External Threats.As recently seen in the news, organized crime, government-backed organizations, andcompetitors all constitute serious threats to data security. In addition to these externalrisks, a company’s own workforce is a major threat to data security, whether due to lackof awareness, education, or a rogue employee. Similarly, third parties may be able tocompromise company information inadverently.B. How Does it Happen?1. Phishing: “Click Here to Download a Critical Update.”After identifying the threats, the next question is how does a data breach happen as apractical matter? One of the most (if not the most) common sources of data breachesor hacking is phishing schemes. Phishing email messages, websites, and phone callsMarch 6, 2015 4 © 3-6-2015 ALFA International Business Litigation P.G.

are designed to steal money or gain access to information. 5Cybercriminals can do thisby installing malicious software on your computer or stealing personal information off ofyour computer. 6Cybercriminals also use social engineering to convince you to installmalicious software or hand over your personal information under false pretenses. 7They might email you, call you on the phone, or convince you to download somethingfrom a website. Some common phishing tricks include:• Spoofed email addresses or caller ID. Hackers can fake a “From” or“Reply” address as well as caller ID. For example, hackers used spoofedIntuit (TurboTax) email addresses (e.g., paypayl@security.intuit.com) to getaccount holders to enter log-in credentials. 8• Fake link. Scam emails often contain a hidden link to a site requestingaccount information: “An urgent file has been uploaded for you, click here.” 9• Fake website. Phony Web sites copy company logos and designs to looklegitimate. Hackers can use HTML, Flash or Java Script to mask or change abrowser address. 10• “Your computer is infected with a virus and I need to help you clean it.”5Microsoft Safety and Security Center, http://www.microsoft.com/security/online-privacy/phishingsymptoms.aspx(last visited Jan. 13, 2015).6 Id.7 Id.8 Intuit, http://security.intuit.com/security-alerts.php (last visited Jan. 13, 2015).9 Id.10 Id.March 6, 2015 5 © 3-6-2015 ALFA International Business Litigation P.G.

Calls that an employee’s computer needs to be “fixed” may be from someoneattempting to install malware or steal information by having an employee giveover control of their computer.Phishing campaigns targeted specifically at attorneys are also on the rise. Maliciousphishing email messages targeting attorneys often involve an initial email genericallyaddressed “Greetings,” “Dear Attorney,” or “Dear Counsel.” The initial email does notcontain any information on how the sender learned of the attorney. Also, the senderemail is often different than the “reply to” address in the body. Attorneys should be waryof emails from Yahoo, Gmail, or Hotmail addresses, as well as emails addressed to agroup and not the attorney specifically. Here are some real examples:• “Do you handle breach of contracts?”• “We seek your partnership in the Litigation and Collection issues with someof our indebted customers within your region.”• “Dear Counsel: We have communicated with our customer in yourjurisdiction regarding merging. Please advise if you handle such cases.”Companies (and their attorneys) should be on guard upon receiving a messageor call with any of the following phishing earmarks:• The message is unexpected but from a known organization;• The message is from an unknown sender;• The message includes misspellings and bad grammar;March 6, 2015 6 © 3-6-2015 ALFA International Business Litigation P.G.

• The message contains no background information;• The sender provides no information on how they decided to contact you;• The message contains an immediate call to action or urgentcircumstances;• The message includes threats (“Act now or your account will be blocked”);• The email originates from a supposed foreign source; and• There are fake links in the email.2. The Internet is Brimming with Data Security Threats.The Internet is another top threat to data security. Popular websites may becompromised unbeknownst to the company or consumer. Consider, for example, thatyour chief engineer goes online to purchase his wife flowers for their anniversary. Thelocal florist’s website has been compromised (unbeknownst to the engineer, or theflorist) and up pops a notification from “Internet Explorer” that his version of the Internetneeds to be updated before he can proceed. By clicking on the box to proceed with the“update,” the engineer unknowingly downloads malware onto his company computer.3. The Insecurity in Unsecured Communications.Protected data can also become unprotected by eavesdropping, through capturingunsecured wired or wireless communications. A common example is public, hotel,airport, café, or convention center Wi-Fi. With public, unencrypted Wi-Fi, you’re neverMarch 6, 2015 7 © 3-6-2015 ALFA International Business Litigation P.G.

sure who or what you’re connecting to. 11Through very basic hacking mechanisms, ahacker can connect to your Wi-Fi account and access confidential data.(a)The Dangers of Wi-Fi: Dark Hotel.As a recent example of the dangers of Wi-Fi, according to a recent report by KasperskyLab, executives traveling from the United States and Asia have been targeted by anelite spy ring which has tricked CEOs, senior vice presidents, sales and marketingdirectors, and top research and development staff into installing software through hotelWi-Fi networks. 12After the executive checks in, the spy ring detects him on thecompromised network using widely available hacking tools and tricks him intodownloading and installing what appears to be a necessary update for legitimatesoftware such as Google Toolbar, Adobe Flash or Windows Messenger. 13Theexecutive downloads this “update” and infects his machine with Dark Hotel, a backdoorspying software. The hackers can then access passwords, login credentials, and otherprivate information, including intellectual property of the victim’s company. 1411 Kurt Marko, Public Hotspots Are a Privacy and Security Minefield: Shield Yourself (May 18, 2014 8:45p.m.), http://www.forbes.com/sites/kurtmarko/2014/05/18/hotspot-security-part1/ (last visited Jan. 13,2015).12 Kapersky, Kaspersky Lab sheds light on “Dark Hotels”, where business executives fall prey to an elitespying crew (Nov. 10, 2014), http://www.kaspersky.com/about/news/virus/2014/Kaspersky-Lab-shedslight-on-DarkHotels-where-business-executives-fall-prey-to-an-elite-spying-crew (last visited Jan. 13,2015).13 Id.14 Id.March 6, 2015 8 © 3-6-2015 ALFA International Business Litigation P.G.

4. Leaving Devices or Data Unattended.Leaving data or devices unattended, as well as traditional theft, can also lead to a databreach. Consider your company’s general counsel traveling to depositions in a caseinvolving allegedly defective medical devices. Through discovery, your companyobtained healthcare and identification information for hundreds of thousands of patients,which the general counsel saved to an unencrypted flash drive before leaving town.Counsel exits the plane and hails a taxi before realizing he cannot find the flash drive.He goes back to the plane to retrieve it, but the flash drive is gone.5. Third Party Vendors: the Target Data Breach.The Target data breach has garnered national attention since the 2013 holiday season.Target got in especially hot water for disabling certain security features and repeatedlyfailing to address security alerts caught by their security vendor. What many peoplemay be surprised to learn, however, is that the Target breach can actually be tracedback to the hackers originally hacking Target’s HVAC vendor. Although we willprobably never know exactly what happened, using data compiled by Bloomberg, hereis a rough timeline of how the hackers broke in:1. The hackers somehow breached Target’s HVAC vendor and prepared touse the HVAC as a pivot point to get into Target’s systems.2. They likely used credentials of an HVAC vendor to get into Target’snetwork, spending weeks on reconnaissance to install a pair of malwareprograms.March 6, 2015 9 © 3-6-2015 ALFA International Business Litigation P.G.

3. The hackers sent credit card number-stealing malware to cashier stationsin all domestic Target stores.4. They also installed malicious code that sent credit card data to threehijacked “staging point” servers in the U.S. before the data headed to Moscow.5. On December 2nd, the credit card numbers started flowing out. Target’ssecurity system detected the hack, but the company failed to act.6. Federal investigators warned Target of a data breach on December 12th.7. Target confirmed and eradicated the malware on December 15th, after 40million credit card numbers had been stolen. 15C. What’s in it for the Bad Guys?Besides the “who” and the “what,” many people want to know why hackers and cybercriminals go to all the trouble to steal certain data and information. The reasons cangenerally be grouped into three categories: money, competition, and politics.1. Data Breach is Big Business.Many law-abiding citizens do not realize there is a massive underground market forstolen payment, healthcare, and personal identity information. Data breach is big15 Michael Riley, Ben Elgin, Dune Lawrence, and Carol Matlack, Missed Alarms and 40 Million StolenCredit Card Numbers: How Target Blew It, Bloomberg Businessweek (March 13, 2014),http://www.businessweek.com/articles/2014-03-13/target-missed-alarms-in-epic-hack-of-credit-carddata(last visited Jan. 13, 2015).March 6, 2015 10 © 3-6-2015 ALFA International Business Litigation P.G.

usiness. Hackers can cheaply rent out zombie networks, or botnets, to steal,warehouse, and resell data. While simple malware runs about $1,500, profits from asuccessful data breach can run over four hundred million dollars.According to Krebs on Security, “[t]here isn’t exactly a central exchange for hackedaccounts in the cybercrime underground, but recent price lists posted by severalmiscreants who traffic in non-financial compromised accounts offer some insights.” 16For example, one underground seller offers customer iTunes accounts for $8.00, andFedex.com, Continental.com and United.com accounts for $6.00. 17Active accounts atFacebook and Twitter retail for just $2.50 a piece. 18According to research by Juniper Networks, personal data such as name, date of birth,address, and social security number can run between $20-$40 per person. 19Somecyber criminals peddle bank account information for less than $200 per person. Thevalue of stolen credit card information varies widely, with some security research groupsfinding a stolen credit card number may run as low as 50 cents or as high as $50, andothers finding that depending on the freshness of the breach and the card limits, a16Krebs on Security, The Value of a Hacked Email Account (June 10, 2013),http://krebsonsecurity.com/2013/06/the-value-of-a-hacked-email-account/ (last visited Jan. 13, 2015).17 Id.18 Id.19 Margaret Utterback, High value of personal data attracts more sophisticated hackers, Safe & SoundBlog (Oct. 27, 2014), http://safeandsound.quarles.com/2014/10/high-value-of-personal-data-attractsmore-sophisticated-hackers/(last visited Jan. 13, 2015).March 6, 2015 11 © 3-6-2015 ALFA International Business Litigation P.G.

stolen credit card number may fetch over $100. 20In contrast to credit card information, medical records are worth about $10 on the openmarket. 21According to Reuters, cyber criminals are beginning to turn their attention tomedical records due to inadequate security systems in the healthcare industry. 22Hackers can steal names, birth dates, policy numbers, billing information, and diagnosiscodes from healthcare providers, and use the information to create fake IDs to buymedical equipment for resale, or to file false insurance claims. 23This data can be usedto create dossiers on the underground market and before you know it, someone fromanother country is getting an appendectomy in your (or your employee’s, customer’s, orpatient’s) name.2. Competitive Trade Secrets and Intellectual Property.Competitive interests are another reason for data breaches or cyber attacks. Forexample, when a business has a new product coming out that will be a game changer,there comes a risk that competitors will do whatever it takes to keep their market share,even if that means illegally obtaining the other company’s intellectual property. Thesecompetitors pose an additional risk to cyber and data security.20 Jamie Sturgeon, How much is your stolen credit card data worth, anyway? (Sept. 9, 2014 2:44 p.m.),http://globalnews.ca/news/1553514/how-much-is-your-stolen-credit-card-data-worth/ (last visited Jan.13, 2015).21 John Oldshue, Stolen Medical Data Worth 10 Times More Than Credit Card Information (Oct. 1, 2014),http://www.lowcards.com/stolen-medical-data-worth-10-times-credit-card-information-27718 (last visitedJan. 13, 2015).22 Caroline Humer and Jim Finkle, Your medical record is worth more to hackers than your credit card(Sept. 24, 2014 2:24 p.m.), http://www.reuters.com/article/2014/09/24/us-cybersecurity-hospitalsidUSKCN0HJ21I20140924(last visited Jan. 13, 2015).23 Id.March 6, 2015 12 © 3-6-2015 ALFA International Business Litigation P.G.

3. Political Motivations May be at Play.As recently highlighted by the Sony Pictures data breach, a major motivation in databreaches and cyber attacks can be politics. In early December 2014, a hacking groupcalling itself Guardians of Peace brought down Sony Pictures’ corporate email andleaked five films and a slew of sensitive personnel data, including a spreadsheetallegedly containing salaries of some 6,000 employees and top executives, as well ashealth-care records, office call lists, and performance reviews. 24The cybersecurity firmSony hired to help deal with the aftermath initially explored the possibility that hackersbased in China targeted studio computers in retaliation for the upcoming release of thefilm “The Interview,” a comedy starring Seth Rogen and James Franco as journalistshired by the CIA to kill dictator Kim Jong-un. Investigations ultimately tended todemonstrate involvement by the North Korean government. 25Similarly, following the Home Depot credit card breach, a massive new batch of creditcards labeled “American Sanctions” and “European Sanctions” went on sale in anunderground crime shop. 26These “Sanctions” caused security experts to opine thebreach was intended retribution for the contemporaneous U.S. and European sanctions24 Rachel Emma Silverman and Ben Fritz, Data Breach Sets off Upheaval at Sony Pictures, The WallStreet Journal (Dec. 4, 2014 10:14 a.m.), http://online.wsj.com/articles/data-breach-sets-off-upheavalat-sony-pictures-1417657799(last visited Jan. 13, 2015).25 James Rogers, Expert: Why the North Korean cyber threat is real, Fox News (Dec. 1, 2014),26www.foxnews.com (last visited Jan. 13, 2015).Krebs on Security, Banks: Credit Card Breach at Home Depot (Sept. 2, 2014),http://krebsonsecurity.com/2014/09/banks-credit-card-breach-at-home-depot/ (last visited Jan. 13,2015).March 6, 2015 13 © 3-6-2015 ALFA International Business Litigation P.G.

against Russia for its aggressive actions in Ukraine. 27In the law firm context, a law firm representing Frank Wuterich, the only Marineconvicted of a crime in the 2005 Haditha massacre in Iraq who received no prison time,was hacked by “Anonymous.” Anonymous’s attack on the law firm Puckett and Farajinvolved a massive data dump that publicized nearly three gigabytes of attorneycorrespondence, which contained confidential client and personnel information anddocuments, among other things. The attack ended up destroying the law firm. 28As demonstrated by the Sony Pictures, Home Depot, and Haditha marine hackingattacks, any politically sensitive work may create an ancillary problem in drawing theattention and ire of hackers or government-backed entities.D. The Costs of a Data Breach.The Ponemon Institute’s 2014 Cost of Data Breach Study (sponsored by IBM) reportedthat the average cost of a corporate data breach was $3.5 million, an increase of 15%for 2013. 29Among these costs may be significant legal costs and enforcement fines, asdiscussed below in Section VI. However, “[t]he research reveals that reputation and the27 Id.28 Adam Martin, Anonymous's Friday Hacks: FBI Conference Call, Haditha Marine's Lawyers, The Wire(Feb. 3, 2012 10:17 a.m.), http://www.thewire.com/technology/2012/02/anonymous-hacked-fbiconference-call-about-anonymous/48264/(last visited Jan. 13, 2015).29 Ponemon Institute, Ponemon Institute Releases 2014 Cost of Data Breach: Global Analysis (May 5,2014 10:15 a.m.), http://www.ponemon.org/blog/ponemon-institute-releases-2014-cost-of-data-breachglobal-analysis(last visited Jan. 13, 2015).March 6, 2015 14 © 3-6-2015 ALFA International Business Litigation P.G.

loss of customer loyalty does the most damage to the bottom line.” 30III.Best Practices for Mitigating the Risk of a Data Breach.A. Technology is Your Friend.A business or law firm can take huge strides in data security by implementing basic andrelatively inexpensive security controls. Below are our top recommended securitycontrols to mitigate the risk of a data breach:1. Encryption, Encryption, Encryption!The importance of encryption cannot be overstated, and a company should encryptcompany hardware as a standard practice. Encryption scrambles data and the onlyway to unencrypt it is with a key. For full disc encryption, a name and password isneeded to access the data. Take the stolen laptop, misplaced flash drive, or companycomputers a disgruntled employee grabbed on his way out the door. If these devicesare encrypted, the exposure and risk related to protected information is dramaticallyreduced. As discussed below, encryption can in most states eliminate breachnotification requirements as well.2. Redact Sensitive Data.Software programs and technology exist to redact sensitive data out of traditionaldisplay formats. Appropriate redaction of sensitive information in displayed (rather than30 Id.March 6, 2015 15 © 3-6-2015 ALFA International Business Litigation P.G.

stored) format in many states may limit or eliminate breach notification requirements.3. Multi-Layered Authentication Offers Another Barrier.Adding another barrier to data access adds an additional layer of protection. Outlook,Gmail, and Twitter now offer a double-layered sign-in process. Many companies andfirms similarly offer: (1) the entry of standard log-in credentials followed by (2) entry of atoken code/secure ID code. Outside of the email context, companies should also haveprotocols for authenticating phone calls. For example, if an executive calls the helpdesk to retrieve his forgotten log-in information, the help desk needs to authenticate therequest before providing access to company databases.4. Update, Complicate, and Do Not Duplicate Credentials.A company should require employees and vendors (including outside counsel) toroutinely change passwords. A 90-180 day timeline for systems to automatically promptusers to change passwords is becoming more commonplace. A best practice would bea 90 day password change cycle. Likewise, accounts for temporary employees orvendors can be set up to automatically shut off when work is complete.Complexity of passwords is also critical. Common words or sequences like 123456 areweak passwords. Passwords should be at least 8 characters long, containingupper/lower case letter combinations, numbers, and symbols. Passwords should not beduplicated or saved (if it is easier for you, it is easier for the bad guys).5. Making Public Wi-Fi More Secure: Virtual Private Networks.To help protect against Dark Hotel malware (discussed above at Section III(B)(iii)(1)),March 6, 2015 16 © 3-6-2015 ALFA International Business Litigation P.G.

Kaspersky recommends travelers use virtual private networks, or VPNs, which providean encrypted communication channel when connecting to public wireless facilities. 31Examples of VPNs include using a MiFi card or cell phone hotspot. VPNs are generallya good way to avoid certain threats of unsecured internet connections.6. Provide Access Only on a Need-to-Know- Basis.In the event of account compromise, the scope of the breach can be minimized bykeeping access to secure repositories limited to only those who need access. Forinstance, if ABC’s account is compromised but ABC didn’t have access to Company Ydata, then Company Y data may not have been impacted and therefore breachnotifications may be avoided to Company Y.7. Block Known Bad Sites and Applications.Companies can should automatically block known bad sites and applications.8. Keep Company Computers Up-to-Date.A company must make sure software is up-to-date with the latest anti-virus, phishingdetection, and blocking software. In certain new computers, more security controls insoftware and through selective administrator rights can also help.B. Employee Training and Education is Paramount.Many employees see data security issues as somebody else’s—like IT’s—problem,31 See source cited supra note 12.March 6, 2015 17 © 3-6-2015 ALFA International Business Litigation P.G.

ather than something that applies to them daily. However, each employee can beeither the strongest or weakest link in company data security. Making employees awareof data security policies and educating them on common and evolving threats is key todata security. Below are some tips for getting employee buy-in:1. Common Sense Goes a Long Way.Hackers and scammers are counting on employees to be in too much of a hurry, tootrusting, and too social to the point of carelessly clicking on malicious links andattachments. A lot of damage can be prevented if employees exercise good judgmentand have a healthy air of distrust. According to security expert Brian Krebs: “The rulesfor downloads are simple: If you didn’t go looking for it, don’t install it. If you installed it,update it. If you don’t need it, delete it. And never click on unknown links or pop-ups.” 32Employees should use good judgment by inspecting links before clicking. This can bedone very easily by hovering (not clicking) over the links. This technique will reveal theactual address that you will be directed to before clicking. If you receive a message thatappears to be from “American Express” and you hover over a link that showshttp://consolerepairparts.co.uk/americanexpress, it is probably not legitimate.Employees should also be wary of notices to update or requests for information.Microsoft does not call people to install security updates to outdated versions of Word.Adobe does not notify users by pop up messages on the Internet that their Adobe isoutdated. The IRS does not communicate with people over email. Urge employees to32 Benjamin Phelan, The Man Whose Mission is to Stop Consumer Crime, Men’s Journal (Dec. 2014),http://www.mensjournal.com/magazine/the-man-whose-mission-is-to-stop-consumer-crime-online-20141203#ixzz3L5cjSgqf (last visited Jan. 13, 2015).March 6, 2015 18 © 3-6-2015 ALFA International Business Litigation P.G.

contact IT if they get a message that their computer or applications need updating.2. Implement Appropriate Policies.It is critical that a company or firm have and implement an Acceptable Use Policy, aNon-Disclosure Policy, a Records Management Policy, and a Code of Conduct relatedto data management and information security. A best practice involves having thesepolicies reviewed annually by a data security and policy compliance consultant to insurethey are current with the legal, business, and IT landscapes. 333. Make Annual Security Awareness Training Mandatory.It is also recommended that employees attend annual mandatory security awarenesstraining. The training can be a time to update employees on key security efforts, recentdata breach trends, and to take any questions.4. Keep the Workforce Regularly Updated.Between annual security awareness trainings, employees need to be kept regularlyupdated about security issues. For example, updates could include security bulletins orupdates on an internal company website. Employees should also know who to call withinformation security questions or notices of potential data breach attempts.5. Screen, Audit, and Monitor Company Vendors.For many companies, third-party vendors with privileged access to corporate data pose33 Judy Selby, What to do about high data breach costs, Law Technology News (June 10, 2013),http://www.lawtechnologynews.com/id=1202603594623?slreturn=20141106235933 (last visited Jan.13, 2015).March 6, 2015 19 © 3-6-2015 ALFA International Business Litigation P.G.

a significant security challenge. Outside law firms, payroll companies, and on-linedatabase managers are all examples of third parties that a hacker or criminal may gothrough in an attempt to obtain a company’s data. Thanks largely to the Target breach,third parties are being required to demonstrate reasonable controls and acceptablestandards like never before.In that regard, financial institutions have been at the forefront in conducting meaningfuland exhaustive audits of their vendors, including outside counsel, to determine thevendor’s compliance with security requirements. Many banks now ask hundreds ofdetailed, targeted questions ranging from Human Resources policies and procedures tofire extinguishers, visitor procedures, access cards, and training. The vendor mustexplain their responses in detail (yes or no answers are not acceptable), and the bankmay conduct an onsite visit to confirm the veracity of the responses.While financial institutions are leading the way here, following the Target breach, it iscritical for companies of all industries to audit and monitor the security compliance oftheir outside attorneys and other vendors, as well as to have controls in place to restrictthird parties from certain protected data.C. Avoid Internal Complacency.Even the best security warnings are of little use if nobody is paying attention to them.Several action items to minimize the risk of a breach going unnoticed are:• Auditing logs of access to company data;March 6, 2015 20 © 3-6-2015 ALFA International Business Litigation P.G.

• Staff dedicated to checking audit logs for red flags;• Management and leadership updated frequently on security issues;• Staff dedicated to daily monitoring of company email and systems;• Document the exceptions after approval; and• Routine audits of and onsite visits to third party vendors.D. Insurance: Get Covered.Companies must ensure they have appropriate data breach insurance coverage. Priorto experiencing a known data breach, companies should have an experienced databreach insurance attorney assess whether they have adequate and appropriate databreach coverage, considering the nature/size of the business and financial/legalexposure. As a general rule, adequate coverage will require purchasing a separatedata breach policy or a data breach endorsement to an existing policy. 34IV.Best Practices in Responding to a Data Breach.Companies should have a breach response action plan in place long before a databreach in order to reign in costs and continue to do business as usual to the extent34 For a thorough discussion of the importance and types of data breach and cybersecurity insurance, seeIt Is Bound To Happen, Track 3; see also Bill Latham, Does Your Data Breach Insurance PolicyMeasure Up?, The Hytech Lawyer Blog (Dec. 4, 2014), http://hytechlawyer.com/ (last visited Jan. 13,2015).March 6, 2015 21 © 3-6-2015 ALFA International Business Litigation P.G.

possible. Improperly handled data breaches can be extremely costly not only directly tothe balance sheet, but additionally to the reputation of the company. Below we discussbasic features of a generic data breach response plan.A. Lock it Down and Clean it Up.It is critical that the company stop the bleeding, immediately close the leak, and secureany data that has not yet been compromised. 35Management should physically securethe affected data systems, data, and documentation. 36B. Retain Breach Counsel.Upon learning of a data breach, companies should promptly make a call to outsidecounsel knowledgeable in responding to data breach emergencies (“breach counsel”). 37Breach counsel should direct the investigation so that the data breach investigation isprotected by the attorney-client privilege and work product doctrines. 38Breach counselshould also conduct their own investigation, including interviewing key employees,35 Dave Maxfield and Bill Latham, Data Breaches Perspectives from Both Sides of the Wall, SouthCarolina Lawyer, May 2014, at 33.36 Id. at 34.37 Id.38 Id.March 6, 2015 22 © 3-6-2015 ALFA International Business Litigation P.G.

ensuring the company has an appropriate legal hold in place, and helping the companynavigate immediate next steps set out below. 39C. Internal Readiness is Critical.A company should also have a team of in-house attorneys, key executives, IT and datasecurity managers, customer relations, and public relations personnel knowledgeableabout the company’s data security measures and what to do if faced with a data breach.This team should generally be looped in as quickly as possible following a data breach.Similarly, the company in many cases may find it a good idea to provide onlineinformation resources, bulletins, and/or training for affected personnel.D. Retain a Forensics Expert.Another critical piece of a data breach action plan is breach counsel retaining aforensics expert to help investigate the who, what, when, how, and how bad. Theinvestigation should be thoroughly documented in writing, noting the details of thebreach, including when it occurred and how it was discovered. 40It is important thatbreach counsel direct the work of the experts for the investigation to be privileged.” 4139 Id.40 Id.41 Id.March 6, 2015 23 © 3-6-2015 ALFA International Business Litigation P.G.

E. Data Breach Notification Statutes.Kentucky recently became the 47th state to enact a data breach notification lawconcerning government and/or consumer notification when there is a data breachinvolving personal information, which generally includes information such as namescoupled with social security numbers, birth dates, and financial information. 42The hodgepodge landscape of state notification laws is confusing and inconsistent. 43This past year, Florida adopted expansive changes to its breach notification law with theFlorida Information Protection Act of 2014 (“FIPA”). Among other things, the law,effective July 1, 2014, imposed a 30-day requirement to notify individuals of a breach,which is one of the quickest timelines in the country. 44If a breach will not likely result inidentity theft or financial harm to affected individuals, no notification is required.However, that determination must be documented in writing, kept for five years, andsubmitted to the attorney general in thirty days. If the breach affects five hundredindividuals or more in Florida, FIPA also requires notification to the State Department ofLegal Affairs of the attorney general.In many states, encryption and/or redaction will limit state law statutory exposure andavoid notification requirements altogether. For instance, S.C. Code Ann. § 39-1-90requires that in certain circumstances an entity suffering a data breach involving42 The states without a data breach notification law are Alabama, New Mexico, and South Dakota.43 Security Breach Notification Laws (last update October 2013),www.beazley.com/our_business/professional_liability/tmb/data_breach_map.html (Interactive Map ofState data breach statutory requirements) (last visited Jan. 13, 2015).44 Fla. Stat. § 501.171.March 6, 2015 24 © 3-6-2015 ALFA International Business Litigation P.G.

“personal identifying data” (e.g., social security numbers, driver’s license numbers, bankaccount numbers, credit card numbers, checking account numbers, dates of birth) ofSouth Carolinians notify the persons whose data has been compromised. In the case ofunintentional data breach, notification must occur quickly: “[t]he disclosure must bemade in the most expedient time possible without unreasonable delay….” 45In the caseof theft, notification must occur “immediately.” 46However, if the data was “renderedunusable through encryption, redaction, or other methods,” no notification is required. 47F. Other Obligations and Exposure.Following a data breach, a company should consider what liability it may have underfederal law, applicable state unfair business practice laws, privacy laws, e-transactionlaws, general security laws and regulations, sector-specific regulations, 48 industry selfregulation,and common law. Relatedly, a company should look at its own policies todetermine whether it acted consistently with any self-imposed obligations.45 S.C. Code Ann. § 39-1-90(A).46 Id at (B).47 Id.48 See, e.g., The Health Insurance Portability and Accountability Act of 1996 (Pub. L. 104-191, 110 Stat.1936) (“HIPPA”) and The Health Information Technology for Economic and Clinical Health Act(“HITECH Act), enacted under Title XIII of the American Recovery and Reinvestment Act of 2009 (Pub.L. 111-5).March 6, 2015 25 © 3-6-2015 ALFA International Business Litigation P.G.

G. Remediation Efforts: Credit Monitoring, Identity TheftProtection, and Customer Hotlines.Companies suffering data breaches have to fight hard to retain current customers andrecruit new customers. Companies must decide whether to offer credit monitoring orsome type of identity theft protection to affected persons following a data breach.According to Dave Maxfield, writing from “the consumer’s perspective” in the May 2014article Data Breaches Perspectives from Both Sides of the Wall, while credit monitoringis helpful in detecting identity thefts, it is not a total solution because it fails to detectmany common fraudulent activities, like a fraudulent tax return. 49Moreover, creditmonitoring usually only lasts one year, while criminals can bide their time until things diedown (and credit monitoring expires) before using the stolen information. 50Credit monitoring aside, other remediation tools are available following a breach. Earlyin the company’s data breach response, management should consider theappropriateness of identity theft protection, setting up a consumer call center, andwhether other business offers would be appropriate. For instance, Target offered a tenpercent discount to customers for a certain time period following the breach.49 Dave Maxfield and Bill Latham, Data Breaches Perspectives from Both Sides of the Wall, SouthCarolina Lawyer, May 2014, at 31 (“Maxfield and Latham” article).50 Id.March 6, 2015 26 © 3-6-2015 ALFA International Business Litigation P.G.

V. A Brief Survey of Litigation and Enforcement Actions.In 2013, Researchers at Temple University analyzed 230 federal cases involving databreach incidents and found more than 80 causes of action used. 51Commonly seenclaims included breach of contract or implied contract, negligence, and statutory causesof action. 52New types of actions, including claims by issuing banks forced to deal withcancelling and reissuing credit and debit cards following a data breach, are also beingbrought. Shareholder derivative claims for breach of duties, waste, andmismanagement against a company’s board of directors are also gaining momentum.Moreover, the FTC and states’ attorneys general may bring their own enforcementactions where appropriate following a data breach. We discuss below how a companymay face litigation and enforcement actions on various fronts following a data breach:A. Consumer Class Actions and Standing.One of the major obstacles for consumer class actions following a data breach—alongwith overcoming differences in state laws—is pleading and proving injury necessary forstanding. 53Although the general trend has historically been for courts to dismissconsumers’ claims absent evidence of actual harm (e.g., identity theft or fraud), some51 Sasha Romanosky, David A. Hoffman, Alessandro Acquisti, Empirical Analysis of Data BreachLitigation, Temple University Legal Studies Research Paper No. 2012-30 (April 6, 2013).52 See Maxfield and Latham article at 32, cited supra at note 49.53 See Clapper v. Amnesty Int’l USA, 133 S. Ct. 1138, 1143 (2013) (holding that plaintiffs “cannotmanufacture standing merely by inflicting harm on themselves based on their fears of hypotheticalfuture harm that is not certainly impending.”); see also Galaria v. Nationwide Mutual Ins. Co., No. 2:13-cv-118, 2014 U.S. Dist. LEXIS 23798 (S.D. Ohio Feb. 10, 2014) (dismissing plaintiffs’ claims for lack ofstanding).March 6, 2015 27 © 3-6-2015 ALFA International Business Litigation P.G.

courts in recent months have been more willing to consider whether an increased risk ofharm is sufficient to confer Article III standing under the U. S. Constitution in certaininstances (e.g., where some of the stolen data appeared on the internet). 54The consumer class action arising from the Target breach provides a helpful example ofhow some courts have recently handled motions to dismiss plaintiffs” data breachclaims for lack of standing. Following the Target breach, consumers filed over 100lawsuits, which were largely consolidated in federal Court in the District of Minnesota.Target moved to dismiss the Consolidated Class Action Complaint in its entiretyarguing, inter alia, that the plaintiffs lacked standing because they failed to plead injurysufficiently. 55To that end, Target argued either the claimed damages could not befairly traced to the data breach or the complaining plaintiff had otherwise already beenreimbursed for the unauthorized charge.The Court, giving arguably short-shrift to these arguments, held Target was trying tohold the plaintiffs to too high a standard at the motion to dismiss phase, and that theplaintiffs had adequately pled standing under Article III:54 Thad Behrens, Ron Breaux, Randall E. Colson, Daniel Gold, David Siegal, Micah Skidmore, LeslieThorne, John Podvin, Kenya Woodruff, Emily Westridge Black, Gavin George, Timothy Newman,Jennifer Kreick, Key Developments in Privacy and Data Security, Haynes and Boone, LLP, Oct. 2014,at 12; see also In re Adobe Sys., Inc. Privacy Litigation, No. 5:13-cv-5226 (N.D. Cal. Sept. 4, 2014)(stating that “[u]nlike in Clapper, where respondents’ claims that they would suffer future harm rested ona chain of events that was both ‘highly attenuated’ and ‘highly speculative,’ the risk that Plaintiffs’personal data will be misused by the hackers who breached Adobe’s network is immediate and veryreal” where some of the plaintiffs’ data already surfaced on the internet); see also In re Sci. ApplicationsInt’l Corp (SAIC) Backup Tape Data Theft Litig., No. 12-347, 2014 U.S. Dist. LEXIS 64125 (D.D.C. May9, 2014) (finding two of thirty one plaintiffs were able to establish standing where one plaintiff alleged hereceived a letter regarding a loan he never applied for and another plaintiff claimed she receivedunsolicited phone calls concerning a certain condition noted in her medical records).55 See In re: Target Corp. Customer Data Breach Sec. Litig., No. 0:14-md-02522, Dkt No. 81, at *1-4(Dist. Minn. Dec. 18, 2014) (Memorandum and Order).March 6, 2015 28 © 3-6-2015 ALFA International Business Litigation P.G.

Target contends that Plaintiffs’ claimed injuries are not actual or imminent, andas such do not suffice to give them standing to sue. But Plaintiffs have allegedinjury. Indeed, paragraphs 1.a through 1.g and 8 through 94 of the Complaintare a recitation of many of the individual named Plaintiffs’ injuries, includingunlawful charges, restricted or blocked access to bank accounts, inability to payother bills, and late payment charges or new card fees. Target ignores much ofwhat is pled, instead contending that because some Plaintiffs do not allege thattheir expenses were unreimbursed or say whether they or their bank closed theiraccounts, Plaintiffs have insufficiently alleged injury. These arguments glossover the actual allegations made and set a too-high standard for Plaintiffs to meetat the motion-to-dismiss stage. Plaintiffs’ allegations plausibly allege that theysuffered injuries that are ‘fairly traceable’ to Target’s conduct. . . . This issufficient at this stage to plead standing. Should discovery fail to bear outPlaintiffs’ allegations, Target may move for summary judgment on that issue. 56B. Third Party Lawsuits on the Rise.Following a data breach, credit and debit card issuers are often faced with handlingdisputed and fraudulent charges and replacing customer credit and debit cards followinga breach. Who should bear these costs? The case law on the merchant’s liability to thebanks and credit unions that issue cards is sparse and until December 2014 seemed to56 See id. at 4 (internal citations omitted).March 6, 2015 29 © 3-6-2015 ALFA International Business Litigation P.G.

slightly favor the merchants and not the issuing banks. 57However, in a Consolidated Class Action Complaint filed in Minnesota federal courtAugust 1, 2014, the banks and credit unions (the “issuing banks”) that issued the debitand credit cards of the one hundred million Target customers whose financialinformation was stolen in the data breach brought claims for negligence, violation of theMinnesota Plastic Card Security Act, Minn. Stat. § 325E.64, negligence per se, andnegligent representation by omission. 58The issuing banks allege they suffered over$18 billion dollars in damages from having to notify customers about the breach, cancelhacked accounts, deal with customer confusion, and replace cards, all during thebusiest shopping season of the year. 59Target argued the issuing banks’ expenditures were not its responsibility under thenegligence theory because the issuing banks failed to demonstrate a specialrelationship between Target and the issuing banks, and moved to dismiss theComplaint. However, the Court determined the case was about basic negligence andnot third-party harm, finding the issuing banks adequately alleged that they wereforeseeable victims of Target’s inadequate security measures. 60In denying Target’sMotion to Dismiss, the Court stated further that the ruling “will aid Minnesota’s policy of57 Compare Pennsylvania State Emps. Credit Union v. Fifth Third Bank, 398 F. Supp. 2d 317 (M.D. Penn.2005) with Lone Star Nat’l Bank NA et al. v. Heartland Payment Sys., Inc., 729 F.3d 421 (5th Cir. 2013)(finding that under New Jersey law the economic loss doctrine “does not bar tort recovery where thedefendant causes an identifiable class of plaintiffs to which it owes a duty of care to suffer economicloss that does not result in boundless liability” if the plaintiffs otherwise “would be left with no remedy.”).58 In re: Target Corporation Customer Data Security Breach Litigation, No. 0:14-md-02522-PAM, Dkt No.163 (D. Minn. Dec. 2, 2014).59 Id.60 Id.March 6, 2015 30 © 3-6-2015 ALFA International Business Litigation P.G.

punishing companies that do not secure consumers’ credit- and debit-cardinformation.” 61Clearly, the decision expands Target’s liability by hundreds of millions ofdollars and is an important decision for companies facing data breaches.C. Shareholder Lawsuits Give Plaintiffs Another Option.The Target data breach further resulted in derivative suits against Target’s directors andofficers by shareholders on behalf of the company. The derivative suits allege breach offiduciary duty, breach of the duties of loyalty and care, corporate waste, grossmismanagement, and abuse of control. Similarly, shareholders of Wyndham WorldwideHotels brought a derivative action against Wyndham’s board of directors following adata breach. 62As such, companies and their board members should be aware ofpotential shareholder derivative suits following a data breach incident.D. State Enforcement Actions: Timely and Adequate Notice.Regulatory enforcement is often triggered by mandatory breach notificationrequirements, and regulators will look to see whether the company provided timely andadequate notice following a breach. For example, in early 2014, Kaiser FoundationHealth Plan, Inc. agreed to pay the California Attorney General $150,000 to settleclaims that Kaiser’s notification to California residents regarding a breach of theirpersonal information was unreasonably delayed because Kaiser failed to make any61 Id.62 Palkon v. Holmes, No. 2:14-cv-01234-SRC-CLW (D.N.J. Oct. 20, 2014) (dismissing case for lack ofevidence that board’s refusal to bring suit constituted bad faith).March 6, 2015 31 © 3-6-2015 ALFA International Business Litigation P.G.

notifications until after it completed its four month long forensic investigation. 63E. FTC Enforcement Actions and “Reasonable Security.”The Federal Trade Commission (“FTC”) has generally taken the view that theunfairness prong of Section 5 of the FTC Act requires “reasonable security.” However,the FTC has not issued regulations specifically defining “reasonable security.”Nevertheless, the FTC has brought numerous enforcement actions for “failure toprovide reasonable security” in violation of Section 5.In one such action, the District of New Jersey recently rejected Wyndham WorldwideCorp.’s arguments that the FTC does not have the authority to regulate data securitypractices and that the FTC was required to issue regulations before bringing a Section 5unfairness enforcement action. 64F. HIPPA Enforcement Efforts: Protected Health Information.HIPPA and its implementing regulations provide federal protection for the privacy andsecurity of protected health information (“PHI”) held by included entities and theirassociates. The U.S. Department of Health and Human Services Office of Civil Rights63 See Cal. Civ. Code § 1798.82 (requiring notification to residents of any breach that exposes theirpersonal information “in the most expedient time possible and without unreasonable delay . . . .”).64 See FTC v. Wyndham Worldwide Corp., No. 13-1887 (D.N.J. April 7, 2014). A parallel case, LabMD,Inc. v. FTC, involves a similar challenge to FTC’s authority to enforce Section 5 without issuingregulations. The FTC initiated an administrative proceeding against LabMD. When the FTC deniedLabMD’s Motion to Dismiss, LabMD filed suit in Georgia federal court arguing the FTC did not have theauthority to regulate LabMD. Because the FTC’s ruling on LabMD’s Motion to Dismiss did notconstitute a final agency action, LabMD’s Northern District of Georgia case was dismissed. LabMD’sappeal to the Eleventh Circuit is pending. See LabMD, Inc. v. FTC, No. 1:14-cv-00810-WSD, 2014U.S. Dist. LEXIS 65090 (N.D. Ga. May 12, 2014).March 6, 2015 32 © 3-6-2015 ALFA International Business Litigation P.G.

oversees HIPPA. HIPPA-regulated entities face significant fines for breaches of PHI. In2014, guidance intended to assist with HIPPA data security efforts was published. 65VI.Conclusion.Whether from employees, competitors, or criminals, companies face numerous threatsto data security everyday. However, with appropriate policies, procedures, education,training, monitoring, and insurance in place a company can minimize the risk and costof an inevitable data breach.65 Behrens et al., supra note 58, at 22-23.March 6, 2015 33 © 3-6-2015 ALFA International Business Litigation P.G.

2015 INTERNATIONAL CLIENT SEMINARFAIRMONT SCOTTSDALE PRINCESSSCOTTSDALE, ARIZONAMARCH 5 – 8, 2015Client Confidentiality in the CloudPatrick MichaelDINSMORE & SHOHL LLPLouisville, Kentucky(502)581-8022patrick.michael@dinsmore.comWilliam G. IrelandHAIGHT, BROWN AND BONESTEEL, LLPLos Angeles, California(213)542-8035wireland@hbblaw.comBarbara StevensVice President & Corporate CounselPRUDENTIALNew York, New Yorkwww.prudential.comJames C. GreenVP, General Counsel & SecretaryMANITOU AMERICAS, INC.West Bend, Wisconsinwww.us.manitou.comJohn RuzichSenior Vice President & General CounselLEGENDSNew York, New Yorkwww.legends.net1

Client Confidentiality in the CloudCloud Computing and Professional Ethics:Making the Cloud Work for You 1I. The CloudLike most technological innovations, the cloud seemingly appeared out of nowhere oneday and immediately established itself as a household name. Before anyone could somuch as blink, the multinational technology giants Apple, Microsoft, Google and evenAmazon had already integrated the cloud into their Smartphone and Tablet platforms.As a result, most Smartphone and Tablet users in the U.S., groups that representapproximately 58% and 42% of U.S. adults, respectively 2 , are familiar on some levelwith the basic concept of the cloud. To most people, the cloud is where their data,pictures, messages, and phone numbers are backed up; it’s what saves them whentheir device crashes. But what exactly is this ethereal cloud?A. What is the Cloud?In the mid 1990’s, the term cloud was used generally as a metaphor for the Internet. 3As the Internet became less a creature of abstract fantasy and more widely understood,1 Article prepared by Patrick Michael and Justin Brown, Dinsmore & Shohl LLP, Louisville, Kentucky.2 Pew Research Center, http://www.pewInternet.org/fact-sheets/mobile-technology-fact-sheet (last visitedDec. 5, 2014)3 David A. Couillard, Note, Defogging the Cloud: Applying Fourth Amendment Principles to EvolvingPrivacy Expectations in Cloud Computing, 93 MINN. L. REV. 2205, 2216 (2009); Dennis Kennedy,Working in the Cloud, ABAJOURNAL.COM (last visited Nov 29, 2014),http://www.abajournal.com/magazine/article/working_in_the_clouds/2

the cloud began to take on a more refined meaning. By 2006, the cloud was no longerjust a synonym for the Internet; instead, the cloud had come to mean a large,interconnected network of servers which allows users to access data stored on theserver from anywhere that they can connect to the Internet. 4In its simplest terms, cloudcomputing means storing and accessing data and programs over the Internet instead offrom your computer's hard drive.Figure 1. A row of secured, air-cooled Cloud servers.Within a few years, the National Institute of Standards and Technology (“NIST”)developed the first working definition for cloud computing 5 . The NIST defines cloudcomputing as “a model for enabling convenient, on-demand network access to a shared4 Id.5 The terms Cloud and Cloud Computing are used interchangeably.3

pool of configurable computing resources (e.g., networks, servers, storage, applications,and services) that can be rapidly provisioned and released.” 6B. How Does the Cloud Work?Cloud computing service falls into one of three distinct categories: Infrastructure-as-a-Service (“IaaS”), Platform-as-a-Service (“PaaS”), and Software-as-a-Service (“SaaS”). 7The IaaS provides companies with computing resources, including servers, storage,and data center space on a pay-per-use basis. 8The PaaS provides a cloud-basedenvironment with everything required to support the complete life cycle of cloudapplications without the complexity of buying and managing the underlying hardware,software, provisioning and hosting. 9However, the cloud service model that is probably most familiar to the average attorneyis SaaS. In Saas, the user operates cloud-based applications on remote computers thatare owned and operated by others and that connect to users’ computers via theInternet. 10SaaS programs are so widely used today that many attorneys probably6 Peter Mell & Timothy Gance, National Institute of Standards and Technology Special Publication 800-145, The NIST Definition of Cloud Computing (2011).7 What is Cloud Computing?, IBM http://www.ibm.com/cloud-computing/in/en/what-is-cloudcomputing.html.8 Id.9 Id.10 Id.4

utilize them without realizing it. Google’s Gmail, Yahoo! Mail, Dropbox, Google Drive,Box.net, and iCloud are all well-known examples of SaaS. 11Using Dropbox as an example, the following illustrates how SaaS operates. Theprocess begins when the user moves a file or files into the Dropbox by ‘dragging anddropping’ them into the Dropbox folder. All of the data that comprises that file is thenencrypted and stored on Amazon's Simple Storage Service in multiple data centersacross the United States. When users wish to view the files, they can either accesstheir Dropbox account from any web-connected computer or they can load the Dropboxprogram onto their netbook, tablet, or Smartphone. Utilizing the loaded software allowsthe user to access the latest version of any given file and to make any changes to thefile that they want.In addition to the three different platforms of cloud computing services, there are fourdifferent mechanisms by which these computing services are deployed. First, there arepublic clouds, which are operated by third-party providers and made available to thegeneral public or a large industry group. 12Next, there are private clouds, which areoperated by companies that have the funds available to invest in off-site or on-siteservers to serve their own personnel. 13Third, there are community clouds, which arelocated on-premise or off-premise, managed by the participating organizations or a thirdparty, shared by participating organizations, and used to support a specific community11 Chuck Tesla, The Explosive Growth of Cloud Computing, Tumotech (April 21, 2014)http://www.tumotech.com/2014/04/21/what-you-need-to-know-about-the-explosive-growth-of-cloudcomputing/.12 Gathering Clouds: The Takeover Talks Between IBM and Sun Highlight a Shift in the Industry, TheEconomist, (Mar. 19, 2009) http://www.economist.com/node/1333133413 Id.5

that shares certain objectives. 14Last, there are hybrid clouds. These clouds arecomposed of two or more clouds (private, public, or community), each of which remainsa separate entity, which are linked by shared standards or shared proprietarytechnology that enhances the portability and movement of data and applications. 15II.What are the Advantages and Disadvantages of the Cloud?A. AdvantagesAttorneys often take for granted that they can, at any time, simply travel to their office towork. While this is almost always true, inclement weather, natural disasters, and evenacts of terrorism, such as those seen in New York and Boston, can shut down cities andhighways, bringing travel to a complete standstill. Those attorneys with paper-basedpractices or whose servers are stored inter-office would likely be unable to provideservices to their clients during this time. However, firms that utilize the cloud wouldremain able to access their data and continue with business as usual.There are many benefits to transitioning to a cloud computing solution for a law firm’sclient and office data. Four of those benefits are articulated below.14 Id.15 Id.6

1. Efficiency and ConvenienceTraditionally, law firms have just purchased computers, servers, and software, and havehired an IT professional or professionals to manage everything. Not only is thisexpensive, but it is likely that there are not many electronic security measures in place.Moving information to the cloud can allow the law firm to lower its expenses, enjoybetter service, and be better protected. In addition to costs savings, law firm data willbe more physically secure in the cloud than in the office. Cloud providers often go togreat lengths to ensure that their servers are physically protected against the elements,fires, electrical shorts, and even intrusions by would be thieves.Additionally, cloud service is more efficient than IT service is in regards to problemresolution. Often with in-house problems, an attorney must wait for the IT professionalto come to his/her office, which can be not only time-consuming, but intrusive. With aproblem on the cloud, the provider can simply access the system and begintroubleshooting the problem remotely. Also, when it is time to update or install newsoftware, the provider can do so without the need of any involvement by the attorney orthe firm.2. Increased Data and Analytics and Better ManagementThe cloud also gives an attorney or a firm access to better information regarding theefficiency of how the firm operates. “Utilizing cloud architecture and services can allowthe firm to efficiently collect data about its practice and its staff, enabling the firm tobetter devise ways to increase its productivity and profits. For instance, a cloud-basedpractice can more easily and accurately track and analyze metrics such as utilization of7

software applications and platforms and an attorney’s time. These metrics can, in turn,be used to make firm-wide overhead decisions such as staffing, and whether or not tooffer alternative billing for certain tasks.” 163. Disaster Readiness and RecoveryDisasters, whether natural or man-made, can not only bring work to a standstill, but canresult in the destruction of a firm’s office, including all physical files. Using the cloud canminimize, and even prevent, the risks of a natural disaster having a negative impact ona law firm because files saved in the cloud are physically stored in a location differentfrom the firm. Additionally, the backed-up files are typically duplicated or stored onmore than one server. Cloud providers tend to have multiple server sites in severalgeographic regions, which helps ensure the safety of data in the event of a natural oreven a regional disaster.4. FlexibilityToday, it is more necessary than ever for an attorney to be able to work outside of theoffice. “An attorney’s ability to review documents on the road and to retrieve informationwhile in court or at a client meeting is an important aspect of running a profitablepractice. With a cloud-based system, all of a firm’s data is saved, cataloged, andindexed in a centralized location that is remotely accessible to the attorney.” 17Thisgives the attorney the flexibility to work from home, on a trip, while traveling, and evenfrom the courthouse.16 Kenneth N Rashbaum, et al, Five Reasons to Consider Moving Law Firm Data to the Cloud,Logicworks, http://www.logicworks.net/blog/2014/06/five-reasons-consider-moving-law-firm-data-cloud/.17 Id.8

B. DisadvantagesWhile the cloud does offer numerous advantages to attorneys and law firms, like anytechnology, it comes with its own set of problems and concerns. Consider the followingfour problems.1. SecurityBecause we are beyond the time when all files can be physically secured under lockand key, security has taken on a new meaning. Instead of locks and file cabinets, wenow have firewalls and 256-bit encryption. Burglars are now called hackers. Thesehackers, such as the group Anonymous, have managed to infiltrate some of the largestand most well equipped cloud providers, including Dropbox, Apple and Amazon.However, it is the interconnectedness of the cloud that poses the greatest risk. Once ahacker gains access to the cloud servers, they can navigate their way through theinterconnected systems, accessing more information than they could on a privateserver.An additional security risk is that posed by the cloud employees themselves. Any cloudemployee who has access to the data can essentially steal that data at any time. Inaddition to the risks posed to a client’s interests, this can also destroy confidentiality.2. Internet Connection FailureBy virtue of being a server based service, access to the cloud will always be through theInternet. Whether because of loss of power or maintenance by the Internet ServiceProvider, if the network connection is down, then the cloud is down. This forces the9

attorney to either wait for the connection to return, or to relocate to find a suitablealternative Internet source.3. Server Maintenance or FailureOn some occasions, it will not be the Internet connection that is down, but the cloudservers themselves. During this time, the attorney will be entirely unable to accessclient documents on the cloud. Unless the provider has built in a workaround such thatthe data stored on the failed servers is accessible through another server, there isnothing the attorney can do but wait. This places the attorney in a precarious position,especially if he or she is preparing for trial, making time sensitive court filings, or in themiddle of mediation and attempting to access documents.4. Provider Business FailureCloud service providers can be bought, sold, dissolved, or liquidated in bankruptcy. “Incase of bankruptcy, the Cloud provider may stop maintaining the servers, or securedcreditors may claim those servers without considering preservation of data for itsowners. This would put the firm in the difficult situation of trying to recover its data froma Cloud provider that does not have any more resources to spend on client services.” 1818 Ashwini Jayaratnam, et al., The Cloud and the Small Law Firm: Business, Ethics and PrivilegeConsiderations, Committee on Small Law Firms, New York Bar Association (November 2013).http://nylawblog.typepad.com/files/nyc-bar-report.pdf.10

III.An Examination of State Bar Ethics Committees Opinions onCloud Computing.Some law firms find that the advantages of cloud computing outweigh thedisadvantages. As a result, they have abandoned their traditional data storagesolutions in favor of the Cloud. Because cloud computing places client data on remoteservers outside of the lawyer's direct control, it has given rise to some concernsregarding its acceptability under applicable ethics rules. This has catalyzed a responsefrom nineteen State Bar Associations in the form of Ethics Opinions. 19The opinions universally adopt “reasonable care” as the standard for attorneys lookingto store data in the cloud. Unfortunately, it is ultimately impossible to find substantiveguidelines on what constitutes reasonable care. Even where some guidelines do exist,they vary by jurisdiction. This is likely attributable to the rapidly changing nature oftechnology and the needs of attorneys in that jurisdiction.In order to insure a geographically diverse representation, this paper examines opinionsfrom California, Iowa, New York, Pennsylvania, Massachusetts, and North Carolina.A. California – Reasonable CareThe State Bar of California's Standing Committee on Professional Responsibility andConduct issued an opinion in December of 2010 that "sets forth the general analysis19 To date, the following state’s State Bar Associations have rendered ethics opinions on cloudcomputing: Alabama, Arizona, California, Connecticut, Florida, Iowa, Maine, Massachusetts, NewHampshire, New Jersey, New York, Nevada, North Carolina, Ohio, Oregon, Pennsylvania, Vermont,Virginia and Washington.11

that an attorney should undertake when considering use of a particular form oftechnology." 20The Committee stated that "transmission of information through a third party reasonablynecessary for purposes of the representation should not be deemed to have destroyedthe confidentiality of the information," but that the "manner in which an attorney acts tosafeguard confidential information is governed by the duty of competence." 21On theissue of competence, the Committee declared: "the duty of competence includes takingappropriate steps to ensure both that secrets and privileged information of a clientremain confidential and that the attorney's handling of such information does not resultin a waiver of any privileges or protections." 22Before using a given type of technology, the Committee suggested that an attorneyshould consider the following factors:1. The nature of the technology in relation to more traditional counterparts(i.e. e-mail versus mail);2. Reasonable precautions possible to improve the security of a giventechnology;3. Limitations on who can monitor the use of technology and discloseactivity;4. The lawyer's own level of technological competence, and whether it'snecessary to consult with an expert;5. Legal ramifications to third parties for intercepting or otherwise interferingwith electronic information;20 State Bar of California's Standing Committee on Professional Responsibility and Conduct, FormalOpinion No. 2010-179.21 Id.22 Id.12

6. The sensitivity of the data;7. Impact of possible disclosure on the client;8. Urgency of the situation; and9. Client instructions. 23In conclusion, the Committee said “An attorney’s duties of confidentiality andcompetence require the attorney to take appropriate steps to ensure that his or her useof technology in conjunction with a client’s representation does not subject confidentialclient information to an undue risk of unauthorized disclosure.” 24B. Iowa – Due DiligenceOn September 9, 2011, The Iowa State Bar Association's Ethics Committee issued anopinion on whether a lawyer or law firm may use cloud computing, with particularemphasis on SaaS. The Committee stated: “We believe the Rule establishes areasonable and flexible approach to guide a lawyer’s use of ever-changing technology.It recognizes that the degree of protection to be afforded client information varies withthe client, matter and information involved. But it places on the lawyer the obligation toperform due diligence to assess the degree of protection that will be needed and to actaccordingly.” 2523 Id.24 Id.25 The Iowa State Bar Association, Committee on Ethics and Practice Guidelines, Ethics Opinion 11-01Use of Software as a Service – Cloud Computing.13

The opinion goes on to provide that lawyers who wish to utilize the cloud "must ensurethat there is unfettered access to the data when it is needed.” 26The onus is on thelawyer to “determine the nature and degree of protection that will be afforded the datawhile residing elsewhere." 27In order to perform their due diligence, the opinion states that lawyers should inquireabout:1. The reputation of the provider;2. The physical location of their cloud servers;3. Their ability to remove data from the service;4. What type of password protection is used, who has access to data; and5. How is the data encrypted? 28The opinion goes on to acknowledge the inherent difficulty in performing due diligence,especially considering that it must be performed by individuals who have the “requisitetechnology expertise and as well as an understanding of the Iowa Rules of ProfessionalConduct.” 29However, the opinion concludes that lawyers may discharge their ethicalduties "by relying on the due diligence services of independent companies, barassociations or other similar organizations or through its own qualified employees." 3026 Id.27 Id.28 Id.29 Id.30 Id.14

C. New York – Four Factor ApproachThe New York State Bar Association’s Committee on Professional Ethics published anopinion outlining the ethical considerations for attorneys who hire third-party providers toelectronically store client files. 31The Committee concluded that, “just as an attorneymay hire a third party to store hard-copies of client files, so too may an attorney use anonline storage system, provided the attorney exercises reasonable care to ensure thatconfidential information will remain secure.” 32The Committee pointed out that “theexercise of reasonable care may differ from one case to the next.” 33The Committee concluded that a lawyer may use a cloud computer data backup systemto store client files provided that the lawyer takes reasonable care to ensure that thesystem is secure and that client confidentiality will be maintained. Reasonable caremay include consideration of the following steps:1. Ensuring that the online data storage provider has an enforceableobligation to preserve confidentiality and security, and that the provider willnotify the lawyer if served with process requiring the production of clientinformation;2. Investigating the online data storage provider's security measures,policies, recoverability methods, and other procedures to determine if theyare adequate under the circumstances;3. Employing available technology to guard against reasonably foreseeableattempts to infiltrate the data that is stored; and/or31 N.Y. State Bar Assoc. Comm. on Prof’l Ethics, Opinion No. 842 (2010)32 American Bar Association, New York State Bar Association Tackles Ethics of Cloud Computing,(May2011)http://www.americanbar.org/newsletter/groups/labor_law/ll_flash/1105_aball_flash/1105_aball_flash_ethics.html33 New York State Bar Assoc. Comm. on Prof’l Ethics, supra note 31.15

4. Investigating the storage provider’s ability to purge and wipe any copies ofthe data, and to move the data to a different host, if the lawyer becomesdissatisfied with the storage provider or for other reasons changes storageproviders. 34D. Pennsylvania – Internal and External Due DiligenceIn November of 2011, The Pennsylvania Bar Association Committee on Legal Ethicsand Professional Responsibility released their opinion on cloud computing. TheCommittee acknowledged that the cloud would "reduce costs, improve efficiency andprovide better client service." 35The Committee provided a fifteen point list of possible steps a firm "may" take inexercising reasonable care with cloud computing:34 Id.1. Backing up data;2. Installing a firewall;3. Limiting information that is provided to others;4. Avoiding inadvertent disclosure of information;5. Verifying the identity of individuals to whom the attorney providesconfidential information;6. Refusing to disclose confidential information to unauthorized individuals;7. Encrypting confidential data;8. Monitor who is accessing the data;9. Creating plans to address security breaches;10. Ensuring the provider does not have any ownership of the data;35 Pennsylvania Bar Association Committee on Legal Ethics and Professional Responsibility, FormalOpinion 2011-200.16

11. Investigate the provider and their reputation;12. Determine if the data is in a non-proprietary format;13. Require training for all individuals accessing the cloud;14. Ensuring a copy of digital data is stored onsite; and15. Having an alternate means to connect to the Internet. 36E. Massachusetts – Client’s ConsentOn May 17, 2012, the Massachusetts Bar Association issued their ethics opinion oncloud computing. The MBA Committee concluded: "the use of an Internet basedstorage provider to store confidential client information would not violate MassachusettsRule of Professional Conduct 1.6(a) in ordinary circumstances so long as the Lawyerundertakes reasonable efforts to ensure that the provider's data privacy policies,practices and procedures are compatible with Lawyer's professional obligations." 37The Committee listed several examples of what constitutes reasonable efforts:1. examining the provider's policies and procedures regarding confidentialdata;2. ensuring that those terms prohibit unauthorized access to data;3. ensuring that the lawyer will have reasonable access and control over thedata;4. examining the provider's security practices; and5. periodically revisiting these topics to ensure continued acceptability. 3836 Id.37 Massachusetts State Bar Association, Ethics Opinion 12-03.38 Id.17

Most unique about this opinion is the Committee’s directive that a lawyer "should refrainfrom storing or transmitting particularly sensitive client information by means of theInternet without first seeking and obtaining the client's express consent to do so." 39[Emphasis added].The Committee concluded by stating that whether the cloud “is compatible with [a]Lawyer's ethical obligation to protect his clients' confidential information is one that theLawyer must answer for himself based on the criteria set forth in this opinion, theinformation that he is reasonably able to obtain regarding the relative security of thevarious alternatives that are available, and his own sound professional judgment.” 40F. North Carolina – Guidelines for Professional JudgmentThe North Carolina State Bar's Ethics Committee issued their opinion on October 20,2011. The Committee opined that lawyers may use the cloud, "provided steps aretaken to minimize the risk of inadvertent or unauthorized disclosure of confidential clientinformation and to protect client property." 41In taking these steps, the lawyer shouldapply "the same diligence and competency to managing the risks of SaaS that thelawyer is required to apply when representing clients." 42Regarding the steps a lawyer should take, the Committee noted that their opinion "doesnot set forth specific security requirements because mandatory security measures39 Id.40 Id.41 North Carolina Bar Association Ethics Committee, 2011 Formal Ethics Opinion 6.42 Id.18

would create a false sense of security in an environment where the risks are continuallychanging." 43Rather, the Committee stated “due diligence and frequent and regulareducation are required.” 44The Committee concluded by generally recommending the following security measures:1. Include an agreement on how the vendor will handle confidential clientinformation in keeping with the lawyer’s professional responsibilities;2. Have a method for retrieving the data, including a provision that vendor iscontractually required to return or destroy the hosted data promptly at therequest of the law firm;3. Careful review of the terms of the law firm’s user or license agreementwith the SaaS vendor including the security policy;4. Evaluation of the SaaS vendor’s (or any third party data hostingcompany’s) measures for safeguarding the security and confidentiality ofstored data including, but not limited to, firewalls, encryption techniques,socket security features, and intrusion-detection systems; and5. Evaluation of the extent to which the SaaS vendor backs up hosted data. 45IV. Suggested Guidelines.The aforementioned ethical opinions contain limited instructions on what exactlyattorneys should do in order to comply with their ethical responsibilities. It is no surprisethat this places the attorney in an unenviable position, as they must determine what isethical and what is not. The following guidelines are intended to assist today’s attorneyin navigating the undefined and confusing waters of reasonable care in regards to cloudcomputing.43 Id.44 Id.45 Id.19

A. Use Only Reliable ProvidersWith technology as new as the cloud, it is difficult to ascertain whether a serviceprovider has a respectable reputation. Some providers, such as Microsoft, Google, andApple have deep roots in the IT field, whereas other smaller market-participants havenot yet earned a reputation at all. In order to meet his or her ethical duties, an attorneyshould consult with news sources, Internet search engines, and an IT specialist todetermine the reputations of potential service providers.B. Request Documents to Evidence Due DiligenceIn order to demonstrate that he or she has done their due diligence, the attorney shouldrequest copies of the prospective provider’s certifications from one of the agencies thatindependently audit the security practices of cloud providers. 46“Internationallyrecognized standards used by these auditors include: SSAE-16 (Statement onStandards for Attestation Engagements, the successor to SAS 70, Statement No. 70 ofthe Statement on Auditing Standards, Service Organizations), and SOC3,SysTrust/Webtrust.” 47By selecting and using a provider who has received one of thesecertifications, the attorney increases the likelihood that, if there was a dispute, theywould be held to have exercised reasonable care.46 Jayaratnam, supra note 18.47 Id.20

C. Get Consent From Your ClientThe easiest procedural safeguard to accomplish is obtaining the client’s express writtenconsent prior to storing their information in the cloud. One of the most effortless andefficient ways to do this is through the engagement letter. The attorney should simplyinclude a provision in the engagement letter, with an accompanying line for initialing,which states that the client consents to having their information stored on cloud servers.D. Keep All of Your Data EncryptedWhenever an attorney uses the cloud to store client data, this information will reside inone of three places: on the computer, in transit to the cloud, or on the cloud server.Regardless of where this information is located, the data should be encrypted at alltimes. 48This can be accomplished through the use of encryption applications toencrypt the computer hard-drive, and portable media such as USB drives, laptops,tablets and smartphones. Because not everyone is familiar with encryption softwareand how to effectively utilize it, those who are unfamiliar should consult with an ITspecialist to receive advice and training.E. Establish Data Management Policies and ProceduresIn order to perform their due diligence, an attorney must do more than simply select areputable provider. 49It is necessary that the attorney “sensitize all staff (professionaland non-professional) to the importance of maintaining security (such as protecting the48 Encryption is the process of transforming information so that it is unreadable to those who don’t have akey that can decrypt it or make it readable again.49 Jayaratnam, supra note 18.21

privacy of passwords, avoiding unsecure networks to access the cloud, etc.) and to theoperation of the online service so that data entry and manipulation is conducted in themanner necessary for the provider to fulfill its part of the protection regimen.” 50It is alsoprudent that all training policies and procedures are documented and acknowledged bythe employee. Because all states require reasonable care and due diligence in order tostore data on the cloud, it is necessary to have some documentation to evidence thatreasonable care was taken. 51F. Include Key Terms in the Contract / Service LevelAgreementWe have saved the most important suggested guideline for last. It is imperative that anattorney scrutinize and negotiate terms of the cloud contract to meet not only theattorney’s needs, but also to comply with ethical guidelines. When reviewing a potentialprovider’s Service Level Agreement (“SLA”), an attorney should be on the lookout forthe following commitments and should negotiate for their inclusion into the contract.1. Definition of Confidential InformationThere should be a comprehensive definition for Confidential Information. The followingis an example of a broad definition of Confidential Information:Confidential Information” means and includes any and all of the followinginformation that has been, or may be disclosed to Recipient, by the Discloser ordirectors, officers, employees, agents, consultants, advisors, or otherrepresentatives, including legal counsel, accountants, and financial advisors(“Representatives”) of the Discloser, regardless of the medium:50 Id.51 Id.22

i. all information that is a trade secret under applicable trade secret orother law;ii. all information concerning product specifications, patents,trademarks, copyrights, service marks, patent applications, data, knowhow,formulae, compositions, processes, designs, sketches,photographs, graphs, drawings, samples, inventions, and ideas, pastcurrent and planned research and development, current and plannedmanufacturing or distribution methods and processes, customer lists,client lists, current and anticipated customer requirements, price lists,bidding processes, market studies, business plans, computer hardware,Software and computer software and database technologies, systems,structures, and architectures;iii. all information concerning the business and affairs of the Discloserand its clients (which includes historical and current financial statements,financial projections and budgets, tax returns and accountants’materials, historical, current and projected sales, capital spendingbudgets and plans, business plans, strategic plans, marketing andadvertising plans, publications, client and customer lists and files,contracts, the names and backgrounds of key personnel and personneltraining techniques and materials, however documented) and allinformation obtained from review of the Discloser’s documents, property,or discussions with the Discloser, regardless of the form ofcommunication;iv. all notes, analyses, compilations, studies, summaries and othermaterial prepared by the Recipient to the extent containing or based, inwhole or in part, upon any information included in the foregoing; andv. all information transmitted between a client and his [or her] lawyerin the course of that relationship and in confidence by a means which, sofar as the client is aware, discloses the information to no third personsother than those who are present to further the interest of the client inthe consultation or those to whom disclosure is reasonably necessary forthe transmission of the information or the accomplishment of thepurpose for which the lawyer is consulted, and includes a legal opinionformed and the advice given by the lawyer in the course of thatrelationship. This includes, but is not limited to, an attorney's legalopinions, impressions, and conclusions, regardless of whether they havebeen communicated to the client.23

2. Ownership of DataThe agreement should explicitly state that the cloud provider does not have anyownership or security interest either in the confidential information or the data uploadedto that provider’s system. Conversely, the agreement should also state that the attorneyowns all of the intellectual property rights in his or her data. The vendor should alsoagree to keep the client’s confidential data separate from other data. Lastly, it isimperative that attorneys completely avoid vendors who claim any ownership rights toinformation stored in the cloud.3. Data Storage LocationDepending on the nature of an attorney’s practice, as well as specific state regulations,it may be beneficial to include a provision establishing geographic parameters for wherethe data may be stored. For example, if data is stored out of the country, the attorneymay be faced with foreign laws on government access and consumer privacy rights.This could prove to be especially difficult for some attorneys unfamiliar with internationallaw.4. Unfettered AccessThe provider should agree to provide unfettered access to client data at least 99.9% ofthe time. 52This takes into account reasonable downtime for the provider to conductnecessary maintenance on its servers.5. Up to Date Security52 The total cloud server downtime should only be approximately forty-five minutes per month.24

Due to concerns of data security breaches, the provider should possess the technologyto withstand a foreseeable attempt by a third party to infiltrate its servers. The contractshould include a provision that the provider will maintain the most up-to-date securitypractices for both the physical and electronic safety and security of its servers. Thisincludes encryption, firewalls, locked facilities, redundant storage, and most importantly,an obligation to react to advancements and developments in the relevant technology.6. Timely Notice of BreachThe onus should be on the provider to give timely notice to the attorney when there iseither a physical or electronic breach of data, or an attempted breach of data. Include aprovision that the degree of breach or attempted breach is irrelevant; even the smallestattempt triggers mandatory notice.7. Timely Subpoena NoticeThe provider should agree to timely notify the attorney as soon as a third party requeststhe provider to make available confidential information, client information, or any datathe attorney has stored on the cloud server. The attorney should be provided withenough time to determine if they want to resist disclosure and act accordingly.8. Access Without Internet ConnectionThe cloud data should be automatically synchronized and stored on any personalcomputer, tablet, or other device in the attorney’s control that is capable of supportingthe cloud data. This will allow the attorney to access the data in the event of a loss ofInternet connectivity.25

9. Data RetrievalThe provider should offer a method of retrieving data if and when the attorney or lawfirm terminates the use of the cloud service, the provider stops offering the service orgoes out of business, or there is a break in continuity.V. ConclusionGiven the numerous advantages that cloud computing has to offer, coupled with itsuniversal acceptance by state bar associations, attorneys and law firms should bewilling to embrace the cloud. So long as the attorney acts with reasonable care inselecting a provider and storing the data, it is likely that he or she will be deemed tohave acted within the boundaries of acceptable ethics practice.26

Exhibit No. 1:Software as a Service AgreementForm Agreement

Software as a Service Agreement (Pro-customer)This Software as a Service (SaaS) Agreement (the "Agreement"), dated as of[DATE] (the "Effective Date"), is by and between [NAME OF CUSTOMER]("Customer"), a [STATE OF ORGANIZATION] [TYPE OF LEGAL ENTITY] withoffices located at [ADDRESS], and [NAME OF PROVIDER], a [STATE OFORGANIZATION] [TYPE OF LEGAL ENTITY] with offices located at [ADDRESS]("Provider").1. Definitions."Accept" has the meaning set forth in Section 4.2(b)."Acceptance" has the meaning set forth in Section 4.2(b)."Action" has the meaning set forth in Section 14.1."Actual Uptime" means the total minutes in the Service Period that the HostedServices are Available."Affiliate" of a Person means any other Person that directly or indirectly, through oneor more intermediaries, controls, is controlled by, or is under common control with, suchPerson. The term "control" (including the terms "controlled by" and "under commoncontrol with") means the direct or indirect [power to direct or cause the direction of themanagement and policies of a Person, whether through the ownership of votingsecurities, by contract or otherwise/ownership of more than [NUMBER IN WORDS]percent ([NUMBER]%) of the voting securities of a Person]."Agreement" has the meaning set forth in the preamble."Allegedly Infringing Features" has the meaning set forth in Section 14.3(b)(ii)."Authorized Users" means all Persons authorized by Customer [or any of itsAffiliates] to access and use the Services through Customer's account under thisAgreement[, each of which shall be identified by Customer's written notice to Provider asset forth in Schedule [A/[OTHER LETTER]] as the same may be amended by Customerfrom time to time]."Availability" has the meaning set forth in Section 5.1.

"Availability Requirement" has the meaning set forth in Section 5.1."Available" has the meaning set forth in Section 5.1."Business Day" means a day other than a Saturday, Sunday or other day on whichcommercial banks in [New York City/[OTHER LOCATION]] are authorized or requiredby Law to be closed for business."Change Order" has the meaning set forth in Section 2.2."Code" has the meaning set forth in Section 20."Confidential Information" has the meaning set forth in Section 10.1."Corrective Action Plan" has the meaning set forth in Section 6.6."Critical Service Error" has the meaning set forth in Section 6.4(a)."Customer" has the meaning set forth in the preamble."Customer Data" means any and all information, data, materials, works, expressionsor other content, including any that are (a) uploaded, submitted, posted, transferred,transmitted or otherwise provided or made available by or on behalf of Customer or anyAuthorized User for Processing by or through the Hosted Services, or (b) collected,downloaded or otherwise received by Provider or the Hosted Services for Customer orany Authorized User pursuant to this Agreement or any Service Order or at the writtenrequest or instruction of Customer or such Authorized User. All output, copies,reproductions, improvements, modifications, adaptations, translations and otherderivative works of, based on, derived from or otherwise using any Customer Data arethemselves also Customer Data. For the avoidance of doubt, Customer Data includes allUser Data and Personal Information but does not include any Provider Materials."Customer" has the meaning set forth in the preamble.["Customer Indemnitee" has the meaning set forth in Section 14.1.]"Customer Modification" has the meaning set forth in Section 14.2(a)."Customer SaaS Manager" has the meaning set forth in Section 2.8."Customer Systems" has the meaning set forth in Section 7.5(a)(vi)."Disclosing Party" has the meaning set forth in Section 10.1.["Divested Business" means any business that at any time during the Term is anoperating division of Customer or [an Affiliate of Customer], but ceases to be so as a2

esult of the sale or other transfer of ownership of a majority of the equity interest or allor substantially all of the assets of (a) such business or (b) Customer by its parent.]"Documentation" means all generally available documentation relating to theServices, including all user manuals, operating manuals and other instructions,specifications, documents and materials, in any form or media, that describe anycomponent, feature, requirement or other aspect of the Services, including anyfunctionality, testing, operation or use thereof."Effective Date" has the meaning set forth in the preamble."Escrow Agent" has the meaning set forth in Section 19.1."Escrow Agreement" has the meaning set forth in Section 19.1."Exceptions" has the meaning set forth in Section 5.2."Fees" has the meaning set forth in Section 8.1."Force Majeure Event" has the meaning set forth in Section 18.1."Harmful Code" means any software, hardware or other technologies, devices ormeans, the purpose or effect of which is to: (a) permit unauthorized access to, or todestroy, disrupt, disable, distort, or otherwise harm or impede in any manner, any (i)computer, software, firmware, hardware, system or network, or (ii) any application orfunction of any of the foregoing or the integrity, use or operation of any data Processedthereby; or (b) prevent Customer or any Authorized User from accessing or using theServices or Provider Systems as intended by this Agreement, and includes any virus, bug,trojan horse, worm, backdoor or other malicious computer code and any time bomb ordrop dead device."High Service Error" has the meaning set forth in Section 6.4(a)."Hosted Services" has the meaning set forth in Section 2.1(a)."Indemnifying Party" has the meaning set forth in Section 14.1.["Indemnitee" has the meaning set forth in Section 14.1.]"Initial Term" has the meaning set forth in Section 7.1."Intellectual Property Rights" means any and all rights comprising or relating to:(a) patents, patent disclosures and inventions (whether patentable or not); (b) trademarks,service marks, trade dress, trade names, logos, corporate names and domain names,together with all of the goodwill associated therewith; (c) authorship rights, copyrightsand copyrightable works (including computer programs) and rights in data and databases;3

(d) trade secrets, know-how and other confidential information; and (e) all otherintellectual property rights, in each case whether registered or unregistered and includingall applications for, and renewals or extensions of, such rights, and all similar orequivalent rights or forms of protection provided by applicable Law in any jurisdictionthroughout the world."Key Personnel" means any Provider Personnel identified as key personnel in thisAgreement or any Service Order."Law" means any statute, law, ordinance, regulation, rule, code, order, constitution,treaty, common law, judgment, decree or other requirement or rule of any federal, state,local or foreign government or political subdivision thereof, or any arbitrator, court ortribunal of competent jurisdiction."Loss" means any and all losses, damages, liabilities, deficiencies, claims, actions,judgments, settlements, interest, awards, penalties, fines, costs or expenses of whateverkind, including reasonable attorneys' fees and the costs of enforcing any right toindemnification hereunder and the cost of pursuing any insurance providers."Low Service Error" has the meaning set forth in Section 6.4(a)."Medium Service Error" has the meaning set forth in Section 6.4(a).["Permitted Uses" means any use of the Services by Customer or any AuthorizedUser[ for the benefit of Customer [or any of its Affiliates] [ in or for Customer's [or itsAffiliate's] internal business operations/for [any and all lawful purposes/the [SPECIFIEDPURPOSE OR PURPOSES]]]].]"Person" means an individual, corporation, partnership, joint venture, limitedliability company, governmental authority, unincorporated organization, trust, associationor other entity."Personal Information" has the meaning set forth in Section 11.1(a)."Plan" has the meaning set forth in Section 13.3(a)."Process" means to perform any operation or set of operations on any data,information, material, work, expression or other content, including to (a) collect, receive,input, upload, download, record, reproduce, store, organize, combine, log, catalog, crossreference,manage, maintain, copy, adapt, alter, translate or make other improvements orderivative works, (b) process, retrieve, output, consult, use, disseminate, transmit,submit, post, transfer, disclose or otherwise provide or make available, or (c) block, eraseor destroy. "Processing" and "Processed" have correlative meanings."Provider" has the meaning set forth in the preamble.4

["Provider Indemnitee" has the meaning set forth in Section 14.4.]["Provider Materials" means all devices, documents, data, know-how, methods,processes, software and other inventions, works, technologies and materials, includingany and all Service Software, Documentation, computer hardware, programs, reports andspecifications, client software and deliverables provided or used by Provider inconnection with performing the Services, in each case developed or acquired by theService Provider independently of this Agreement.]"Provider Personnel" means all employees and agents of Provider[, allSubcontractors and all employees and agents of any Subcontractor,] involved in theperformance of Services."Provider Security Officer" has the meaning set forth in Section 2.5(a)."Provider Service Manager" has the meaning set forth in Section 2.5(a)."Provider Systems" has the meaning set forth in Section 12.3."Receiving Party" has the meaning set forth in Section 10.1."Regulator" has the meaning set forth in Section 12.5.Section 12.4(b)."Reimbursable Expenses" has the meaning set forth in Section 8.4."Reject" has the meaning set forth in Section 4.2(b)."Rejection" has the meaning set forth in Section 4.2(b)."Release Event" has the meaning set forth in Section 19.2."Renewal Term" has the meaning set forth in Section 7.2."Representatives" means a party's [and its Affiliates' respective] employees,officers, directors, consultants, legal advisors [and, with respect to Provider, Provider'sSubcontractors,][ and, with respect to Customer, solely those of its independentcontractors or service providers that are Authorized Users]."Resolve" has the meaning set forth in Section 6.4(b)."Scheduled Downtime" has the meaning set forth in Section 5.3."Scheduled Uptime" means the total minutes in the Service Period."Secondary Backup Facility" has the meaning set forth in Section 13.1.5

"Service Availability Credits" has the meaning set forth in Section 5.5(a)."Service Error" means any failure of any Hosted Service to be Available orotherwise perform in accordance with this Agreement and the Specifications."Service Level Credits" has the meaning set forth in Section 6.5."Service Level Failure" means a failure to perform the Support Services fully incompliance with the Support Service Level Requirements."Service Order" has the meaning set forth in Section 2.1(a)."Service Period" has the meaning set forth in Section 5.1."Service Software" means the Provider software application or applications and anythird-party or other software, and all new versions, updates, revisions, improvements andmodifications of the foregoing, that Provider provides remote access to and use of as partof the Services."Services" has the meaning set forth in Section 2.1."Source Code" means the human readable source code of the Service Software towhich it relates, in the programming language in which the Service Software was written,together with all related flow charts and technical documentation, including a descriptionof the procedure for generating object code, all of a level sufficient to enable aprogrammer reasonably fluent in such programming language to understand, build,operate, support, maintain and develop modifications, upgrades, updates, adaptations,enhancements, new versions and other derivative works and improvements of, and todevelop computer programs compatible with, the Service Software."Specifications" means the specifications for the Services set forth in the applicableService Order and, to the extent consistent with and not limiting of the foregoing, theDocumentation.["Subcontractor" has the meaning set forth in Section 2.4(a).]"Support Request" has the meaning set forth in Section 6.4(a)."Support Service Level Requirements" has the meaning set forth in Section 6.4."Support Services" has the meaning set forth in Section 6."Sustaining Resources" means (a) personnel that are: (i) technically qualified toperform the Services; (ii) made available during the time period and at the place whereperformance of the Services is required to occur; and (iii) sufficient, ready, willing andable to perform all of Provider's [material] obligations; (b) materials, facilities and6

equipment that are sufficient to perform Provider's obligations; and (c) other assets,including Intellectual Property Rights, that are sufficient to perform Provider'sobligations, in the case of each of clauses (a), (b) and (c), in a professional, timely andefficient manner in accordance with this Agreement and the Specifications."Term" has the meaning set forth in Section 7.2."Territory" means [the United States/worldwide/[OTHER TERRITORY]]."User Data" means any and all information reflecting the access or use of the HostedServices by or on behalf of Customer or any Authorized User, including any end userprofile-, visit-, session-, impression-, click through- or click stream- data and anystatistical or other analysis, information or data based on or derived from any of theforegoing.2. Services.2.1 Services. Throughout the Term and at all times in connection with its actual orrequired performance under this Agreement, Provider shall, in accordance with all termsand conditions set forth in this Agreement and each applicable Service Order, provide toCustomer and its Authorized Users the following services ("Services"):(a) the hosting, management and operation of the Service Software and otherservices for remote electronic access and use by the Customer and its Authorized Users("Hosted Services") as described in one or more written, sequentially numbered, serviceorders specifically referencing this Agreement, including all Specifications set forth insuch service orders, which, upon their execution will be attached as part of Schedule[B/[OTHER LETTER]] and by this reference are incorporated in and made a part of thisAgreement (each, a "Service Order");(b) service maintenance and the Support Services as set forth in Section 6 andin the Service Order; and(c)such other services as may be specified in the applicable Service Order.2.2 Service Orders. Service Orders will be effective only when signed by Customerand Provider. Any modifications or changes to the Services under any executed ServiceOrder will be effective only if and when memorialized in a mutually agreed writtenchange order ("Change Order") signed by both Parties, provided, however, that for anyServices provided on a limited basis (for example, on a per user, server, CPU or nameduserbasis), Customer may, at any time, increase or decrease the number of its licenseshereunder subject to a corresponding forward-going adjustment of the Fees to reflectthese changes in accordance with the pricing set forth in Schedule [B/[OTHERLETTER]] or otherwise in an applicable Service Order.7

2.3 Compliance With Laws. Provider shall comply with all applicable Laws as theyconcern this Agreement or the subject matter hereof, including by securing andmaintaining all required and appropriate visas, work permits, business licenses and otherdocumentation and clearances necessary for performance of the Services.2.4 Subcontracting. Provider shall not itself, and shall not permit any Person to,subcontract any Services, in whole or in part[, without Customer's prior written consent,which consent [shall not be unreasonably withheld or delayed/may be given or withheldin Customer's sole discretion]]. [ Without limiting the foregoing:(a) Provider shall ensure each Provider subcontractor (including anysubcontractor of a Provider subcontractor, each, a "Subcontractor") complies with allrelevant terms of this Agreement, including all provisions relating to Customer Data,Personal Information or other Confidential Information of Customer;(b) Customer's consent to any such Subcontractor shall not relieve Provider ofits representations, warranties or obligations under this Agreement;(c) Provider shall remain responsible and liable for any and all: (i) performancerequired hereunder, including the proper supervision, coordination and performance ofthe Services; and (ii) acts and omissions of each Subcontractor (including, suchSubcontractor's employees and agents, who, to the extent they are involved in providingany Services, are deemed Provider Personnel) to the same extent as if such acts oromissions were by Provider;(d) any noncompliance by any Subcontractor or its employees or agents withthe provisions of this Agreement or any Service Order will constitute a breach byProvider[;/; and](e) [Provider shall name Customer a third party beneficiary under each ofProvider's agreements with any Subcontractor that relate to the Services; and](f) prior to the provision of Services by any Subcontractor, Provider shallobtain from each such proposed Subcontractor:(i)the identity of such Subcontractor and the location of all its datacenters, if any, that will be used in Processing any Customer Data,which information Provider shall promptly disclose to Customer inwriting; and(ii) a written confidentiality, restricted use, work-for-hire and intellectualproperty rights assignment agreement[ in form and substanceacceptable to Customer/substantially in the form of Exhibit[1/[OTHER NUMBER]]], giving Customer rights at least equal tothose set forth in Section 9 (Ownership), Section 10 (Confidentiality),8

Section 11 (Personal Information), Section 12 (Security) and Section13 (Redundancy, Data Backup and Disaster Recovery) and containingthe Subcontractor's acknowledgment of and agreement to theprovisions of Section 2.5 (Provider Personnel), a fully-executed copyof which agreement Provider shall promptly provide to Customer onCustomer's request].2.5 Provider Personnel. Provider shall:(a) [subject to the prior written approval of Customer, [not to be unreasonablywithheld or delayed]] appoint: (i) a Provider employee to serve as a primary contact withrespect to the Services who will have the authority to act on behalf of Provider in matterspertaining to the receipt and processing of Support Requests and the Support Services(the "Provider Service Manager"); (ii) a Provider employee to respond to Customer'sinquiries regarding the security of the Provider Systems who has sufficient knowledge ofthe security of the Provider Systems and the authority to act on behalf of Provider inmatters pertaining thereto ("Provider Security Officer"); and (iii) other Key Personnel,who will be suitably skilled, experienced and qualified to perform the Services;(b) maintain the same Provider Service Manager[,/and] Provider SecurityOfficer [ and other Key Personnel] throughout the Term and such additional period, ifany, as Provider is required to perform the Services, except for changes in such personneldue to: (i) Customer's request pursuant to Section 2.5(c); or (ii) the death, disability,resignation or termination of such personnel or other circumstances outside Provider'sreasonable control; and(c) upon the [reasonable] written request of Customer, promptly replace anyProvider Personnel.2.6 Management and Payment of Provider Personnel. Provider is solely responsiblefor the payment of Provider Personnel, including all fees, expenses and compensation to,by or on behalf of any Provider Personnel and, if applicable, the withholding of incometaxes and payment and withholding of social security and other payroll taxes,unemployment insurance, workers' compensation insurance payments and disabilitybenefits. Provider shall ensure that no Person who has been convicted of a felony or anymisdemeanor involving, in any way, theft, fraud, bribery or the violation of any securitieslaw provides any Services or has access to any Personal Information or other ConfidentialInformation of Customer. Provider shall be solely responsible for conducting allbackground checks necessary to comply with the foregoing.2.7 Time of the Essence. Provider acknowledges and agrees that time is of theessence with respect to its obligations under this Agreement and that prompt and timelyperformance of all such obligations, including all timetables and other requirements ofthis Agreement and each Service Order, is strictly required.9

2.8 Customer SaaS Manager. Customer shall appoint and, in its reasonablediscretion, replace, [a/two (2)] Customer employee[s] to serve as the primary contact[s]with respect to the Services who will have the authority to act on behalf of Customer inmatters pertaining to the Support Services, including the submission and processing ofSupport Requests (each, a "Customer SaaS Manager").3. License Grant and Restrictions.3.1 License Grant. Provider hereby grants to Customer [and its Affiliates],exercisable by and through [its/their] Authorized Users, a nonexclusive, royalty-free,irrevocable (except as provided herein) and, [solely] as set forth in this Agreement,transferable and sublicensable, right and license throughout the [world/Territory] duringthe Term and such additional periods, if any, as Provider is required to perform Servicesunder this Agreement or any Service Order for such Services, to:(a) access and use the Hosted Services, including in operation with othersoftware, hardware, systems, networks and services, for [Customer's [and its Affiliates'respective] business purposes/the Permitted Uses], including for Processing CustomerData;(b) generate, print, copy, upload, download, store and otherwise Process allGUI, audio, visual, digital and other output, displays and other content as may result fromany access to or use of the Services;(c) prepare, reproduce, print, download and use [as many copies/a reasonablenumber of copies/one (1) copy] of the Specifications and Documentation [as may benecessary or useful] for any [use/Permitted Uses] of the Services [permitted] under thisAgreement;(d) access and use the Services for all such non-production uses andapplications as may be necessary or useful for the effective use of the Hosted Services [aspermitted/for the Permitted Uses] hereunder, including for purposes of analysis,development, configuration, integration, testing, training, maintenance, support andrepair, which access and use will be without charge and not included for any purpose inany calculation of Customer's or its Authorized Users' use of the Services, including forpurposes of assessing any Fees or other consideration payable to Provider or determiningany excess use of the Hosted Services as described in Section 3.4[;/; and](e) [perform, display, execute, reproduce and modify (including to createimprovements and derivative works of), and distribute and otherwise make available toAuthorized Users, any Provider Materials solely to the extent necessary to access or usethe Services in accordance with the terms and conditions of this Agreement; and]10

(f) grant [sublicenses to Divested Businesses pursuant to Section 3.2 and] anyand all such sublicenses as may be required to authorize third parties to exercise[, forCustomer's benefit and on its behalf,] the license rights set forth in this Section 3.3.2 [Divested Businesses. In the event Customer divests one or more of its operatingdivisions or Affiliates, or Customer itself is divested, Customer may [in its sole discretionby written notice to Provider/subject to Provider's prior written consent, not to beunreasonably withheld or delayed], assign in part or grant sublicenses under thisAgreement to each Divested Business to allow each Divested Business to continue toaccess and use the Services and Documentation to the same extent as prior to thedivestiture for [the duration of the Term and such additional periods, if any, as Provider isrequired to perform the Services/a period not to exceed [NUMBER IN WORDS]([NUMBER)] [year[s]/months] from the effective date of the divestiture of such DivestedBusiness]. Following such divestiture, Customer shall have no obligation or liability forany amounts payable for a Divested Business's use of the Services or any otherperformance or nonperformance by any Divested Business, provided that such DivestedBusiness agrees in writing to be liable directly to Provider therefor. [Use of the Servicesby Customer and all Divested Businesses shall be aggregated for the purposes ofcalculating[ any required minimum use of the Services and] all volume-based rates anddiscounts due Customer and such Divested Businesses hereunder.]]3.3 License Restrictions. Customer shall not: (a) rent, lease, lend, sell, sublicense,assign, distribute, publish, transfer or otherwise make the Hosted Services available toany third party, except as expressly permitted by this Agreement or in any Service Order;or (b) use or authorize the use of the Services or Documentation in any manner or for anypurpose that is unlawful under applicable Law.3.4 Excess Use. If Customer's uses of the Hosted Services exceeds the volume ofuse permitted by the license then in effect under Section 3 and the applicable ServiceOrder (including as to the number of uses, users, machines or locations), Customer shallpay Provider the Fees attributable to the excess use in accordance with Section 8. [SuchFees will be Provider's sole and exclusive remedy for such excess use.]4. Service Preparation, Testing and Acceptance.4.1 Service Preparation. Promptly upon the parties' execution of a Service Order,Provider shall take all steps necessary to make the Services procured thereunder readyand available for Customer's use in accordance with the Service Order and thisAgreement, including any applicable milestone date or dates set forth in such ServiceOrder.4.2 Testing and Acceptance.11

(a) When Provider notifies Customer in writing that the Hosted Services areready for use in a production environment, Customer shall have [thirty (30)/[NUMBERIN WORDS] ([NUMBER])] days (or such other period as may be expressly set forth inthe applicable Service Order) from receipt of the notice to test the Hosted Services todetermine whether they comply in all material respects with the requirements of thisAgreement and the Specifications.(b) (Upon completion of Customer's testing, Customer shall notify Provider ofits acceptance ("Accept" or "Acceptance") or, if it has identified any noncompliancewith the Specifications, rejection ("Reject" or "Rejection") of the Hosted Services. IfCustomer Rejects the Hosted Services, Customer shall provide a written list of items thatmust be corrected. On receipt of Customer's notice, Provider shall promptly commence,at no additional cost or charge to Customer, all reasonable efforts to complete, as quicklyas possible and in any event within [twenty (20)/[NUMBER IN WORDS] ([NUMBER])]days (or such other period as may be agreed upon by the Parties in writing) from receiptof Customer's notice, such necessary corrections, repairs and modifications to the HostedServices to bring them into full compliance with the Specifications.(c) If any corrective measures are required under Section 4.2(b), upon itscompletion of all such measures, Provider shall notify Customer in writing and theprocess set forth in Section 4.2(a) and Section 4.2(b) shall be repeated; provided that ifCustomer determines that the Hosted Services, as revised, still do not comply in allmaterial respects with the Specifications, Customer may, in its sole discretion:(i)require the Provider to repeat the correction, repair and modificationprocess set forth in Section 4.2(b) at no additional cost or charge toCustomer; or(ii) terminate any and all of the relevant Service Order, this Agreementand any other Service Orders hereunder.(d) The parties shall repeat the foregoing procedure until Customer Accepts theHosted Services or elects to terminate the relevant Service Order as provided in Section4.2(c)(ii) above. If Customer so terminates the relevant Service Order, Provider shallrefund to Customer all sums previously paid to Provider under such Service Order withinten (10) Business Days of Customer's written notice of termination, and Customer will berelieved of all obligations thereunder.5. Service Availability and Service Availability Credits.5.1 Availability Requirement. Provider shall make the Hosted Services Available, asmeasured over the course of each calendar month during the Term and any additionalperiods during which Provider does or is required to perform any Hosted Services (eachsuch calendar month, a "Service Period"), at least [ninety-nine and ninety five one12

hundredths percent (99.95%)/[PERCENTAGE IN WORDS] ([NUMBER]%)] of thetime, excluding only the time the Hosted Services are not Available solely as a result ofone or more Exceptions (the "Availability Requirement"). "Available" means theHosted Services are available and operable for access and use by Customer and itsAuthorized Users over the Internet in [full/material] conformity with the Specifications."Availability" has a correlative meaning. The Hosted Services are not consideredAvailable in the event of [any/a material] performance degradation or inoperability of theHosted Services, in whole or in part.5.2 Exceptions. No period of Hosted Service degradation or inoperability will beincluded in calculating Availability to the extent that such downtime or degradation isdue to any of the following ("Exceptions"):(a)(b)Customer's misuse of the Hosted Services;failures of Customer's or its Authorized Users' internet connectivity;(c) internet or other network traffic problems other than problems arising in orfrom networks actually or required to be provided or controlled by Provider [or itsSubcontractor]; [or](d) Customer's or any of its Authorized Users' failure to meet any minimumhardware or software requirements set forth in the Specifications[; or(e) Scheduled Downtime as set forth in Section 5.3].5.3 Scheduled Downtime. Provider shall notify Customer at least twenty-four (24)hours in advance of all scheduled outages of the Hosted Services in whole or in part("Scheduled Downtime"). All such scheduled outages shall: (a) last no longer than one(1) hour; (b) be scheduled between the hours of ([NUMBER]) a.m. and ([NUMBER])a.m., [TIME ZONE/LOCATION] Time; and (c) occur no more frequently than[once/[OTHER FREQUENCY]] per [week/[OTHER PERIOD]]; provided that Providermay request for Customer's approval, extensions of Scheduled Downtime above one (1)hour and such approval by Customer may not be unreasonably withheld or delayed.5.4 Service Availability Reports. [Within [thirty (30)/[NUMBER IN WRITING]([NUMBER])] days after the end of each Service Period/In real time simultaneously withthe performance of the Hosted Services], Provider shall provide to Customer a reportdescribing the Availability and other performance of the Hosted Services during [that/thecurrent] calendar month and the [calendar/contract] year-to-date as compared to theAvailability Requirement and Specifications. The report shall be in electronic or suchother form as Customer may approve in writing and shall include, at a minimum: (a) theactual performance of the Hosted Services relative to the Availability Requirement andSpecifications; and (b) if Hosted Service performance has failed in any respect to meet or13

exceed the Availability Requirement or Specifications during the reporting period, adescription in sufficient detail to inform Customer of the cause of such failure and thecorrective actions the Provider has taken and will take to ensure that the AvailabilityRequirement and Specifications are fully met.5.5 Remedies for Service Availability Failures.(a) If the actual Availability of the Hosted Services is less than the AvailabilityRequirement for any Service Period, such failure shall constitute a Service Error forwhich Provider shall issue to Customer the corresponding service credits as set forth inSchedule [C/[OTHER LETTER]] ("Service Availability Credits") in accordance withSection 8.13.(b) If the actual Availability of the Hosted Services is less than the AvailabilityRequirement in any [two (2)/[NUMBER IN WORDS] ([NUMBER])] of [four(4)/[NUMBER IN WORDS] ([NUMBER])] consecutive Service Periods, then, inaddition to all other remedies available to Customer, Customer may terminate thisAgreement and/or [any/the applicable] Service Order on written notice to Provider withno liability, obligation or penalty to Customer by reason of such termination.(c) Any Service Availability Credits due under this Section 5.5 will be appliedas set forth in Schedule [C/[OTHER LETTER]].6. Support and Maintenance Services. Provider shall provide Hosted Servicemaintenance and support services (collectively, "Support Services") in accordance withthe provisions of this Section 6. The Support Services are included in the Services, andProvider shall not assess any additional Fees, costs or charges for such Support Services.6.1 Support Service Responsibilities. Provider shall:(a) correct all Service Errors in accordance with the Support Service LevelRequirements, including by providing defect repair, programming corrections andremedial programming;(b) provide unlimited telephone support during the hours of [8 a.m. to 6p.m./[OTHER time frame]] [TIME ZONE/LOCATION] on Business Days;(c) Provide online access to technical support bulletins and other user supportinformation and forums, to the full extent Provider makes such resources available to itsother customers; and(d) Respond to and Resolve Support Requests as specified in this Section 6.14

6.2 Service Monitoring and Management. Provider shall continuously monitor andmanage the Hosted Services to optimize Availability that meets or exceeds theAvailability Requirement. Such monitoring and management shall include:(a) proactively monitoring on a twenty-four (24) hour by seven (7) day basis allHosted Service functions, servers, firewall and other components of Hosted Servicesecurity;(b) if such monitoring identifies, or Provider otherwise becomes aware of, anycircumstance that is reasonably likely to threaten the Availability of the Hosted Service,taking all necessary and reasonable remedial measures to promptly eliminate such threatand ensure full Availability;(c) if Provider receives knowledge that the Hosted Service or any HostedService function or component is not Available (including by written notice fromCustomer pursuant to the procedures set forth herein or in the applicable Service Order):(i)confirming (or disconfirming) the outage by a direct check of theassociated facility or facilities;(ii) if Provider's facility check in accordance with clause (i) aboveconfirms a Hosted Service outage in whole or in part: (A) notifyingCustomer in writing pursuant to the procedures set forth herein or inthe applicable Service Order that an outage has occurred, providingsuch details as may be available, including a Provider trouble ticketnumber, if appropriate, and time of outage; and (B) working allproblems causing and caused by the outage until they are Resolved asCritical Service Errors in accordance with the Support RequestClassification set forth in Section 6.4, or, if determined to be aninternet provider problem, open a trouble ticket with the internetprovider; and(iii) notifying Customer that Provider has fully corrected the outage andany related problems, along with any pertinent findings or action takento close the trouble ticket.6.3 Service Maintenance. Provider shall continuously maintain the Hosted Servicesto optimize Availability that meets or exceeds the Availability Requirement. Suchmaintenance services shall include providing to Customer and its Authorized Users:(a) all updates, bug fixes, enhancements, new releases, new versions and otherimprovements to the Hosted Services, including the Service Software, that Providerprovides at no additional charge to its other similarly situated customers; and15

(b) all such services and repairs as are required to maintain the Hosted Servicesor are ancillary, necessary or otherwise related to Customer's or its Authorized Users'access to or use of the Hosted Services, so that the Hosted Services operate properly inaccordance with this Agreement and the Specifications.6.4 Support Service Level Requirements. Provider shall correct all Service Errorsand respond to and Resolve all Support Requests in accordance with the required timesand other terms and conditions set forth in this Section 6.4 ("Support Service LevelRequirements"), this Agreement and the applicable Service Order.(a) Support Requests. Customers shall classify its requests for Service Errorcorrections in accordance with the descriptions set forth in the chart below (each a"Support Request"). The Customer Service Manager shall notify Provider of SupportRequests by e-mail, telephone or such other means as the parties may hereafter agree toin writing.Support Request ClassificationDescription:Any Service Error Comprising orCausing any of the Following Events orEffectsCritical Service ErrorHigh Service ErrorIssue affecting entiresystem or single criticalproduction function;System down or operatingin materially degradedstate;Data integrity at risk;Material financial impact;Declared a Critical SupportRequest by the Customer;orWidespread accessinterruptions.Primary component failurethat materially impairs itsperformance; or16

Medium Service ErrorLow Service ErrorData entry or access ismaterially impaired on alimited basis.Hosted Service is operatingwith minor issues that canbe addressed with a workaround.Request for assistance,information, or servicesthat are routine in nature.(b) Response and Resolution Time Service Levels. Response and Resolutiontimes will be measured from the time Provider receives a Support Request until therespective times Provider has (i) responded to, in the case of response time and (ii)Resolved such Support Request, in the case of Resolution time. "Resolve" (including"Resolved", "Resolution" and correlative capitalized terms) means that, as to any ServiceError, Provider has provided Customer the corresponding Service Error correction andCustomer has confirmed such correction and its acceptance thereof. Provider shallrespond to and Resolve all Service Errors within the following times based on theseverity of the Service Error:SupportRequestClassificationService LevelMetric(RequiredResponseTime)Service LevelMetric(RequiredResolutionTime)Service LevelCredits(For Failureto Respond toany SupportRequestWithin theCorresponding ResponseTime)Service LevelCredits(For Failureto Resolve anySupportRequestWithin theCorresponding RequiredResolutionTime)Critical ServiceError[[NUMBERIN WORDS]([NUMBER])hours][NUMBERIN WORDS]([NUMBER])hours[PERCENTAGE IN WORDS]([NUMBER])% of the Feesfor the monthin which theinitial Service[PERCENTAGE IN WORDS]([NUMBER])% of the Feesfor the monthin which theinitial Service17

Level Failurebegins and[PERCENTAGE IN WORDS]([NUMBER])% of suchmonthly Feesfor eachadditional[hour/[OTHERPERIOD]] orportion thereofthat thecorrespondingService Error isnot respondedto within therequiredresponse time.Level Failurebegins and[PERCENTAGE IN WORDS]([NUMBER])% of suchmonthly Feesfor the firstadditional[hour/[OTHERPERIOD]] orportion thereofthat thecorrespondingService Errorremains un-Resolved,which amountshall thereafterdouble for eachadditional[NUMBER INWORDS]([NUMBER])hourincrement.High ServiceError[[NUMBERIN WORDS]([NUMBER])hours][NUMBER INWORDS]([NUMBER])hours[PERCENTAGE IN WORDS]([NUMBER])% of the Feesfor the monthin which theinitial ServiceLevel Failurebegins and[PERCENTAGE IN WORDS]([NUMBER])% of suchmonthly Feesfor eachadditional[PERCENTAGE IN WORDS]([NUMBER])% of the Feesfor the monthin which theinitial ServiceLevel Failurebegins and[PERCENTAGE IN WORDS]([NUMBER])% of suchmonthly Feesfor eachadditional18

[hour/[OTHERPERIOD]] orportion thereofthat thecorrespondingService Error isnot respondedto within therequiredresponse time.[hour/[OTHERPERIOD]] orportion thereofthat thecorrespondingService Errorremains un-Resolved.MediumService Error[[NUMBERIN WORDS]([NUMBER])days][[NUMBERIN WORDS]([NUMBER])days][PERCENTAGE IN WORDS]([NUMBER])% of the Feesfor the monthin which theinitial ServiceLevel Failurebegins and[PERCENTAGE IN WORDS]([NUMBER])% of suchmonthly Feesfor eachadditional[hour/[OTHERPERIOD]] orportion thereofthat thecorrespondingService Error isnot respondedto within therequiredresponse time.[PERCENTAGE IN WORDS]([NUMBER])% of the Feesfor the monthin which theinitial ServiceLevel Failurebegins and[PERCENTAGE IN WORDS]([NUMBER])% of suchmonthly Feesfor eachadditional[NUMBER INWORDS]([NUMBER])day thereafteror portionthereof that thecorrespondingService Errorremains un-Resolved.Low ServiceError[[NUMBERIN WORDS]([NUMBER])days][NUMBER INWORDS]([NUMBER])days[PERCENTAGE IN WORDS]([NUMBER])% of the Feesfor the month[PERCENTAGE IN WORDS]([NUMBER])% of the Feesfor the month19

in which theinitial ServiceLevel Failurebegins and[PERCENTAGE IN WORDS]([NUMBER])% of suchmonthly Feesfor eachadditional[hour/[OTHERPERIOD]] orportion thereofthat thecorrespondingService Error isnot respondedto within therequiredresponse time.in which theinitial ServiceLevel Failurebegins and[PERCENTAGE IN WORDS]([NUMBER])% of suchmonthly Feesfor eachadditional[NUMBER INWORDS]([NUMBER])day thereafteror portionthereof that thecorrespondingService Errorremains un-Resolved.(c) Escalation. With respect to any Critical Service Error Support Request,until such Support Request is Resolved, Provider shall escalate that Support Requestwithin sixty (60) minutes of the receipt of such Support Request by the appropriateProvider support personnel [ hereafter identified to Customer in writing/designated byProvider in Schedule [D/[OTHER LETTER]])], including, as applicable, the ProviderService Manager and Provider's management or engineering personnel, as appropriate,each of whom shall be Key Personnel.6.5 Support Service Level Credits. Failure to achieve any of the Support ServiceLevel Requirements will constitute a Service Level Failure for which Provider shall issueto Customer the corresponding service credits set forth in Section 6.4(b) ("Service LevelCredits") in accordance with Section 8.13.6.6 Corrective Action Plan. If two or more Critical Service Errors occur in any[thirty (30)/[NUMBER IN WORDS] ([NUMBER])] day period during (a) the Term or(b) any additional periods during which Provider does or is required to perform anyHosted Services, Provider shall promptly investigate the root causes of these ServiceErrors and provide to Customer within five (5) Business Days of its receipt of notice ofthe second such Support Request an analysis of such root causes and a proposed writtencorrective action plan for Customer's review, comment and approval, which, subject to20

and upon Customer's written approval, shall be a part of, and by this reference isincorporated in, this Agreement as the parties' corrective action plan (the "CorrectiveAction Plan"). The Corrective Action Plan shall include, at a minimum: (a) Provider'scommitment to Customer to devote the appropriate time, skilled personnel, systemssupport and equipment and other resources necessary to Resolve and prevent any furtheroccurrences of the Service Errors giving rise to such Support Requests; (b) a strategy fordeveloping any programming, software updates, fixes, patches, etc. necessary to remedy,and prevent any further occurrences of, such Service Errors; and (c) time frames forimplementing the Corrective Action Plan. There will be no additional charge forProvider's preparation or implementation of the Corrective Action Plan in the time framesand manner set forth therein.7. Term and Termination.7.1 Term. The initial term of this Agreement commences as of the Effective Dateand will continue in effect until [NUMBER IN WORDS] [(NUMBER)] year[s] fromsuch date unless and until terminated as provided under this Agreement (the "InitialTerm").7.2 Renewal. Unless this Agreement is terminated earlier pursuant to its provisions,[Customer may renew this Agreement/this Agreement shall automatically renew] foradditional successive [NUMBER IN WORDS] [(NUMBER)] [month/year] terms (each a"Renewal Term")[, unless Customer provides/by providing] written notice to Provider ofits intent[ not] to renew at least [NUMBER IN WORDS] [(NUMBER)] days prior to theexpiration of the then pending term (the Initial Term together with any Renewal Terms,collectively, the "Term").7.3 Termination for Cause. In addition to any right of termination set forthelsewhere in this Agreement:(a) either party may terminate this Agreement or any Service Order, by writtennotice to the other party effective as of the date specified in such notice, if the other party[materially] breaches this Agreement or such Service Order and such breach: (i) cannotbe cured; or (ii) being capable of cure, remains uncured [NUMBER IN WORDS]([NUMBER]) days after the breaching party receives written notice thereof; and(b) Customer may terminate any and all of this Agreement or any ServiceOrder, effective immediately, by written notice to Provider if Provider: (i) becomesinsolvent or admits inability to pay its debts generally as they become due; (ii) becomessubject, voluntarily or involuntarily, to any proceeding under any domestic or foreignbankruptcy or insolvency law, which is not fully stayed within [seven/[OTHERNUMBER]] [([7/[OTHER NUMBER]])] Business Days or is not dismissed or vacatedwithin[ forty-five/[OTHER NUMBER]] [(45/[OTHER NUMBER])] days after filing;(iii) is dissolved or liquidated or takes any corporate action for such purpose[ with no21

permitted successor or assignee having assumed and given Customer adequate writtenassurance of its continued full performance of this Agreement]; (iv) makes or seeks tomake a general assignment for the benefit of creditors; or (v) has or is made subject to theappointment of a receiver, trustee, custodian or similar agent by order of any court ofcompetent jurisdiction to take charge of or sell any material portion of its property orbusiness.7.4 Termination for Convenience. At any time without cause and without causingany breach or incurring any additional obligation, liability or penalty, Customer mayterminate this Agreement and, except as may otherwise expressly be set forth in therein,any Service Order, in each case by providing at least [NUMBER IN WORDS]([NUMBER]) days' prior written notice to Provider.7.5 Effect of Termination; Data Retention. The expiration or termination of thisAgreement will not effectuate a termination of any Service Order then in effect and nototherwise expressly terminated, and the terms and conditions of this Agreement willcontinue in effect with respect to any such Service Order until its expiration ortermination as set forth herein. In addition, unless otherwise expressly provided in thisAgreement or the applicable Service Order:(a) upon and after the termination or expiration of this Agreement or one ormore Service Orders for any or no reason:(i)subject to the continuing rights, licenses and obligations of eitherparty under this Agreement, including this Section 7.5, or any ServiceOrder, all licenses granted hereunder will immediately terminate andthe respective parties shall cease all activities concerning, including alluse of, in the case of Customer, the expired or terminated HostedServices [and related Provider Materials,] and, in the case of Provider,the Customer Data;(ii) Customer shall pay to Provider, subject to[ its right of set-off underSection 8.14 and] any Service Availability Credits and Service LevelCredits accrued, respectively, under Section 5.5 and Section 6.4, allundisputed charges and amounts due and payable to Provider, if any,for Services actually performed under the terminated or expiredService Order or Service Orders;(iii) Provider shall repay, on a pro rata basis, all fees, expenses and otheramounts paid in advance for any Services that Provider has notperformed as of the effective date of such expiration or termination, asapplicable, with respect to Services required to be performed under theterminated or expired Service Order or Service Orders;22

(iv) Provider shall, at Customer's option and upon its written request: (A)promptly return or[, subject to Provider's obligations under Section7.5(a)(v) and Section 7.5(a)(vi),] destroy and erase from all systems itdirectly or indirectly uses or controls, [i] all originals and copies of alldocuments, materials and other embodiments and expressions in anyform or medium that contain, reflect, incorporate or are based onCustomer's Confidential Information or [ii] solely such specificdatabases or other collections or articles of Customer's ConfidentialInformation as Customer may request, and (B) provide a [notarized]written statement to Customer certifying that it has complied with therequirements of this Section 7.5(a)(iv);(v)[if on or before the effective date of such expiration or terminationProvider does not receive any written request or instruction fromCustomer to destroy, erase or return any Customer Data or otherConfidential Information of Customer, ]Provider shall notify Customerin writing within [three (3)/[NUMBER IN WORDS] ([NUMBER])]Business Days after such effective date of expiration or termination,and in no event fewer than[ thirty (30)/ [NUMBER IN WORDS]([NUMBER])] days before erasing, destroying or otherwise disposingof any such Confidential Information of Customer, of such intendederasure, destruction or other disposition and the pending date thereof,and request Customer's written instruction with respect to the return orother disposition of such Confidential Information in accordance withthis Section 7.5; and(vi) at Customer's option and upon its written request, Provider shall: (A)continue to retain the Customer Data, or solely such specific databasesor other collections or articles of Customer Data as Customer mayrequest, as though this Agreement and all Service Orders were still inforce, for a period to be agreed to by the parties in writing, but that inno event will be shorter than [forty five (45)/[NUMBER IN WORDS]([NUMBER])] days or longer than [one hundred eighty(180)/[NUMBER IN WORDS] ([NUMBER])] days after the effectivedate of such expiration or termination, as applicable[, provided thatCustomer pays in full all undisputed Fees due Provider as of theeffective date of such expiration or termination and pays monthly datastorage fees to Provider for its retention of such Customer Datapursuant to Provider's standard rates for such data storage in effect atthe time, or if such standard rates are not in effect, such reasonableprevailing industry rates as may be agreed to by the parties in writing];and (B) [at Customer's reasonable expense,] immediately upon theconclusion of such Customer Data retention period, return such23

Customer Data to the information technology infrastructure, includingthe computers, software, databases, electronic systems (includingdatabase management systems) and networks, of Customer or any ofits designees (collectively, "Customer Systems"), taking all stepsrequired or reasonably requested to make an orderly transition of theHosted Services to the Customer Systems [and to assist Customer andany of Customer's designees in migrating such Customer Data to theCustomer Systems in both Provider's data format and a platformagnosticformat].(b) without limiting the generality of Section 7.5(a), upon the termination orexpiration of this Agreement and all Service Orders hereunder, [Provider/the ReceivingParty] shall, at [ Customer's/the Disclosing Party's] option and upon its written request: (i)promptly return or[, subject to Provider's obligations under Section 7.5(a)(iv), Section7.5(a)(v) and Section 7.5(a)(vi),] destroy and erase from all systems it directly orindirectly uses or controls, all originals and copies of all documents, materials and otherembodiments and expressions in any form or medium that contain, reflect, incorporate orare based on the [Customer's/Disclosing Party's] Confidential Information and; and (ii)provide a[ notarized] written statement to the Disclosing Party certifying that it hascomplied with the requirements of this Section 7.5(b);(c)the contrary:notwithstanding any provisions of this Agreement or any Service Order to(i)the [Provider/Receiving Party] shall not be required to[, or, in the caseof Provider, to cause its Subcontractors hereunder, to] return, destroyor erase any[ Customer/Disclosing Party] Confidential Information tothe extent that any applicable Law prevents it from doing so, in whichcase the [Provider/Receiving Party] shall retain, in its then currentstate, all such Confidential Information then within its [or anyProvider Personnel's] right of control or possession in accordance withthe confidentiality, security and other requirements of this Agreementand perform its obligations under this Section 7.5 as soon as such Lawno longer prevents it from doing so; and(ii) upon Customer's termination of this Agreement or any Service Orderfor breach pursuant to Section 7.3(a), Customer shall have the rightand option to continue to access and use the Services under eachapplicable Service Order, in whole and in part, for a period not toexceed [one hundred and eighty (180)/[NUMBER IN WORDS]([NUMBER])] days from the effective date of such terminationpursuant to the terms and conditions of this Agreement and the eachapplicable Service Order hereunder and [for the/at a reduced rate of24

[PERCENTAGE IN WORDS] ([NUMBER]%) off the] applicableFees set forth in each such Service Order.7.6 Survival. The rights, obligations and conditions set forth in this Section 7.6 andSection 1 (Definitions), Section 7.5 (Effect of Termination; Data Retention), Section 9(Ownership), Section 10 (Confidentiality), Section 11 (Personal Information), Section 12(Security), Section 14.1 (Indemnification), Section 15 (Limitations of Liability), Section16 (Representations and Warranties)[, Section 17 (Insurance)] and Section 20 (Effect ofProvider Bankruptcy) and Section 21 (General Provisions), and any right, obligation orcondition that, by its express terms or nature and context is intended to survive thetermination or expiration of this Agreement, shall survive any such termination orexpiration hereof.8. Fees and Expenses.8.1 Fees. Subject to the terms and conditions of this Agreement and the applicableService Order, including the provisions of this Section 8, Customer shall pay the fees setforth in the applicable Service Order, which shall be determined and invoiced by Providerin accordance with the rates, pricing and discounts set forth in Schedule [B/[OTHERLETTER]], subject to such increases and adjustments as may be permitted pursuant toSection 8.2 ("Fees").8.2 Fees During Renewal Terms. Provider's Fees are fixed during the Initial Term.Provider may increase Fees for any Renewal Term by providing written notice toCustomer at least sixty (60) calendar days prior to the commencement of such RenewalTerm. No increase in Fees in effect for any twelve (12) month period in any RenewalTerm shall exceed[ the lesser of]:(a) [four/[NUMBER IN WORDS]] percent ([4/[NUMBER]]%) of the Feeseffective during the immediately preceding twelve (12) month period of the Initial Termor Renewal Term[./; or](b) [the amount equal to[ eighty percent (80%) of] the percentage by which the[then most-recently published/[MONTH]] [CONSUMER PRICE INDEX] (CPI) exceedsthe CPI published in the same month of the preceding calendar year, it being understoodand agreed that, if the CPI is no longer published, Provider and Customer will negotiate,in good faith to select a new index that best reflects and accounts for cost changesrelevant to Provider's business].No increase in Fees is effective unless made in compliance with theprovisions of this Section 8.2.8.3 Responsibility for Costs. [Except for any Reimbursable Expenses specified in aService Order or otherwise pre-authorized by Customer in writing, and subject to Section8.4, ]Provider shall be responsible for all costs and expenses incurred in or incidental to25

the performance of Services, including all costs of any materials supplied by Provider, allfees, fines, licenses, bonds, or taxes required of or imposed against Provider, and all otherof Provider's costs of doing business.8.4 [Reimbursable Expenses. Customer shall reimburse Provider, in accordance withCustomer's standard expense reimbursement policy in effect from time to time, a currentcopy of which is attached as Exhibit [2/[OTHER NUMBER]], for direct, documented,out-of-pocket [travel and lodging] expenses ("Reimbursable Expenses") incurred byProvider in performing the Services, subject to the following:(a) [Customer shall only be obligated to reimburse Provider for travel approvedin advance by Customer.](b) All travel arrangements shall conform to Customer's standard travel policyapplicable to its employees in effect from time to time, a current copy of which is setforth in Exhibit [2/[OTHER NUMBER]].(c) [Customer shall have the right to require that all travel arrangements bemade through Customer's in-house or contracted outside travel agent.](d) [Any individual expense item in excess of [DOLLAR AMOUNT INWORDS] ($ [NUMBER]) shall require Customer's prior written approval.]]In no event will any other expenses or charges incurred or payable by Provider(including for any licenses, rights, materials, goods or services) be a ReimbursableExpense, except to the extent, if any, expressly otherwise provided in an applicableService Order.8.5 Taxes. All Fees and amounts set forth this Agreement or any Service Order are[exclusive/inclusive] of taxes. [Customer/Provider] shall be solely responsible for allsales, service, value-added, use, excise, consumption and any other taxes, duties andcharges of any kind, if any, imposed by any [federal, state or local] governmental entityon any amounts payable by Customer under this Agreement or any Service Order, otherthan any taxes imposed on, or with respect to, Provider's income, revenues, grossreceipts, personnel, real or personal property or other assets. The parties shall reasonablycooperate to more accurately determine each party's tax liability and to minimize suchliability to the extent legally permissible.8.6 Invoices. Provider shall invoice Customer for all Fees [and ReimbursableExpenses] monthly in arrears in [both hard copy and] electronic format, via such deliverymeans and to such address as are [set forth in the applicable Service Order or otherwise]specified by Customer in writing from time to time. If more than one Service Order is ineffect, Provider shall provide an aggregate invoice for all amounts invoiced, together withseparate invoices for each Service Order. Each separate invoice shall: (a) clearly identify26

the Service Order to which it relates, in such manner as is required by Customer; (b) listeach Fee item [and/,] Service Credit[ and Reimbursable Expense] separately; (c) includesufficient detail for each line item to enable Customer to verify the calculation thereof;(d) [for Fees determined on a time and materials basis, report details of time taken toperform Services, and such other information as Customer requires, on a per-individualbasis;] [[(d)/(e)] be accompanied by all [original] supporting documentation requiredhereunder for Reimbursable Expenses]; and [(d)/(e)/(f)] include such other information asmay be required by Customer as set forth in the applicable Service Order.8.7 Payment Terms.(a) Customer shall pay [all properly invoiced] amounts payable and duehereunder within [thirty (30)/[OTHER NUMBER]] days after Customer's receipt ofProvider's proper invoice therefor, except that Customer may withhold from any paymentany charge or amount disputed in good faith by Customer pending resolution of suchdispute. Pending the resolution of such payment dispute, Provider shall continueperforming its obligations in accordance with this Agreement. No charge or amount shallbe payable for any Fees for Services until at least [NUMBER IN WORDS] ([NUMBER])days after the date of Customer's Acceptance of such Services.(b) [Provider shall give Customer a discount of [two percent(2%)/[PERCENTAGE IN WORDS] ([NUMBER]%)] of Fees [(but not ReimbursableExpenses)] paid within ten (10) days following the due date determined pursuant toSection 8.7(a).](c) All payments hereunder shall be in US dollars and made[, atCustomer's/Provider's] option, by check or wire transfer. Payments shall be made to theaddress or account specified in Schedule [B/[OTHER LETTER]] or such other address oraccount as is specified by Provider in writing from time to time, provided that Providershall give Customer at least [NUMBER IN WORDS] ([NUMBER]) days' prior notice ofany account, address or other change in payment instructions. Customer will not be liablefor any late or misdirected payment caused by Provider's failure to provide timely noticeof any such change.8.8 [Most Favored Pricing. All Fees and other charges under this Agreement shallbe the lowest fees, prices and rates contemporaneously charged by Provider to any of itscustomers for similar volumes of services of the same or comparable type and scope. If atany time Provider charges any comparable customer a lower fee, rate or price for similarvolumes of such comparable services than the corresponding Fees or other amountscharged hereunder, Provider shall immediately apply such lower rate or amount, asapplicable, for all comparable Services provided to Customer. Such lower rates oramounts, as applicable, shall apply retroactively to the date on which Provider begancharging them to such comparable customer.]27

8.9 [Customer Audits of Provider. During the Term [and for [NUMBER] year[s]after], Provider shall maintain complete and accurate books and records regarding itsbusiness operations relevant to the calculation of Fees[, Reimbursable Expenses] and anyother information relevant to Provider's compliance with this Section 8. During the Term[and for [NUMBER] year[s] after], upon Customer's request, Provider shall make suchbooks and records, and appropriate personnel, available during normal business hours forinspection and audit by Customer or[ an independent accountant[ that is reasonablyacceptable to Provider]/its authorized representative], provided that Customer shall: (a)provide Provider with [reasonable/at least [NUMBER IN WORDS] ([NUMBER]) days]prior notice of any audit; (b) undertake an audit no more than once per calendar[year/quarter/month][, except for good cause shown]; and (c) conduct or cause to beconducted such audit in a manner designed to minimize disruption of Provider's normalbusiness operations.Customer may take copies and abstracts of materials audited[, provided that suchmaterial is deemed Confidential Information of Provider]. Customer will pay the cost ofsuch audits unless an audit reveals an overbilling or over-reporting of [five percent(5%)/[PERCENTAGE IN WORDS] ([NUMBER] %)] or more, in which case Providershall reimburse Customer for the[ reasonable] cost of the audit. Provider shallimmediately upon written notice from Customer pay Customer the amount of anyoverpayment revealed by the audit[, together with any reimbursement payable pursuant tothe preceding sentence].]8.10 All Fees Stated. Except as expressly provided in this Section 8, Customer has noobligation or liability to pay or reimburse any fees, charges or other amounts [for theServices to be provided] under this Agreement.8.11 Payment Does Not Imply Acceptance. The making of any payment or paymentsby Customer, or the receipt thereof by Provider, will in no way affect the responsibility ofProvider to perform the Services in accordance with this Agreement, and will not implyCustomer's Acceptance of any Services or the waiver of any warranties or requirementsof this Agreement, including any right to Service Credits.8.12 [Withhold Remedy. In addition and cumulative to all other remedies in law, atequity and under this Agreement, if Provider is in material default of its performance orother obligations under this Agreement or any Service Order and fails to cure the defaultwithin [fifteen (15)/[NUMBER IN WORDS] [NUMBER]] days after receipt ofCustomer's written notice of default, Customer may, without waiving any other rightsunder this Agreement, elect to withhold from the payments due to Provider under thisAgreement during the period beginning with the sixteenth (16th) day after Provider'sreceipt of such notice of default, and ending on the date that the default has been cured tothe reasonable satisfaction of Customer, an amount that[, in Customer's reasonablejudgment,] is in proportion to the magnitude of the default or the Service that Provider is28

not providing. Upon Provider's cure of the default, Customer will cause the withheldpayments to be paid to Provider, without interest. Upon a final and binding legaldetermination that Customer has withheld any payment in bad faith [or without anobjectively reasonable basis], such payment shall promptly be paid to Provider, plusinterest at the maximum legal rate.]8.13 Availability and Support Service Level Credits. The parties acknowledge andagree that each of the Service Availability Credits and Service Level Credits assessedpursuant to Section 5 and Section 6, respectively: (a) is a reasonable estimate of andcompensation for the anticipated or actual harm to Customer that may arise from thecorresponding Service Error or Service Level Failure, which would be impossible or verydifficult to accurately estimate [as of the Effective Date]; and (b) may[, at Customer'soption,] be credited or set off against any Fees or other charges payable to Provider underthis Agreement [or be payable to Customer upon demand]. No Service AvailabilityCredits, Service Level Credits, or combination thereof, for any Service Period shallexceed the total amount of Fees that would be payable for that Service Period if theServices were fully provided in accordance with this Agreement and the Specifications.8.14 [Right of Set-off. Without prejudice to any other right or remedy it may have,Customer reserves the right to set off at any time any amount then due and owing to it byProvider against any amount payable by Customer to Provider under this Agreement [orotherwise].]8.15 Support Not to be Withheld or Delayed. Provider shall not withhold or delay anyHosted Services or Support Services or fail to perform any other Services or obligationshereunder by reason of: (a) Customer's good faith withholding of any payment or amountin accordance with this Section 8; or (b) any dispute whatsoever between the parties,including any payment or other dispute arising under or concerning this Agreement orany other agreement between the parties.9. Ownership.9.1 Ownership of Customer Data. Customer may, but is not required to, provideCustomer Data to Provider in connection with this Agreement. As between Customer andProvider, Customer is and will remain the sole and exclusive owner of all right, title andinterest in and to all Customer Data, including all Intellectual Property Rights relatingthereto, subject only to the limited license granted in Section 9.2.9.2 Limited License to Use Customer Data. Subject to the terms and conditions ofthis Agreement, Customer[ and each of its Affiliates licensed hereunder] hereby grantsProvider a limited, royalty-free, fully-paid up, non-exclusive[, transferable/nontransferableand] [ sublicensable/non-sublicensable] license to Process the Customer Datain the United States strictly as instructed by Customer or an Authorized User and solelyas necessary to provide the Services for Customer's [and such Affiliates'] benefit as29

provided in this Agreement for so long as Customer or any Authorized User uploads orstores such Customer Data for Processing by or on behalf of the Provider on the ProviderSystems.9.3 [Ownership of Provider Materials. As between Customer and Provider, Provideris and will remain the sole and exclusive owner of all right, title and interest in and to theProvider Materials, including all Intellectual Property Rights relating thereto, subject onlyto the license granted to Customer in Section 3.1(e).]9.4 No Implied Rights. Except for the limited license expressly provided [(a)] in thisSection 9, nothing contained in this Agreement shall be construed as granting Provider orany third party any right, title, or interest in or to any Customer Data [or (b) in Section3.1(e) or this Section 9, nothing contained in this Agreement shall be construed asgranting Customer or any third party any right, title, or interest in or to any ProviderMaterials, in each case] whether by implication, estoppel or otherwise.10. Confidentiality.10.1 Confidential Information. "Confidential Information" means any informationthat is treated as confidential by either party ("Disclosing Party"), including trade secrets,technology, information pertaining to business operations and strategies, and informationpertaining to customers, pricing and marketing, regardless of whether such informationwas intentionally or unintentionally disclosed or marked as "confidential" or"proprietary" by the Disclosing Party or otherwise obtained (including by visualinspection) by the other party or any of its Representatives ("Receiving Party"). Allnotes, analyses, summaries, interpretations and other embodiments, expressions andderivative works of, containing, based on, derived from or otherwise reflecting anyConfidential Information, in whole or in part, and prepared by any Person, shallthemselves constitute the Confidential Information of the Disclosing Party on whoseConfidential Information they are based. Without limiting the foregoing, (a) all CustomerData (including all Personal Information) is and will remain the Confidential Informationof Customer [and] (b) the Service Software, Specifications and Documentation are andwill remain the Confidential Information of Provider [and (c) the terms and existence ofthis Agreement are and will remain the Confidential Information of each of the parties].10.2 Exclusions. Confidential Information does not include any information ormaterial that[ the Receiving Party can demonstrate by written or other documentaryrecords]: (a) is or becomes generally known other than through a breach of thisAgreement or another confidentiality or non-disclosure agreement, obligation or duty, orother wrongful act, of or on behalf of the Receiving Party or any of its Representatives;(b) was already rightfully known to the Receiving Party, without restriction on use ordisclosure, prior to being directly or indirectly disclosed by or on behalf of the DisclosingParty, or obtained by or on behalf of the Receiving Party; (c) has been or hereafter isrightfully received by or on behalf of the Receiving Party from a third party without30

estriction on use or disclosure and without breach of any agreement[ or obligation orduty of confidentiality] to the Disclosing Party or any other Person; or (d) was or isindependently developed by the Receiving Party without access [or reference] to [or useof] any Confidential Information of the Disclosing Party.10.3 Customer Data Exception. Notwithstanding the provisions of Section 10.2 orany other provisions of this Agreement, none of the exclusions set forth in Section 10.2apply to any Customer Data, whether provided by or on behalf of Customer to Provideror the Services for Processing or generated or derived from such Processing andregardless of whether such Customer Data may be publicly available or otherwise qualifyfor exclusion under any of the other provisions of Section 10.2. The preceding sentencedoes not prohibit or limit Provider from any use or disclosure of any information that maybe the same as any Customer Data but which Provider can demonstrate by documentaryevidence was: (a) obtained by Provider without access to, reference to or use of anyCustomer Data; and (b) at all times maintained separately from and not in any waycombined, commingled, compared, benchmarked or in any way associated with anyCustomer Data.10.4 Confidentiality and Use. Each Receiving Party recognizes and agrees that theConfidential Information of the Disclosing Party is critical to the Disclosing Party'sbusiness and that neither party would enter into this Agreement without assurance thatsuch information and its value will be protected as provided in this Section 10 andelsewhere in this Agreement. The Receiving Party shall use, and ensure that itsRepresentatives use, reasonable care that is at least as protective as the efforts it uses withrespect to its own confidential information[, including the maintenance and enforcementof rules and policies,] to safeguard the Disclosing Party's Confidential Information fromuse or disclosure other than as permitted under this Agreement. Without limiting theforegoing, the Receiving Party shall maintain in effect and enforce rules and policies toprotect against access to or use or disclosure of Confidential Information other than inaccordance with this Agreement. As a condition to being provided with such ConfidentialInformation, the Receiving Party agrees that[, during the Term [and for [NUMBER INWORDS] [(NUMBER)] years thereafter],] it will(a) not use or permit the use of the Disclosing Party's Confidential Informationother than as strictly necessary to exercise its rights or perform its obligations under thisAgreement;(b) not use or permit the use of any of the Disclosing Party's ConfidentialInformation, directly or indirectly, in any manner to the detriment of the Disclosing Partyor to obtain any competitive advantage over the Disclosing Party;(c) maintain the Disclosing Party's Confidential Information in strictconfidence and, subject to Section 10.5, not disclose or make available the DisclosingParty's Confidential Information to any Person without the Disclosing Party's prior31

written consent, provided, however, that the Receiving Party may disclose theConfidential Information to its Representatives who: (i) have a "need to know" forpurposes of any performance, or exercise of any rights with respect to such ConfidentialInformation, under this Agreement; (ii) have been informed in writing of the highlyconfidential nature of the Confidential Information and the limitations, procedures andobligations that apply to the access, use and disclosure of Confidential Information underthis Section 10; and (iii) are themselves bound by written restricted use andnondisclosure agreements or obligations at least as restrictive as those set forth in thisAgreement, provided, further, that the Receiving Party shall be responsible for ensuringits Representatives' compliance with, and shall be liable for any breach by itsRepresentatives, of this Section 10[./; and](d) [notify the Disclosing Party in writing [promptly/immediately/within[NUMBER IN WORDS] ([NUMBER]) Business Days] of any unauthorized disclosureor use of the Disclosing Party's Confidential Information and cooperate with theDisclosing Party to protect the confidentiality and ownership of all Intellectual PropertyRights, privacy rights and other rights therein.]10.5 Compelled Disclosures. If the Receiving Party becomes compelled by applicableLaw to disclose any Confidential Information, the Receiving Party shall[, to the extentpermissible by applicable Law]:(a) as soon as possible after becoming aware of such requirement and prior todisclosing Confidential Information pursuant thereto, notify the Disclosing Party inwriting of such required disclosure so that the Disclosing Party may seek a protectiveorder or other appropriate remedy or waive its rights under this Section 10;(b) [, at the Disclosing Party's expense,] use reasonable efforts not to releasesuch Confidential Information pending the outcome of any measures taken by theDisclosing Party to contest, oppose or limit such compelled disclosure or any furtherdisclosure or use of Confidential Information that may result therefrom;(c) cooperate with and provide assistance to the Disclosing Party in connectionwith any measures taken by the Disclosing Party as described in Section 10.4(d) and, if aprotective order or other remedy is not obtained or the Disclosing Party waivescompliance with this Section 10, use reasonable efforts[, at the Disclosing Party'sexpense,] to obtain assurance that the Confidential Information will be accordedconfidential treatment; and(d) disclose only the portion of Confidential Information that it is legallyrequired to produce to the minimum extent required by applicable Law.32

No such compelled disclosure by the Receiving Party will otherwise affect theReceiving Party's obligations hereunder with respect to the Confidential Information sodisclosed.10.6 Return or Destruction of Customer's Confidential Information. [Upon/Within[one/[OTHER NUMBER] Business Days after] Customer's written request at any timeand subject to any contrary obligations under applicable Law, Provider shall atCustomer's direction [promptly] return or destroy and erase from all systems it directly orindirectly uses or controls (a) all originals and copies of all documents, materials andother embodiments and expressions in any form or medium that contain, reflect,incorporate or are based on Customer's Confidential Information, in whole or in part, or(b) solely such specific Customer Data, databases or other collections or articles ofCustomer's Confidential Information as Customer may request[, and provide a [notarized]written statement to Customer certifying that it has complied with the requirements ofthis Section 10.6].11. Personal Information.11.1 Definition and Permitted Use.(a) For purposes of this Agreement, "Personal Information" means anyinformation that any of the Provider Personnel collects, receives or obtains, from or onbehalf of Customer or any of its Authorized Users that does or can identify a specificindividual or by or from which a specific individual may be identified, contacted orlocated, such as the individual's name, address, social security number, etc., and any otherinformation relating to an identified or identifiable individual. Personal Informationincludes such information of or pertaining to Customer's personnel, directors, officers,agents, suppliers, contractors, investors or customers and all "nonpublic personalinformation," as defined under the Gramm-Leach-Bliley Act (15 U.S.C. § 6801 et seq.),"protected health information" as defined under the Health and Insurance Portability andAccountability Act of 1996 (42 U.S.C. § 1320d), and "Personal Data" as that term isdefined in EU Data Protection Directive (Directive 95/46/EEC) on the protection ofindividuals with regard to processing of personal data and the free movement of suchdata, and all rules and regulations issued under any of the foregoing.(b) Provider shall not cause or permit any Personal Information to be Processedin any manner or for any purpose other than the performance of the Services incompliance with the restrictions set forth in this Agreement and all applicable Laws.11.2 Ownership and Treatment of Personal Information. As between Customer andProvider, Customer is and shall remain the sole and exclusive owner of all right, title andinterest in and to Personal Information. Without limiting any other representation,warranty or obligation of Provider under this Agreement, Provider represents, warrants33

and covenants[, and shall obtain the binding written representations, warranties andcovenants of all Provider Personnel involved in any aspect of the Services] that:(a) during the Term and thereafter in perpetuity,[Provider/it] will not Process orotherwise undertake or refrain from any act with respect to any Personal Data in anymanner, including any actual or attempted Processing thereof, except for the sole purposeof performing the Services and in compliance with: (i) the express terms and conditionsof this Agreement or as Customer may hereafter expressly direct in advance in writing;(ii) Customer's then current privacy and security policies (available at www.[DOMAINNAME].com); and (iii) all applicable Laws (including all then current and applicableLaws relating to spamming, privacy and consumer and data protection);(b) except as Customer or an Authorized User may submit to ProviderPersonnel for purposes of Customer's or such Authorized User's use of the Services, or asCustomer may hereafter expressly direct in advance in writing,[Provider/it] will not underor in connection with this Agreement or any transaction or arrangement hereunder collectany Personal Data from or in connection with Customer's or any Authorized User's accessto or use of the Services, or through any access Provider may have to the CustomerSystems, including through any cookies, applets, beacons or other data mining methodsor technologies;(c) [Provider/it] shall promptly notify Customer in writing when Providerbecomes aware of any unauthorized access, use or other act respecting PersonalInformation or if Provider becomes the subject of any government, regulatory or otherinvestigation or proceeding relating to its data privacy, security or handling practices;12. Security.12.1 Protection of Customer's Confidential Information. Throughout the Term and atall times in connection with its actual or required performance of the Services hereunder,Provider shall:(a) maintain and enforce an information security program including safety andphysical and technical security policies and procedures with respect to its Processing ofCustomer's Confidential Information that [comply with/meet or exceed] the requirementsof the [Customer's] data security policies as set forth in Schedule [E/[OTHER LETTER]](Data Security Requirements) and, to the extent such practices and standards areconsistent with and not less protective than the foregoing requirements, are at least equalto applicable [best] industry practices and standards;(b) provide technical and organizational safeguards against accidental,unlawful or unauthorized access to or use, destruction, loss, alteration, disclosure,transfer, commingling or Processing of such information that ensure a level of securityappropriate to the risks presented by the Processing of Customer's Confidential34

Information and the nature of such Confidential Information, consistent with [best]industry practice and standards.(c)take all reasonable measures to:(i)secure and defend all locations, equipment, systems and othermaterials and facilities employed in connection with the Servicesagainst "hackers" and others who may seek, without authorization, todisrupt, damage, modify, access or otherwise use Provider Systems orthe information found therein;(ii) prevent (A) Customer and its Authorized Users from having access tothe data of other customers or such other customer's users of theServices; (B) Customer's Confidential Information from beingcommingled with or contaminated by the data of other customers ortheir users of the Services; and (C) unauthorized access to anyCustomer's Confidential Information;(d) [periodically test/continuously monitor] its systems for potential areaswhere security could be breached;(e) immediately report to Customer any breach of security or unauthorizedaccess to Customer's Confidential Information that Provider detects or becomes aware of;(f) use diligent efforts to remedy such breach of security or unauthorizedaccess in a timely manner and deliver to Customer a root cause assessment and futureincident mitigation plan with regard to any breach of security or unauthorized accessaffecting any Confidential Information of Customer that sets out written details regardingProvider's investigation of such incident and, upon Customer's written request, provide asecond more in-depth investigation and results of its findings;(g) refrain from notifying, for or on behalf of Customer or any AuthorizedUser, any regulatory authority, consumer or other Person of any such security breach orunauthorized access unless Customer specifically requests in writing that Provider do so;and(h) if such security breach or unauthorized access results from any act oromission of Provider or any Provider Personnel, promptly reimburse Customer for all[reasonable] costs and expenses Customer may incur in [notifying any Person/providingany notification] of such security breach or unauthorized access[ required by applicableLaw].Without limiting the generality of the foregoing, Provider and Customer will worktogether to formulate a plan to rectify all security breaches and unauthorized accessconcerning Customer's Confidential Information.35

12.2 Unauthorized Access. Provider shall not access, and shall not permit any accessto, the Customer Systems, in whole or in part, whether through Provider's Systems orotherwise, without Customer's express prior written authorization. Such authorizationmay be revoked by Customer in writing at any time in its sole discretion. Any access tothe Customer Systems shall be solely in accordance with the terms and conditions, and inno case exceed the scope of, the Customer's authorization pursuant to this Section 12.2.All Customer-authorized connectivity or attempted connectivity to the Customer Systemsshall be only through Customer's security gateways and firewalls and in compliance with[Customer's] security policies set forth in Schedule [E/[OTHER LETTER]] as the samemay be supplemented or amended by Customer and provided to Provider from time totime.12.3 Provider Systems. Provider shall be solely responsible for the informationtechnology infrastructure, including all computers, software, databases, electronicsystems (including database management systems) and networks used by or for Providerto access the Customer Systems or otherwise in connection with the Services ("ProviderSystems") and shall prevent unauthorized access to the Customer Systems through theProvider Systems.12.4 Security Audits. During the Term [and for [NUMBER] year[s] thereafter],Provider shall:(a) maintain complete and accurate records relating to its data protectionpractices and the security of any of Customer's Confidential Information, including anybackup, disaster recovery or other policies, practices or procedures relating to Customer'sConfidential Information and any other information relevant to its compliance with thisSection 12; and(b) upon Customer's request, make all such records, appropriate personnel andrelevant materials available during normal business hours for inspection and audit byCustomer or[ an independent data security expert[ that is reasonably acceptable toProvider]/its authorized representative], provided that Customer shall: (i) give Provider[reasonable/at least [NUMBER IN WORDS] ([NUMBER]) days] prior notice of anysuch audit; (ii) undertake such audit no more than once per calendar[year/quarter/month][, except for good cause shown]; and (iii) conduct or cause to beconducted such audit in a manner designed to minimize disruption of Provider's normalbusiness operations and that complies with the terms and conditions of all dataconfidentiality, ownership, privacy, security and restricted use provisions of thisAgreement. Customer may, but is not obligated to, perform such security audits, whichshall, at Customer's option and request, include penetration and security tests, of any andall Provider Systems and their housing facilities and operating environments.12.5 Regulatory and Compliance Audits. Any authorized representative of anyregulatory agency, taxing authority or private entity that functions in a quasi-regulatory36

manner that has jurisdiction over Customer in connection with its regulatory functions(each, a "Regulator") shall, upon request, have the same audit rights as those set forth inSection 12.4(b), provided that no condition or restriction stated in Section 12.4(b) shallapply to any Regulator to the extent it is contrary to applicable Law. Provider shallcooperate with all individuals conducting such audits and comply with all reasonablerecommendations that result from such inspections, tests and audits within reasonabletime frames. Without limiting any of Provider's other obligations under this Section 12 orSection 13, if Provider engages a third party auditor to perform a Statement on Standardsfor Attestation Engagements No. 16 (SSAE 16) audit of Provider's operations,information security program or disaster recovery/business continuity plan, Provider shallprovide a copy of the audit report to Customer [promptly/within [NUMBER IN WORDS]([NUMBER]) [days/Business Days]] after Provider's receipt of such report. Any suchaudit reports shall be Provider's Confidential Information.12.6 Nonexclusive Remedy for Security Breach. Any failure of the Services to meetthe requirements of this Agreement with respect to the security of any Customer Data orother Confidential Information of Customer, including any related backup, disasterrecovery or other policies, practices or procedures, is a material breach of this Agreementfor which Customer, at its option, may terminate this Agreement immediately on writtennotice to Provider without any notice or cure period, and Provider shall promptlyreimburse to Customer any Fees prepaid by Customer prorated to the date of suchtermination.13. Redundancy, Data Backup and Disaster Recovery. Provider shall, in accordance withthe provisions of this Section 13, maintain or cause to be maintained disaster avoidanceprocedures designed to safeguard the Customer Data and Customer's other ConfidentialInformation, Provider's Processing capability and the availability of the Hosted Services,in each case throughout the Term and at all times in connection with its actual or requiredperformance of the Services hereunder. The force majeure provisions of Section 17.1shall not limit Provider's obligations under this Section 13.13.1 Redundant Hosting and Connectivity. Provider shall simultaneously operate amirror system at a hardened data center facility in the United States that is geographicallyremote from the primary system on which the Service Software and Hosted Services arehosted (the "Secondary Backup Facility"). Except for its location and housing facility,the mirror system shall: (a) be identical in all respects to the primary system; (b) havehardware and software, network connectivity, power supplies, backup generators andother similar equipment and services that operate independently of the primary system;(c) have fully current backups of all Customer Data stored on the primary system; and (d)have the ability to provide the Hosted Services in accordance with this Agreement[ andthe Specifications] during the performance of routine and remedial maintenance or anyoutage or failure of the primary system fails. Provider shall operate, monitor and maintain37

such mirror system so that it may be activated within [PERIOD] of any failure of theHosted Services to be Available.13.2 Data Backup. Provider shall conduct or have conducted[contemporaneous/daily/[FREQUENCY]] backups of Customer Data and perform orcause to be performed [other] periodic backups of Customer Data [on at least a[daily/weekly/[FREQUENCY]] basis] and store such backup Customer Data [in acommercially reasonable location and manner and, in addition, [no less than daily] at theSecondary Backup Facility/as specified in Schedule [F/[OTHER LETTER]]]. On writtennotice from Customer and, in any case, on a [quarterly/monthly/[OTHER PERIOD])basis], Provider shall provide Customer with a copy of the backed up Customer Data insuch machine readable format as is specified in Schedule [F/[OTHER LETTER]] orCustomer otherwise reasonably requests. Provider shall provide all [quarterly/monthly/[OTHER PERIOD]] backups at its sole cost and expense. [Customer shallreimburse Provider for all media costs and shipping charges reasonably incurred infulfilling Customer's additional requests for copies of backed up Customer Data.] Nobackup of Customer Data shall be counted in allotting or calculating any data storageactually used or permitted to be used by Customer or any associated payment or fee.13.3 Disaster Recovery/Business Continuity. Throughout the Term and at all times inconnection with its actual or required performance of the Services hereunder, Providershall:(a) maintain a Business Continuity and Disaster Recovery Plan for the HostedServices (the "Plan"), and implement such Plan in the event of any unplannedinterruption of the Hosted Services. Provider's current Plan, revision history, and anyreports or summaries relating to past testing of or pursuant to the Plan are attached asExhibit [3/[OTHER NUMBER]]. Provider shall actively test, review and update the Planon at least [an annual/a quarterly] basis using industry best practices as guidance.Provider shall provide Customer with copies of all such updates to the Plan[promptly/within [NUMBER IN WORDS] ([NUMBER]) days of its adoption byProvider]. All updates to the Plan shall be subject to the requirements of this Section13.3; and(b) provide Customer with copies of all reports[ and summaries] resulting fromany testing of or pursuant to the Plan [promptly/within [NUMBER IN WORDS]([NUMBER]) [days/Business Days]] after Provider's receipt or preparation thereof. IfProvider fails to reinstate [all material/the] Hosted Services within the periods of time setforth in the Plan, Customer may, in addition to any other remedies available hereunder, inits sole discretion, immediately terminate this Agreement as a non-curable default underSection 7.3(b).14. Indemnification.38

14.1 General Indemnification. [Provider/Each party (the "Indemnifying Party")]shall defend, indemnify and hold harmless [Customer/the other party] and each of[Customer's/the other party's][ Affiliates], and each of the foregoing Persons' respectiveofficers, directors, employees, agents[, contractors,] successors and assigns, (each of theforegoing Persons, a[n] ["Customer Indemnitee"/"Indemnitee"]) from and against allLosses arising out of or resulting from any third party claim, suit, action or proceeding(each, an "Action") [to the extent] that [such Action] does or is alleged to arise out of orresult from:(a) [the Provider's/the Indemnifying Party's] breach of any representation,warranty, covenant or obligation of [Provider/the Indemnifying Party] under thisAgreement (including, in the case of Provider, any action or failure to act by any ProviderPersonnel that, if taken or not taken by Provider, would constitute such a breach byProvider); or(b) any [action or failure to take a required action/negligence/gross negligence]or more culpable act or omission (including recklessness or willful misconduct) inconnection with the performance or nonperformance of any Services or other activityactually or required to be performed by or on behalf of, [Provider/the IndemnifyingParty] (including, in the case of Provider, any Provider Personnel) under this Agreement,[in the case of each of clause (a) and clause (b), except to the extent, if any, that afinal judgment or other final determination in such Action from which no appeal ispermitted or taken determines that such Losses were caused by the [CustomerIndemnitee's/Indemnitee's] [gross] negligence or more culpable conduct, or [material]breach of this Agreement and] provided that, to the extent that any Action or Lossesdescribed in this Section 14.1 arises out of, results from or alleges a claim that any of theServices does or threatens to infringe, misappropriate or otherwise violate any IntellectualProperty Rights or other rights of any third party, Provider's obligations with respect tosuch Action and Losses, if any, shall be subject to the terms and conditions of Section14.2(a) through Section 14.2(e) and Section 14.3.14.2 Infringement Indemnification By Provider. Provider shall indemnify, defend andhold each and all of the Customer Indemnitees, harmless from and against all Lossesarising out of or resulting from any Action [to the extent] that [such Action] does or isalleged to arise out of or result from a claim that any of the Services, or Customer's or anyAuthorized User's use thereof, actually does or threatens to infringe, misappropriate orotherwise violate any [US] Intellectual Property Right or other right of a third party,provided however, that Provider shall have no liability or obligation for any Action orLoss to the extent that such Action or Loss arises out of or results from any:(a) alteration or modification of the Hosted Services or Service Software by oron behalf of Customer or any Authorized User without Provider's authorization (each, a39

"Customer Modification"), provided that no infringement, misappropriation or otherviolation of third party rights would have occurred without such Customer Modificationand provided further that any alteration or modification made by or for Provider atCustomer's request shall not be excluded from Provider's indemnification obligationshereunder unless (i) such alteration or modification has been made pursuant toCustomer's written specifications and (ii) the Hosted Services, as altered or modified inaccordance with the Customer's specifications, would not have violated such third partyrights but for the manner in which the alteration or modification was implemented by orfor Provider;(b) use of the Hosted Services by Customer or an Authorized User pursuant tothis Agreement in combination with any[ apparatus, hardware,] software or service notprovided, authorized or approved by or on behalf of Provider, if (i) no violation of thirdparty rights would have occurred without such combination and (ii) such[ apparatus,hardware,] software or service is not commercially available and not standard inProvider's or Customer's industry and there are no Specifications, Documentation or othermaterials[ that have been provided to Customer] indicating Provider's specification,authorization or approval of [Customer's/the] use of the Hosted Services in combinationtherewith;(c) access to or use of the Hosted Services that is expressly prohibited by thisAgreement or otherwise outside the scope of access or manner or purpose of usedescribed or contemplated anywhere in this Agreement, the Specifications or theapplicable Service Order;(d) [material] breach of this Agreement by Customer or[ material]noncompliance herewith by any Authorized User; or(e)violation of any applicable law by Customer or any of its Authorized Users.14.3 Mitigation.(a) If Provider receives or otherwise learns of any [written] threat, warning ornotice alleging that all, or any component or feature, of the Services violates a thirdparty's rights, Provider shall promptly notify Customer of such fact in writing, and[exercise its best efforts/take all commercially reasonable actions necessary] to ensureCustomer's continued right to access and use such Services and otherwise protectCustomer from any Losses in connection therewith[, including investigating suchallegation and obtaining a credible opinion of counsel that it is without merit].(b) [Subject to the exclusions set forth in clauses (a) through (e) of Section14.2,] [i/I]f any of the Services or any component or feature thereof is ruled to infringe orotherwise violate the rights of any third party by any court of competent jurisdiction, or ifany use of any Services or any component thereof is threatened to be enjoined, or [in40

Provider's opinion,] is likely to be enjoined or otherwise the subject of an infringement ormisappropriation claim, Provider shall, at Provider's sole cost and expense:(i)procure for Customer the right to continue to access and use theServices to the full extent contemplated by this Agreement and theSpecifications; or(ii) modify or replace all components, features and operations of theServices that infringe or are alleged to infringe ("Allegedly InfringingFeatures") to make the Services non-infringing while providingequally or more suitable features and functionality, which modifiedand replacement services shall constitute Services and be subject to theterms and conditions of this Agreement.(c) If neither of the remedies set forth in Section 14.3(b) is reasonablyavailable with respect to the Allegedly Infringing Features then Provider may directCustomer to cease any use of any materials that have been enjoined or finally adjudicatedas infringing, provided that Provider shall:(i)refund to Customer any prepaid Fees for Services that have not beenprovided[./; and](ii) in any case, at its sole cost and expense, secure the right for Customerto continue using the Allegedly Infringing Features for a transitionperiod of up to [NUMBER IN WORDS] [(NUMBER)] month[s] toallow Customer to replace the affected the Services or AllegedlyInfringing Features without disruption.(d) The remedies set forth in this Section 14.3 are in addition to, and not in lieuof[, all other remedies that may be available to Customer under this Agreement orotherwise, including] Customer's right to be indemnified pursuant to Section 14.1 andSection 14.2.14.4 [Indemnification By Customer. Customer shall indemnify, defend and holdProvider [and its Affiliates] and each of Provider's [and its Affiliates' respective] officers,directors, employees, agents, successors and assigns (each, a "Provider Indemnitee")harmless from and against all Losses incurred by any of them arising out of or resultingfrom any Action [to the extent] that [such Action] arises out of, results from or alleges:(a) any claim that any Customer Data is unlawful or actually does or threatensto infringe, misappropriate or otherwise violate any[ United States] Intellectual PropertyRights or other rights of any third party, provided however, that Customer shall have noliability or obligation with respect to any Action or Loss to the extent that such Action orLoss arises out of or results from any unauthorized access to or use, disclosure or other41

Processing of Customer Data, including Personal Information, by or on behalf ofProvider, or through or enabled by the Provider Systems, whether authorized by Provider,due to a security breach or otherwise; or(b) any use of the Hosted Services or Service Software by Customer or anyAuthorized User that is beyond the scope of or otherwise fails to conform to thisAgreement or any authorization or approval given in writing by Provider to Customer orsuch Authorized User. The remedies set forth in this paragraph are Provider's exclusiveremedies with respect to any Action or Loss described in this Section 14.4.]14.5 Indemnification Procedure. [Customer/The party seeking indemnification] shallpromptly notify [Provider/the Indemnifying Party] in writing of any Action for which itseeks indemnification pursuant to this Section 14 and cooperate with [Provider/theIndemnifying Party] at [Provider's/the Indemnifying Party's] sole cost and expense.[Provider/The Indemnifying Party] shall immediately take control of the defense andinvestigation of such Action and shall employ counsel[ of its choice/reasonablyacceptable to [Customer/the other party]] to handle and defend the same, at[Provider's/the Indemnifying Party's] sole cost and expense. [Provider/The IndemnifyingParty] shall not settle any Action on any terms or in any manner that adversely affects therights of [Customer or any Customer Indemnitee/the other party or any Indemnitee]without [Customer's/the other party's] prior written consent[, which shall not beunreasonably withheld or delayed]. The [Customer and any Customer Indemnitee/otherparty and any Indemnitee] may participate in and observe the proceedings at its own costand expense with counsel of its own choosing. [[Customer's/A party's] failure to performany obligations under this Section 14.5 will not relieve [Provider/the Indemnifying Party]of its obligations under Section 14 except to the extent that [Provider/the IndemnifyingParty] can demonstrate that it has been [materially] prejudiced as a result of such failure.]15. Limitations of Liability.15.1 EXCLUSION OF INDIRECT DAMAGES. [EXCEPT AS OTHERWISEPROVIDED IN Section 15.3, IN NO EVENT WILL EITHER PARTY BE LIABLEUNDER THIS AGREEMENT FOR ANY CONSEQUENTIAL, INCIDENTAL,INDIRECT, EXEMPLARY, SPECIAL OR PUNITIVE DAMAGES.OREXCLUSION OF INDIRECT DAMAGES. EXCEPT AS OTHERWISEPROVIDED IN Section 15.3, IN NO EVENT WILL EITHER PARTY BE LIABLE[ TOTHE OTHER PARTY OR TO ANY THIRD PARTY] FOR (A) ANY CLAIMSASSERTING OR BASED ON THE USE, INABILITY TO USE, LOSS,INTERRUPTION OR DELAY OF THE SERVICES, LOSS OF USE OF FACILITY OREQUIPMENT, LOST BUSINESS, REVENUES OR PROFITS, LOSS OF GOODWILL,FAILURE TO ACHIEVE COST SAVINGS, FAILURE OR INCREASED COST OF42

OPERATIONS, LOSS, DAMAGE OR CORRUPTION OF DATA, LOSS RESULTINGFROM SYSTEM OR SERVICE FAILURE, MALFUNCTION, DOWNTIME,SHUTDOWN, SERVICE INCOMPATIBILITY OR PROVISION OF INCORRECTCOMPATIBILITY INFORMATION, FAILURE TO ACCURATELY TRANSFER,READ OR TRANSMIT INFORMATION, FAILURE TO UPDATE OR PROVIDECORRECT INFORMATION OR BREACHES IN SYSTEM SECURITY, OR (B) FORANY CONSEQUENTIAL, INDIRECT, INCIDENTAL, EXEMPLARY, SPECIAL,PUNITIVE OR ENHANCED DAMAGES, ARISING OUT OF OR IN CONNECTIONWITH THIS AGREEMENT OR ITS SUBJECT MATTER, IN THE CASE OF EACHOF CLAUSE (A) AND CLAUSE (B), EVEN IF ADVISED OF THE POSSIBILITY OFSUCH DAMAGES OR SUCH DAMAGES ARE OTHERWISE FORESEEABLE,REGARDLESS OF THE LEGAL OR EQUITABLE THEORY (CONTRACT, TORT,STRICT LIABILITY OR OTHERWISE) UPON WHICH THE CLAIM IS BASED,AND NOTWITHSTANDING THE FAILURE OF ANY AGREED OR OTHERREMEDY OF ITS ESSENTIAL PURPOSE.]15.2 [CAP ON MONETARY LIABILITY. EXCEPT AS OTHERWISE PROVIDEDIN Section 15.3, IN NO EVENT SHALL EITHER PARTY'S LIABILITY UNDERTHIS AGREEMENT EXCEED [[NUMBER IN WORDS] [(NUMBER)] TIMES] THEAGGREGATE FEES AND REIMBURSABLE EXPENSES UNDER THISAGREEMENT (INCLUDING AMOUNTS ALREADY PAID AND AMOUNTS THATHAVE ACCRUED BUT NOT YET BEEN PAID) [IN THE [NUMBER IN WORDS][(NUMBER)] [YEARS/MONTHS] PRECEDING THE EVENT GIVING RISE TO THECLAIM].]15.3 Exceptions. The exclusions and limitations in Section 15.1 and Section 15.2shall not apply to:(a) Losses arising out of or relating to a party's failure to comply with itsobligations under Section 9 (Ownership), Section 10 (Confidentiality), Section 11(www.practicallaw.com/A (Personal Information), Section 12 (Security) or Section 13(Data Backup and Disaster Recovery);(b)A party's indemnification obligations under Section 14 (Indemnification);(c) Losses arising out of or relating to Provider's unauthorized [intentional]suspension, termination or disabling of the Services in breach of this Agreement;(d) Losses arising out of or relating to a party's gross negligence or moreculpable conduct, including any willful misconduct or intentional wrongful acts;(e) Losses for death, bodily injury or damage to real or tangible personalproperty arising out of or relating to a party's negligent or more culpable acts oromissions[;/; or]43

(f)(g)Losses to the extent covered by a party's insurance[./; or][Losses arising from or relating to a party's violation of Law[./; or]](h) [A party's obligation to pay attorneys' fees and court costs in accordancewith Section 21.15.]16. Representations and Warranties.16.1 Mutual Representations and Warranties. Each party represents and warrants tothe other party that:(a) it is duly organized, validly existing and in good standing as a corporationor other entity as represented herein under the laws and regulations of its jurisdiction ofincorporation, organization or chartering;(b) it has, and throughout the Term and any additional periods during which itdoes or is required to perform the Services will retain, the full right, power and authorityto enter into this Agreement and perform its obligations hereunder;(c) the execution of this Agreement by its representative whose signature is setforth at the end hereof has been duly authorized by all necessary[corporate/organizational] action of the party; and(d) when executed and delivered by such party, this Agreement will constitutethe legal, valid and binding obligation of such party, enforceable against such party inaccordance with its terms[, except as the enforceability thereof may be limited bybankruptcy and similar Laws affecting creditors' rights generally and by general equitableprinciples].16.2 Additional Provider Warranties. Provider represents, warrants and covenants toCustomer that:(a) Provider has, and throughout the Term and any additional periods duringwhich Provider does or is required to perform the Services will have, the unconditionaland irrevocable right, power and authority[, including all permits and licenses required,]to provide the Services and grant and perform all rights and licenses granted or requiredto be granted by it under this Agreement;(b) neither Provider's grant of the rights or licenses hereunder nor itsperformance of any Services or other obligations under this Agreement does or [toProvider's knowledge as of the Effective Date] at any time will: (i) conflict with or violateany applicable Law, including any Law relating to data privacy, data security or PersonalData; (ii) require the consent, approval or authorization of any governmental orregulatory authority or other third party; or (iii) require the provision of any payment or44

other consideration by Customer or any Authorized User to any third party, and Providershall promptly notify Customer in writing if it becomes aware of any change in anyapplicable Law that would preclude Provider's performance of its [material] obligationshereunder;(c) [to Provider's knowledge as of the Effective Date,] [a/A]s accessed andused by Customer or any Authorized User [in accordance with this Agreement and theSpecifications], the Hosted Services, Documentation and all other Services and materialsprovided by Provider under this Agreement will not infringe, misappropriate or otherwiseviolate any Intellectual Property Right or other right of any third party;(d) there is no settled, pending or[, to Provider's knowledge as of the EffectiveDate,] threatened Action, and it has not received any written, oral or other notice of anyAction (including in the form of any offer to obtain a license): (i) alleging that any accessto or use of the Services or Service Software in the Territory does or would infringe,misappropriate or otherwise violate any Intellectual Property Right of any third party; (ii)challenging Provider's ownership of, or right to use or license, any software or othermaterials used or required to be used in connection with the performance or receipt of theServices, or alleging any adverse right, title or interest with respect thereto; or (iii) that, ifdecided unfavorably to Provider, would reasonably be expected to have an actual orpotential adverse effect on its ability to perform the Services or its other obligations underthis Agreement, and it has no knowledge [after reasonable investigation] of any factual,legal or other reasonable basis for any such litigation, claim or proceeding;(e) the Service Software and Services will [in all material respects] conform toand perform in accordance with the Specifications and all requirements of thisAgreement, including the Availability and Availability Requirement provisions set forthin Section 5;(f) all Specifications are, and will be continually updated and maintained sothat they continue to be, current, complete and accurate and so that they do and willcontinue to fully describe the Hosted Services in all [material] respects such that at notime [during the Term or any additional periods during which Provider does or is requiredto perform the Services] will the Hosted Services have any [material] undocumentedfeature;(g)Code; andthe Provider Systems and Services are and will remain free of Harmful(h) it will perform all Services in a timely, professional and workmanlikemanner with a level of care, skill, practice and judgment consistent with [best/generallyrecognized/commercially reasonable] industry standards and practices for similarservices, using personnel with the requisite skill, experience and qualifications, and will45

devote adequate resources to meet Provider's obligations (including the AvailabilityRequirement and Support Service Level Requirements) under this Agreement.16.3 [DISCLAIMER. EXCEPT FOR THE EXPRESS WARRANTIES IN THISAGREEMENT, EACH PARTY HEREBY DISCLAIMS ALL WARRANTIES,WHETHER EXPRESS, IMPLIED, STATUTORY OR OTHERWISE UNDER OR INCONNECTION WITH THIS AGREEMENT OR ANY SUBJECT MATTER HEREOF.]17. [Insurance.17.1 Required Coverage. At all times during the Term [and for a period of [three(3)/[NUMBER IN WORDS] [(NUMBER)]] years thereafter], Provider shall procure andmaintain, at its sole cost and expense, [all insurance coverage required by applicableLaw, and in any event] insurance coverage in the following types and amounts:(a) Commercial General Liability with limits no less than [NUMBER INWORDS US DOLLARS] ($ [NUMBER]) per occurrence and [NUMBER IN WORDSUS DOLLARS] ($ [NUMBER]) in the aggregate[, including bodily injury and propertydamage and products and completed operations and advertising liability], which policywill include contractual liability coverage insuring the activities of Provider under thisAgreement;(b) Cyber Liability Insurance, including first party and third party coverage,with limits no less than [NUMBER IN WORDS US DOLLARS] ($ [NUMBER]) peroccurrence and [NUMBER IN WORDS US DOLLARS] ($ [NUMBER]) in theaggregate for all claims each policy year;(c) Worker's Compensation and employers' liability insurance with limits noless than the greater of (i) [NUMBER IN WORDS US DOLLARS] ($ [NUMBER]) and(ii) the minimum amount required by applicable Law each accident, includingoccupational disease coverage;(d) Commercial Automobile Liability with limits no less than [NUMBER INWORDS US DOLLARS] ($ [NUMBER]), each occurrence combined single limit ofliability for bodily injury, death and property damage, including owned and non-ownedand hired automobile coverages, as applicable; and(e) Errors and Omissions/Professional Liability with limits no less than[NUMBER IN WORDS US DOLLARS] ($ [NUMBER]) per occurrence and[NUMBER IN WORDS US DOLLARS] ($ [NUMBER]) in the aggregate for all claimseach policy year.17.2 Policy Terms. All insurance policies required pursuant to this Section 17 shall:46

(a) be issued by insurance companies [reasonably acceptable to Customer][with a Best's Rating of no less than [A-VII]];(b) provide that such insurance carriers give Customer at least thirty (30) days'prior written notice of any cancellation or non-renewal of, or material change in, thecoverage, scope or amount of such policy and, prior to any such cancellation, nonrenewalor material change in coverage, Provider shall have new insurance policies inplace that meet the requirements of this Section 17;(c) waive any right of subrogation of the insurers against the Customer [or anyof its Affiliates];(d) provide that such insurance be primary insurance and any similarinsurance in the name of and/or for the benefit of Customer shall be excess and noncontributory;and(e) name Customer [and Customer's Affiliates], including, in each case, allsuccessors and permitted assigns, as additional insureds.17.3 Coverage. To the extent any insurance coverage required under this Section 17is purchased on a "claims-made" basis, such insurance shall cover all prior acts ofProvider during the Term and any additional periods during which Provider does or isrequired to perform the Services, and such insurance shall be continuously maintaineduntil at least [four (4)/[NUMBER IN WORDS] ([NUMBER])] years beyond theexpiration or termination of the Term, or Provider shall purchase "tail" coverage,effective upon termination of any such policy or upon termination or expiration of theTerm, to provide coverage for at least four (4) years from the occurrence of either suchevent.17.4 Certificates of Insurance. Upon the written request of Customer, Provider shallprovide Customer with copies of the certificates of insurance and policy endorsements forall insurance coverage required by this Section 17, and shall not do anything to invalidatesuch insurance. Certificates of Insurance evidencing all coverages described in thisSection 17 shall be furnished to Customer on written request. Provider shall give thirty(30) days' prior written notice to Customer of any cancellation, non-renewal or materialchange in coverage, scope, or amount of any insurance policy required by or affecting theCustomer's rights or remedies under this Agreement.17.5 Non-waiver. This Section 17 is not intended to and shall not be construed in anymanner as waiving, restricting or limiting the liability of either party for any obligationsunder this Agreement (including any provisions hereof requiring a party to indemnify,defend and hold harmless the other party).]18. Force Majeure.47

18.1 Force Majeure Events. [Subject to Section 18.2, n/N]either party shall be liableor responsible to the other party, or be deemed to have defaulted under or breached thisAgreement, for any failure or delay in fulfilling or performing any term hereof, when andto the extent such failure or delay is caused by: acts of God, flood, fire or explosion, war,terrorism, invasion, riot or other civil unrest, embargoes or blockades in effect on or afterthe date of this Agreement, national or regional emergency[,/ or] [strikes, labor stoppagesor slowdowns or other industrial disturbances[,/ or]] [any passage of law or governmentalorder, rule, regulation or direction, or any action taken by a governmental or publicauthority, including imposing an embargo, export or import restriction, quota or otherrestriction or prohibition[,/ or]] [national or regional shortage of adequate power ortelecommunications or transportation facilities] (each of the foregoing, a "Force MajeureEvent"), in each case provided that: (a) such event is outside the reasonable control of theaffected party; (b) the affected party gives [prompt/immediate] written notice to the otherparty, stating the period of time the occurrence is expected to continue; (c) the affectedparty uses diligent efforts to end the failure or delay and minimize the effects of suchForce Majeure Event.18.2 [Customer Performance; ]Termination. [In the event of a Force Majeure Eventaffecting Provider's performance under this Agreement, Customer may suspend itsperformance hereunder until such time as Provider resumes performance.] Customer mayterminate this Agreement by written notice to Provider if a Force Majeure Event affectingProvider's performance hereunder continues substantially uninterrupted for a period of[five (5) Business Days/[NUMBER IN WORDS] ([NUMBER]) days] or more. UnlessCustomer terminates this Agreement pursuant to the preceding sentence, any datespecifically designated for Provider's performance under this Agreement shallautomatically be extended for a period up to the duration of the Force Majeure Event.18.3 Exclusions; Non-suspended Obligations. Notwithstanding the foregoing or anyother provisions of this Agreement:(a)in no event shall any of the following be considered a Force Majeure Event:(i)shutdowns, disruptions or malfunctions of the Provider Systems or anyof Provider's telecommunication or internet services other than as aresult of general and widespread internet or telecommunicationsfailures that are not limited to the Provider Systems; or(ii) the delay or failure of any Provider Personnel to perform anyobligation of Provider hereunder unless such delay or failure toperform is itself by reason of a Force Majeure Event; and(b) no Force Majeure Event shall modify or excuse Provider's obligations underSection 5 (Service Availability and Service Availability Credits), Section 6.5 (SupportService Level Credits)Section 9 (Ownership), Section 10 (Confidentiality), Section 1148

(Personal Information), Section 12 (Security), Section 13 (Data Backup and DisasterRecovery) or Section 14 (Indemnification), or any Availability Requirement, SupportService Level Requirement, Service Availability Credit or Service Level Creditobligations under this Agreement or an applicable Service Order;19. Software Escrow.19.1 Escrow Agreement. [Concurrently with their execution of this Agreement, theparties are entering into a source code escrow agreement/As soon as practicable after theEffective Date [but in no event later than Customer's Acceptance of the Hosted Services],the parties shall enter into a source code escrow Agreement] with [[NAME OF ESCROWAGENT]/a mutually agreed third-party escrow agent] ("Escrow Agent"). Such sourcecode escrow agreement [is/shall be] on the terms and conditions, and in the form,attached as Schedule [G] ("Escrow Agreement"). All terms and conditions of the EscrowAgreement are a part of, and by this reference are incorporated in, this Agreement, andany breach thereof by Provider shall be a breach of this Agreement.19.2 Release Events. Each of the following shall constitute a "Release Event" forpurposes of this Agreement and the Escrow Agreement [should they occur at any timeduring the Term or at any time at which the Services are performed or required to beperformed hereunder]:(a)Provider:(i)is the named debtor in any bankruptcy or insolvency proceeding;(ii) has made a general assignment for the benefit of its creditors;(iii) has terminated its on-going business operations or transfers all orsubstantially all of the assets or obligations associated with or set forthin this Agreement to a third party except in connection with acontinuation of the Provider's business;(iv) has terminated its provision of the Hosted Services or Support Servicesor ceased to perform the Hosted Services or Support Services for acontinuing period of [five (5) or more Business Days/thirty (30) ormore days] (by reason of a Force Majeure Event or otherwise), exceptpursuant to the expiration or termination of this Agreement inaccordance with its terms;(b) Provider's incapability, failure, or demonstrated or threatenedunwillingness, to perform fully any of the Services on a timely basis, whether or not thesame would give Customer a right to terminate this Agreement (other than pursuant toSection 7.4), it being understood and agreed that Provider shall be deemed to beincapable to perform the Services if either a duly authorized representative of Provider so49

informs Customer in writing or, as a result of any (i) employee layoffs, (ii) termination ofany contract, supply of goods or services or grant of rights, licenses or privileges (otherthan by Customer) or (iii) sale or loss of assets, Provider for [five (5)/[NUMBER INWORDS] [(NUMBER)]] or more consecutive days fails to maintain sufficient SustainingResources to fully perform all Services in accordance with the applicable provisions ofthis Agreement and the Specifications, including, in the case of the Support Services, inaccordance with Section 6;(c) the Escrow Agreement terminates [prior to the expiration or termination ofthis Agreement and is not replaced within [ten (10)/[NUMBER IN WORDS]([NUMBER])] [Business Days/days] with another escrow agreement reasonablyacceptable to Customer[, provided that Provider has received notice of such terminationand Customer's acceptance of a replacement escrow agreement is not unreasonablywithheld or delayed (it being understood and agreed that it shall be unreasonable forCustomer to fail or refuse to accept an escrow agreement containing the Release Eventsset out in this Section 19.2]]; and(d) any other cause or event that, by the terms of this Agreement (other than theterms of Section 7.4) or the applicable Service Order, gives Customer the right toterminate this Agreement or such Service Order, regardless of whether Customerexercises such right of termination.19.3 Escrow License Grant. Provider hereby grants Customer a license to possess,control and use the Service Software, including the Service Software Source Code andobject code, and to reverse engineer, disassemble, decompile, decode, adapt, develop,modify and maintain the Service Software (including the Service Software Source Codeand object code) and make any related modifications to the Specifications, and use allresulting corrections, repairs, translations, enhancements and other derivative works andimprovements for any and in connection with Customer's and its Authorized Users' use ofthe Services as permitted hereunder, in each case solely upon and after the occurrence ofa Release Event.20. Effect of Provider Bankruptcy. All rights and licenses granted by Provider under thisAgreement or the Escrow Agreement (which is supplementary to this Agreement) are andshall be deemed to be rights and licenses to "intellectual property," and the subject matterof this agreement and the Escrow Agreement, including the Services and all escrowdeposit materials comprising or relating to any of the Services, is and shall be deemed tobe "embodiment[s]" of "intellectual property" for purposes of and as such terms are usedin and interpreted under section 365(n) of the United States Bankruptcy Code (the"Code") (11 U.S.C. § 365(n) (2010)). Customer shall have the right to exercise all rightsand elections under the Code and all other applicable bankruptcy, insolvency and similarlaws with respect to this Agreement (including all executory Service Orders), the EscrowAgreement and the subject matter hereof and thereof.[ Without limiting the generality ofthe foregoing, if Provider or its estate becomes subject to any bankruptcy or similar50

proceeding: (a) subject to Customer's rights of election, all rights and licenses granted toCustomer under this Agreement and the Escrow Agreement will continue subject to therespective terms and conditions hereof and thereof, and will not be affected, even byProvider's rejection of this Agreement or the Escrow Agreement; (b) Customer shall beentitled to a complete duplicate of (or complete access to, as appropriate) all suchintellectual property and embodiments of intellectual property, and the same, if notalready in Customer's possession, shall be promptly delivered to Customer, unlessProvider elects to and does in fact continue to perform all of its obligations under thisAgreement; and (c) the automatic stay under Section 362 of the Code (11 U.S.C. § 362(2011)) shall not apply to any instructions from Customer to the Escrow Agent relating tothe escrow deposit materials.]21. General Provisions.21.1 Further Assurances. Each party shall, upon the [reasonable] request[, and at thesole cost and expense,] of the other party, [promptly] execute such documents andperform such acts as may be necessary to give full effect to the terms of this Agreement.21.2 Relationship of the Parties. The relationship between the parties is that ofindependent contractors. Nothing contained in this Agreement shall be construed ascreating any agency, partnership, joint venture or other form of joint enterprise,employment or fiduciary relationship between the parties, and neither party shall haveauthority to contract for or bind the other party in any manner whatsoever.21.3 Public Announcements. Neither party shall issue or release any announcement,statement, press release or other publicity or marketing materials relating to thisAgreement or, unless expressly permitted under this Agreement, otherwise use the otherparty's trademarks, service marks, trade names, logos, domain names or other indicia ofsource, association or sponsorship, in each case, without the prior written consent of theother party[, which shall not be unreasonably withheld or delayed].21.4 Notices. All notices, requests, consents, claims, demands, waivers and othercommunications hereunder [, other than routine communications having no legal effect,]shall be in writing and addressed to the parties as follows (or as otherwise specified by aparty in a notice given in accordance with this Section):If to Provider:[PROVIDER NAME]Facsimile: [FAX NUMBER][E-mail: [E-MAIL ADDRESS]]51

Attention: [NAME OF OFFICER TO RECEIVE NOTICES]Title: [TITLE OF OFFICER TO RECEIVE NOTICES]If to Customer:[CUSTOMER NAME]Facsimile: [FAX NUMBER][E-mail: [E-MAIL ADDRESS]]Attention: [NAME OF OFFICER TO RECEIVE NOTICES]Title: [TITLE OF OFFICER TO RECEIVE NOTICES]Notices sent in accordance with this Section 21.4 shall be deemed effectivelygiven: (a) when received, if delivered by hand (with written confirmation of receipt); (b)when received, if sent by a nationally recognized overnight courier (receipt requested);(c) on the date sent by facsimile [or e-mail] ([in each case, ]with confirmation oftransmission), if sent during normal business hours of the recipient, and on the nextbusiness day, if sent after normal business hours of the recipient; or (d) on the[NUMBER] day after the date mailed, by certified or registered mail, return receiptrequested, postage prepaid.21.5 Interpretation. For purposes of this Agreement: (a) the words "include,""includes" and "including" are deemed to be followed by the words "without limitation";(b) the word "or" is not exclusive; [and] (c) the words "herein," "hereof," "hereby,""hereto" and "hereunder" refer to this Agreement as a whole[./; and all personalpronouns, whether used in the feminine, masculine, or neuter gender, include all othergenders and the singular shall include the plural and vice versa.] Unless the contextotherwise requires, references herein: (x) to Sections, Schedules and Exhibits refer to thesections of, and schedules and exhibits attached to, this Agreement; (y) to an agreement,instrument or other document (including this Agreement) means such agreement,instrument or other document as amended, supplemented and modified from time to timeto the extent permitted by the provisions thereof, and together with all schedules andexhibits thereto; and (z) to a statute means such statute as amended from time to time andincludes any successor legislation thereto and any regulations promulgated thereunder.This Agreement shall be construed without regard to any presumption or rule requiringconstruction or interpretation against the party drafting an instrument or causing aninstrument to be drafted. The Schedules and Exhibits referred to herein shall be construedwith, and as an integral part of, this Agreement to the same extent as if they were set forthverbatim herein.52

21.6 Headings. The headings in this Agreement are for reference only and shall notaffect the interpretation of this Agreement.21.7 Entire Agreement. This Agreement, including all Service Orders and otherSchedules and Exhibits[, together with [SPECIFIC RELATED AGREEMENTS] and anyother documents, agreements or instruments incorporated by reference herein, constitutesthe sole and entire agreement of the parties to this Agreement with respect to the subjectmatter contained herein, and supersedes all prior and contemporaneous understandingsand agreements, both written and oral, with respect to such subject matter. In the event ofany conflict between the terms of this Agreement and those of any Schedule, Exhibit orother document, the following order of precedence shall govern: [(a) first, thisAgreement, excluding its Exhibits and Schedules; (b) second, the Exhibits and Schedulesto this Agreement as of the Effective Date; and (c) third, any other documents,instruments or agreements incorporated herein by reference/[OTHER ORDER OFPRECEDENCE]]. [Except as expressly identified in Section 21.7 or a Service Order,n/N]o browse-wrap, shrink-wrap, click-wrap or other non-negotiated terms andconditions provided with any of the Services[,/ or] Documentation [or other ProviderMaterials] hereunder will constitute a part or amendment of this Agreement or is bindingon Customer or any Authorized User for any purpose. All such other terms andconditions have no force and effect and are deemed rejected by Customer and theAuthorized User, even if access to or use of such Service[,/ or] Documentation [or otherProvider Materials] requires affirmative acceptance of such terms and conditions.]21.8 Assignment.(a) Neither party shall assign or otherwise transfer any of its rights, or delegateor otherwise transfer any of its obligations or performance, under this Agreement withoutthe other party's prior written consent, which consent shall not unreasonably be withheldor delayed, provided that each party shall have the right, without the other party's consent,to assign or otherwise transfer this Agreement in its entirety:(i)to any of its Affiliates[, provided that all such rights, obligations andperformance hereunder shall revert to Customer automatically andimmediately at such, if any, time as such affiliated entity ceases to bean Affiliate of Customer, and provided further that Customer shallremain responsible for all acts and omissions of such Affiliate in theperformance of this Agreement]; or(ii) in connection with any merger, consolidation or reorganizationinvolving Customer (regardless of whether Customer is a surviving ordisappearing entity), or a sale of all or substantially all of Customer'sbusiness or assets relating to this Agreement to an unaffiliated thirdparty [of good financial standing].53

(b) Customer shall have the right to terminate this Agreement in its entirety orany Services or Service Orders hereunder pursuant to Section 7.4 if Provider delegates orotherwise transfers any of its obligations or performance hereunder, whether voluntarily,involuntarily, by operation of law or otherwise, and no such delegation or other transferwill relieve Provider of any of such obligations or performance. [For purposes of thepreceding sentence, and without limiting its generality, any merger, consolidation orreorganization involving Provider (regardless of whether Provider is a surviving ordisappearing entity) will be deemed to be a transfer of Provider's obligations orperformance under this Agreement.] The effects of any termination of this Agreementpursuant to this Error! Reference source not found., including the resulting rights andobligations of the parties, shall be governed by Section 7.5.(c) Any purported assignment, delegation or transfer in violation of this Error!Reference source not found. is void. This Agreement is binding upon and inures to thebenefit of the parties hereto and their respective permitted successors and assigns.21.9 No Third-party Beneficiaries. This Agreement is for the sole benefit of theparties hereto and their respective [permitted] successors and [permitted] assigns andnothing herein, express or implied, is intended to or shall confer on any other person orentity any legal or equitable right, benefit or remedy of any nature whatsoever under orby reason of this Agreement.21.10 Amendment and Modification; Waiver. This Agreement may only beamended, modified or supplemented by an agreement in writing signed by each partyhereto. No waiver by any party of any of the provisions hereof shall be effective unlessexplicitly set forth in writing and signed by the party so waiving. Except as otherwise setforth in this Agreement, no failure to exercise, or delay in exercising, any right, remedy,power or privilege arising from this Agreement shall operate or be construed as a waiverthereof; nor shall any single or partial exercise of any right, remedy, power or privilegehereunder preclude any other or further exercise thereof or the exercise of any other right,remedy, power or privilege.21.11 Severability. If any term or provision of this Agreement is invalid, illegalor unenforceable in any jurisdiction, such invalidity, illegality or unenforceability shallnot affect any other term or provision of this Agreement or invalidate or renderunenforceable such term or provision in any other jurisdiction. Upon such determinationthat any term or other provision is invalid, illegal or unenforceable, the parties heretoshall negotiate in good faith to modify this Agreement so as to effect the original intent ofthe parties as closely as possible in a mutually acceptable manner in order that thetransactions contemplated hereby be consummated as originally contemplated to thegreatest extent possible.21.12 Governing Law; Submission to Jurisdiction.54

(a) This Agreement and all related documents[, and all matters arising out of orrelating to this Agreement,] are governed by, and construed in accordance with, the lawsof the State of [STATE], United States of America [(including [APPLICABLE STATECHOICE OF LAW STATUTE(S)])][, without regard to the conflict of laws provisionsthereof to the extent such principles or rules would require or permit the application ofthe laws of any jurisdiction other than those of the State of [STATE]]. [The UniformComputer Information Transactions Act does not have any application to thisAgreement.](b) Any legal suit, action or proceeding arising out of [or related to] thisAgreement or the licenses granted hereunder shall be instituted [exclusively] in thefederal courts of the United States or the courts of the State of [STATE] in each caselocated in the city of [CITY] and County of [COUNTY], and each party irrevocablysubmits to the [exclusive] jurisdiction of such courts in any such suit, action orproceeding. Service of process, summons, notice or other document by mail to suchparty's address set forth herein shall be effective service of process for any suit, action orother proceeding brought in any such court.21.13 [Waiver of Jury Trial. Each party irrevocably and unconditionally waivesany right it may have to a trial by jury in respect of any legal action arising out of orrelating to this Agreement or the transactions contemplated hereby.]21.14 Equitable Relief. Each party to this Agreement acknowledges and agreesthat (a) a breach or threatened breach by such party of any of its obligations under [thisAgreement/Section 5 (Service Availability and Service Availability Credits), Section 6(Support and Maintenance Services),Section 9 (Ownership), Section 10(Confidentiality), Section 11 (Personal Information), Section 12 (Security), Section 13(Data Backup and Disaster Recovery) or Section 19 (Software Escrow)] would give riseto irreparable harm to the other party for which monetary damages would not be anadequate remedy and (b) in the event of a breach or a threatened breach by such party ofany such obligations, the other party hereto shall, in addition to any and all other rightsand remedies that may be available to such party at law, at equity or otherwise in respectof such breach, be entitled to equitable relief, including a temporary restraining order, aninjunction, specific performance and any other relief that may be available from a courtof competent jurisdiction, without any requirement to post a bond or other security, andwithout any requirement to prove actual damages or that monetary damages will notafford an adequate remedy. Each party to this Agreement agrees that such party will notoppose or otherwise challenge the appropriateness of equitable relief or the entry by acourt of competent jurisdiction of an order granting equitable relief, in either case,consistent with the terms of this Section 21.14. [Notwithstanding the immediatelypreceding two sentences, instead of any remedies set forth under this Section 21.14, theparties intend that the Customer's right to [EXCLUSIVE REMEDY] is the exclusiveremedy for Provider's failure to [SPECIFIED BREACH].]55

21.15 [Attorneys' Fees. In the event that any action, suit, or other legal oradministrative proceeding is instituted or commenced by either party hereto against theother party arising out of [or related to] this Agreement, the prevailing party shall beentitled to recover its [reasonable/actual] attorneys' fees[, expert witness fees and out-ofpocket]and court costs from the non-prevailing party.]21.16 Schedules and Exhibits. All Exhibits that are referenced herein andattached hereto, or are signed by both parties on or after the Effective Date, are herebyincorporated by reference. The following Schedules and Exhibits are attached hereto andincorporated herein:[Schedule [A/[OTHER LETTER]]Schedule [B/[OTHER LETTER]]Schedule [C/[OTHER LETTER]][Schedule [D/[OTHER LETTER]]Schedule [E/[OTHER LETTER]]Schedule [F/[OTHER LETTER]]Schedule [G/[OTHER LETTER]][Exhibit [1/[OTHER NUMBER]][Exhibit [2/[OTHER NUMBER]]Exhibit [3/[OTHER NUMBER]]Authorized Users]Service Orders, Pricing and SpecificationsService Availability CreditsKey Personnel]Data Security RequirementsData Backup RequirementsEscrow AgreementConfidentiality, Work-Made-For-Hire andAssignment Agreement]Customer Expense ReimbursementPolicy]Business Continuity and DisasterRecovery Plan21.17 Counterparts. This Agreement may be executed in counterparts, each ofwhich shall be deemed an original, but all of which together shall be deemed to be oneand the same agreement[ and will become effective and binding upon the parties as of theEffective Date at such time as all the signatories hereto have signed a counterpart of thisAgreement]. A signed copy of this Agreement delivered by facsimile[, e-mail or othermeans of electronic transmission (to which a signed PDF copy is attached)] shall bedeemed to have the same legal effect as delivery of an original signed copy of thisAgreement.56

[SIGNATURE PAGE FOLLOWS]57

IN WITNESS WHEREOF, the parties hereto have caused this Agreement to beexecuted as of the Effective Date by their duly authorized representatives.ProviderCustomerBy: _____________________Name: _____________________Title: _____________________Date: _____________________By: _____________________Name: _____________________Title: _____________________Date: _____________________58

SCHEDULE [A/[OTHER LETTER]][AUTHORIZED USERS]59

SCHEDULE [B/[OTHER LETTER]]SERVICE ORDERS, PRICING AND SPECIFICATIONS[GENERAL PRICING AND SERVICE SPECIFICATIONS]All payments shall be in US dollars and made at [Customer's/Provider's] option bycheck or wire transfer to [[NAME, NUMBER AND BANK OR DEPOSITORYINSTITUTION OF ACCOUNT]/Provider at [ADDRESS]].All Service Orders shall include the following information and be submitted in theform set forth below:SERVICE ORDER NO. __This Service Order, effective as of the last signature date set forth below, is a partof and incorporated into the Software As A Service Agreement dated between [NAMEOF ORGANIZATION] as Customer and [NAME OF ORGANIZATION] as Provider,dated ________ __, ____ ("Agreement"). Capitalized terms not defined in this ServiceOrder are as defined in the Agreement. In the event of any conflict between the body ofthe Agreement and this Service Order, the body of the Agreement shall govern.1. Summary of Services; Acceptance Criteria:2. Additional Service Levels and Remedies:3. Fees and Expenses:ProviderCustomerBy: _____________________Name: _____________________Title: _____________________Date: _____________________By: _____________________Name: _____________________Title: _____________________Date: _____________________60

SCHEDULE [C/[OTHER LETTER]]AVAILABILITY AND SERVICE AVAILABILITY CREDITSRequired AvailabilityService LevelHosted Services shall beAvailable[99.95%/[PERCENTAGE]] of the time during eachService Period excludingperiods Hosted Servicesare not Available due to anException.Calculation Formula(Actual Uptime – TotalMinutes in Service PeriodHosted Services are notAvailable Due to anException) ÷ (ScheduledUptime – Total Minutes inService Period HostedServices are not AvailableDue to an Exception) x 100= Percentage Uptime.Service AvailabilityCreditsNo Service AvailabilityCredits will be given forany Service Period inwhich Percentage Uptimeequals or exceeds theAvailability Requirement.Customer shall be entitledto a Service AvailabilityCredit of 10% of the Feespayable for HostedServices provided duringthe Service Period for each1% by which PercentageUptime is less than theAvailability Requirement,such credit not to exceed100%.61

SCHEDULE [D/[OTHER LETTER]][KEY PERSONNEL]62

SCHEDULE [E/[OTHER LETTER]]DATA SECURITY REQUIREMENTS63

SCHEDULE [F/[OTHER LETTER]]DATA BACKUP REQUIREMENTS64

SCHEDULE [G/[OTHER LETTER]]ESCROW AGREEMENT65

EXHIBIT [1/[OTHER NUMBER]][CONFIDENTIALITY, WORK-MADE-FOR-HIRE]66

EXHIBIT [2/[OTHER NUMBER]][CUSTOMER EXPENSE REIMBURSEMENT POLICY]67

EXHIBIT [3/[OTHER NUMBER]]BUSINESS CONTINUITY AND DISASTER RECOVERY PLAN68

2015 INTERNATIONAL CLIENT SEMINARFAIRMONT SCOTTSDALE PRINCESSSCOTTSDALE, ARIZONAMARCH 5 – 8, 2015IT IS BOUND TO HAPPEN:MANAGING LOSSES FORTHE INEVITABLE DATA BREACHElaine MossBROWN & JAMES PCSt. Louis, Missouri314-242-5208emoss@bjpc.comLisa MickleyHALL & EVANS, LLCDenver, Colorado303-628-3325mickleyl@hallevans.comAdam CottiniManaging Director – CyberLiability PracticesARTHUR J. GALLAGHER & CO.New York, New Yorkwww.ajg.comKatherine KeefeBreach Response ServicesDirectorBEAZLEY GROUPPhiladelphia, Pennsylvaniawww.bezley.com

IT IS BOUND TO HAPPEN:Managing Losses for the Inevitable Data Breach 1I. IntroductionIt is bound to happen. In fact it may already have happened and you do not even knowit. Reports of significant data breaches are becoming everyday news, and the troublingpart is that it is estimated that approximately twenty-five percent of breaches goundetected.Myriad studies have shown that the number of data breaches continues to rise. In 2013,33 percent of respondents to the Ponemon study reported that their company had adata breach. 2In 2014, that number had increased to 43 percent. Verizon’s 2014 DataBreach Investigations Report found 63,000 confirmed security incidents for the 2014reporting period. 3 In the first five months of 2014, there were 311 confirmed data breachevents with 8.5 million records exposed. 4The actual number of breaches is likely muchhigher since many breaches go unreported.If your company or firm has not yet suffered a data breach, your days are probablynumbered. Cyber risks vaulted to number eight on the top ten global business risk in1 Materials prepared by Elaine Moss of Brown & James, P.C., St. Louis, MO, and Lisa Mickley of Hall &Evans, LLC, Denver, CO.2 Ponemon Institute, 2014 Cost of Data Breach Study: Global Analysis,http://public.dhe.ibm.com/common/ssi/ecm/se/en/sel03027usen/SEL03027USEN.PDF.3 Www.verizonenterprise.com/DBIR/2014.4 Hartwig, Robert P., Cyber Risks: The Growing Threat, Insurance Information Institute.http://www.iii.org/white-paper/cyber-risks-the-growing-threat-062714 (last visited January12, 2015).

2014, up from number 15 in 2013. 5 Even the best managed information technologyprograms remain vulnerable to cyber attack. The breadth and depth of the attack is allthat remains unknown.II.The Legal Obligations to Respond to Data LeaksForty-seven states currently have laws requiring notification of security informationinvolving personal information. 6The federal laws and regulations requiring notificationof information breaches are more patchwork and industry-specific. For instance theGramm-Leach-Bliley Act 7covers financial institutions, while the Health InsurancePortability and Accountability Act governs healthcare 8 . Despite repeated efforts andcountless pieces of proposed legislation, a federal standard remain elusive. TheFederal Trade Commission has publicly announced the need for legislation that wouldallow the FTC to mandate more uniform data security standards, while clarifying thetiming and content for notification of a security breach. 9The proposed federallegislation has run the gamut on whether state notification requirements should be preempted,and this remains an issue to watch. In the 2015 State of the Union address,President Obama reiterated the need for legislation that encourages businesses to5 Allianz Risk Barometer 2014, January 2014, http://www.agces.allianz.com/assets/PDFs/Reports/Allianz-Risk Barometer-2014_EN.pdf.6 For a summary of the various state laws, seehttps://www.beazley.com/PreBuilt/databreach/allstates.pdf.7 P.L. 106-102, 15 U.S.C. § 6801, et seq. (1992)8 P.L. No. 104-191, 110 Stat. 1938 (1996).9 Prepared Statement of the Federal Trade Commission, Data Breach on the Rise: Protecting PersonalInformation From Harm, Before the Committee on Homeland Security and Governmental Affairs, U.S.Senate (Apr. 2, 2014),

share cyber-threat information with the federal government. The idea is to alert theDepartment of Homeland Security quickly when private companies are hacked sofederal law enforcement officials can help stop cyber criminals from striking again.Notification requirements pose one of the greatest financial burdens to industry. In April2012, the Congressional Research Service noted that in response to notification laws,the compromise of over 535 million records had been disclosed by data brokers,businesses, retailers, educational institutions, government and military agencies,healthcare providers, financial institutions, nonprofits, utilities, and Internet basedbusinesses. Since that time, the number of compromised records and resultingnotifications have increased exponentially.The average response cost for each record compromised by a data breach is roughly$200. Multiply that times tens or hundreds of thousands of records and this cost maythreaten not only the bottom line, but the health and viability of your business.III.Planning for the Expense of a Security Breaches/Cyber AttacksCompanies are becoming increasingly focused on identifying and preventing securitybreaches on the front end, however, there remains some lag with regard to respondingto the inevitable security breach. The good news is that in 2014 U.S. companies’perceptions of the cyber risks had increased at a faster pace than actual reported cyberevents. 10In 2013, 61percent of companies had a breach response plan in place that10 http://download.pwc.com/ie/pubs/2014_global_economic_crime_survey.pdf

increased to 73 percent in the 2014 study. Unfortunately, data breaches have alsoincreased in frequency and the cost of response has exploded.Based on current studies, the expected cost per record can be decreased throughformal management of the response plan. The average time to resolve a cyber attack is32 days at a cost of just over $1,000,000. 11 According to research conducted by thePonemon Institute, a formal incident response plan that is in place prior to the incident,can reduce the average cost of a data breach breach by as much as $17 per record.Having dedicated information security officer also can reduce the cost per lost or stolenrecord by another $10. 12In addition to the response cost, which can be substantial, companies also incurdamage to their reputation and stock value. Target put the cost of its December 2013 at$148 million, but it also was forced to lower its full-year earnings forecast in the wake ofthe breach and its stock took a hit. CIO Today, August 24, 2014 13 . Fortunately forTarget, over thirty percent of its response costs were covered by insurance. Id.However, since that initial estimate, a Minnesota court has ruled that consumers candirectly pursue Target for failure to protect their personal information. 1411 2013 Cost of Cyber Crime: United States, Ponemon Institute.12 2014 Cost of Data Breach Study: United States, Ponemon Institute.13 http://www.cio-today.com/article/index.php?story_id=111001SF8BY6.14 In re Target Corp. Data Sec. Breach Litigation, 2014 WL 7192478, 1 (D.Minn.) (D.Minn. 2014).

IV.Liability for Data BreachesHaving realized that a cyber event is likely, the next step to managing the risk isunderstanding possible legal liabilities that may arise from the event. The first, andmost obvious, is the litigation that arises out of the disclosure of personal information,usually on theories of negligence, breach of fiduciary duty, and/or breach of contract.As noted above, these disclosures expose the business to the costs of notification lawsand may also give rise to suits and claims. Recently the Federal Trade Commissionwas allowed to go forward with a suit against Wyndham Hotels for failure to protectcustomer data. 15Class action lawsuits have also been filed against several of the large companiesthat have suffered data loss. Twenty-five class action lawsuits were settled in the wakeof the 2007 TJ Maxx data breach which involved the theft of over 45 million credit anddebit cards. The settlement included: up to $1million to customers without receipts; upto $10 million to customers with receipts, $6.5 million in Plaintiffs’ attorneys fees; andthree years of creditor monitoring, reported to cost $177 million. 1615 FTC v. Wyndham Worldwide Corp., No. 2:13-cv-01887-ES-JAD, 2014 BL 94785, 2014 ILRC 1615, 37ILRD 470 (D.N.J. Apr. 07, 2014).16 Cyber Risks: The Growing Threat, supra.

V. Cyber Liability Insurance is a Must-Have for BusinessA. Commercial General Liability CoverageThe standard Commercial General Liability policy was not written with cyber risks inmind. In fact, the bulk of the policy provisions have been around since before SteveJobs started tinkering in his garage. The CGL policy generally provides two separateinsuring agreements. Coverage A insures for liability damages arising from bodily injuryor property damage. The standard definition of property damage is two-fold:a. Physical injury to tangible property, including all resulting loss of use of thatproperty. All such loss of use shall be deemed to occur at the time of thephysical injury that caused it; orb. Loss of use of tangible property that is not physically injured. All such lossof use shall be deemed to occur at the time of the “occurrence” that causedit. 17The 2007 edition added to that definition: “for the purposes of this insurance, electronicdata is not tangible property.”While there are several older cases finding that a data breach is property damage, the2007 amendment appears to resolve that question. On the other hand, the introductionof malware or worms may result in actual physical damage to the end users computerhardware, thereby meeting the above definition of property damage. Counsel shouldconduct a careful review to determine whether the alleged data breach resulted in anypotentially covered property damage.17 ISO, CG 00 01 12 07.

The CGL form contains a second insuring provision, Coverage B – Personal andAdvertising Injury. This coverage part insures against liability arising out of a list ofoffenses enumerated in the definition of “personal and advertising injury,” including:3. Oral or written publication, in any manner, of material that violates aperson’s right of privacy.Consider the following example, on April 26, 2011, Sony Corporation (Sony) disclosedthat 77 million records were compromised after its PlayStation network was hacked. Atthe time of the incident, Sony had a CGL policy with Zurich American InsuranceCompany and filed a claim under that policy. Zurich filed a declaratory judgment actionasking the court for a ruling that it was not obligated to cover the losses associated withthat breach. In February 2014, the court obliged. Travelers Companies has filed asimilar action seeking to avoid coverage for the P.F. Chang data breach. BusinessInsurance, Insurers Fight to Bar Cyber Cover under Commercial General LiabilityPolicies.1. The New ExclusionsThe Insurance Services Office, the industry leader in drafting insurance policy language,revised the standard CGL form in 2013. As part of that revision, ISO introduced anoptional endorsement that deletes the rights to privacy-related offenses such as oral orwritten publications that violate a person’s right to privacy. Further, in May 2014, ISOreleased several additional endorsements intended to limit coverage available underCGL policies for any cyber risks:

CG 21 06 05 14 (Exclusion – Access Or Disclosure Of Confidential OrPersonal Information And Data-Related Liability – With Bodily InjuryException) — excludes coverage, under Coverages A and B, for injury ordamage arising out of any access to or disclosure of any person’s ororganization’s confidential or personal information, including patents, tradesecrets, processing methods, customer lists, financial information, creditcard information, health information or any other type of nonpublicinformation.CG 21 07 05 14 (Exclusion – Access Or Disclosure Of Confidential OrPersonal Information And Data-Related Liability – Limited Bodily InjuryException Not Included) – which is very similar to CG 21 06 but does notinclude the bodily injury exception described above.CG 21 08 05 14 (Exclusion – Access Or Disclosure Of Confidential OrPersonal Information (Coverage B Only) — exclusion with respect to anyaccess to or disclosure of any person’s or organization’s confidential orpersonal information is limited to personal and advertising injuryB. Cyber Specific InsuranceThe cyber insurance industry has taken off in the last several years. It is estimated thatindustry premium for cyber coverage moved from $675 million in 2012 to $1 billion in2013. About 70 admitted and non-admitted carriers have entered the market spaceoffering a wide range or products. However, corporations must work carefully with their

okers to ensure that they have adequately disclosed their risks and matched theirinsurance to those risks. Cyber policy forms vary greatly in structure, terms andcoverages offered. Ensuring you have the coverage you need and expect requires acareful review of the insuring agreement, definitions, and exclusions.1. Definition of claimThe new cyber policies generally have a broader definition of claim, moving away from“bodily injury”, “property damage” and “personal and advertising injury.” The broadeneddefinition includes a demand for monetary and non-monetary damages.Cyber policies may limit coverage to internal and/or external cyber attacks. Likewise,coverage may be provided for directed viruses or malware, while excluding untargetedthreats distributed across the Internet.Cyber policies are being written as claims made, providing that a claim be made againstthe insured, and reported to the carrier within the policy period or the extended reportingperiod. But some policies also require that the cyber breach also take place during thepolicy period. This limitation can be deadly since the median time between an intrusioninto a company’s network and the discovery of the breach is 229 days. 18The longestreported presence without detection is over 2000 days. 19To avoid the gaps betweenthe intrusion and discovery, consider purchasing a policy with a retroactive date (that isinsurance jargon for pre-dating coverage to a specific time before the inception of thepolicy). Companies can also purchase policies with extended reporting (or tail)18 Mandiant, 2014 Threat Report – Beyond the Breach, https://dl.mandiant.com/EE/library/WP_M-Trends2014_140409.pdf19 Id.

coverage. This coverage provides coverage for losses that occurred within the policyperiod but that was not discovered until after the policy period.Cyber policies offer a variety of coverages and may include the following:2. First Party LiabilityIn insurance jargon, first party claims are those claims by the policyholder against itsinsurer seeking money for a loss that the insured sustained. This may take the form ofproperty loss, business interruption, etc. With the cyber insurance it is important thatthe first party coverage extend to the expenses the insured is likely to incur, such asnotification costs, credit monitoring, etc. In addition, the policy should protect theinsured’s intellectual property and information technology platforms, keeping in mindthat an entire business can be taken down simply by a talented hacker seizing control ofa company’s information technology platform.Extortion/Threat. This covers the cost for payments of electronic extortion whendata or systems are threatened and ‘ransom’ must be paid to prevent or mitigatethe damage. 20Business interruption. Similar to business interruption coverage in propertypolicies, this covers loss of income due to a cyber event, and often covers relatedexpenses incurred in returning the system to full operation.20 This cyber ransom affects individuals as well as corporations. Seehttp://www.nytimes.com/2015/01/04/opinion/sunday/how-my-mom-got-hacked.html (last visited January7, 2014).

Privacy notification. This covers the cost of statutorily mandated notices toindividuals whose personal information may have been compromised by abreach. The coverage often includes the cost of credit monitoring for potentiallyimpacted individuals.Theft losses. Some policies afford coverage for events in which a policyholdersuffers a loss due to wrongful transmission of data. For instance, if a breachresults in an unauthorized transfer of funds.Data recovery. Some policies afford coverage for the cost of replacement ofhardware, as well as the labor costs, of restoring systems impaired by a breach.Social media/Networking coverage. Some carriers are now offering coveragefor corporate social networking activities, including claims for defamation,advertising, libel, and slander.Cloud computing. The more common (to the extent there is commonality) cyberpolicies exclude losses incurred by third cloud providers. However, as cloudstorage becomes more widely used, the insurance market has responded withproducts that will protect the cloud providers against loss or theft of data theyhave been charged to store. See Track 2, Client Confidentiality in the Cloud, formore details.Whether the losses arise from misfeasance or malfeasance, the risk of loss is high.However, the risk of loss is even higher when cyberterrorism is behind the attack. Oneneed not go beyond the Sony hack to grasp the breadth and depth of the damage

esulting from a cyber terrorism attack and having the appropriate insurance in place iskey to a company surviving such an attack.3. Third Party LiabilityThird party liability insurance is intended to protect the insured for liability it may have toanother person or company arising from certain types of damages. For instance,commercial general liability insurance protects an insured from liability for bodily injury,property damage, and personal and advertising injury, which is not otherwise excludedby the policy provisions. The insurance company generally agrees to investigate anyliability claims, hire defense counsel, and pay claims for covered damages.The goal of cyber liability third party coverage is the same. It is intended to protect theinsured against claims brought by “third persons” as the result of a data breach or othercyber event. The most common third party specific coverages are:Cyber liability or data breach liability. This type of coverage is intended tocover liability for claims of third parties who allege they sustained damages dueto the disclosure of their personal information.Regulatory fines and penalties-This covers the legal, technical, or forensicservices necessary to assist the policyholder in responding to governmentalinquiries relating to a cyber attack, and provides coverage for fines, penalties,investigations or other regulatory actions.Crisis management and forensics costs. Some policies provide a sublimit forcrisis management and retention of a public relations consultant, as well ascoverage for the cost of computer forensics necessitated by the breach.

Advertising injury. Similar to Coverage B in CGL policies, some cyber policiesoffer coverage in the event that data displayed via your company’s websitecauses injury to third persons, such as defamation, invasion of privacy,plagiarism, misappropriation of copyright, etc.D&O/Management liability. Generally broad form/all risks coverage for officersand directors. Risks are covered unless specifically excluded.4. Apples to OrangesBecause of the vast differences in coverages, it is difficult to compare apples to apples,so each form must be carefully reviewed for the types of coverage. The devil is in thedetails – and in this case, in the definitions – so review of the insuring language is only afirst step in understanding the scope of coverage being purchased as the definitionsmay well limit what might otherwise appear to be broad coverage. Care should also betaken when reviewing the defense coverage as some policies afford defense outside oflimits, some provide that defense coverage erodes limits, and some provide that thecarrier has the right to recoup defense expenses under certain circumstances.Below are some samples of various policy terms with some cautionary notes to assist inyour review.

Policy A Policy B Commentary“The Company shall payLoss on behalf of anInsured on account of anyClaim first made againstsuch Insured during thePolicy Period or, ifexercised, during theExtended Reporting Period,for Injury.”Policy A“The Insurer will payDamages and ClaimsExpenses by reason of aClaim first made againstthe Insured during thePolicy Period and reportedto the Insurer . . . forWrongful Acts taking placeafter the Retroactive Dateand prior to the end of thePolicy Period.”CommentaryPolicy A requires only that theclaim be made and reportedduring the applicable period,whereas Policy B alsorequires the Wrongful Act toalso take place during thisperiod. Additionally, WrongfulAct is defined, generally, asan act by an insured.“The Insurer will pay Data BreachExpenses incurred by the Insured duringthe Policy Period by reason of a Claimreported to the Insurer . . . for anyWrongful Acts taking place after theRetroactive Date and prior to the end ofthe Policy Period.”Claim is defined as: “a written report byIntended to cover notification costs (as wellas other costs) associated with a breach, thelimitation in the definition of claim that therebe a failure on the part of the insured or anindependent contractor for which the insuredis legally responsible significantly limitcoverage. For instance, what if the failure isby a cloud storage provider?

the Insured to the Insurer of a failure bythe Insured or by an independentcontractor for which the Insured is legallyresponsible to properly handle, manage,store, destroy or otherwise controlPersonal Information.”Policy A Policy B CommentaryFor purposes of businessFor purposes of businessDepending on the business,interruptioncoverage,interruptioncoverage,the wait time of 24 businessPeriod of Restoration isdefined as beginning “afterthe time of interruption,degradation or failure of theComputer System.”Period of Restoration isdefined as beginning:“twenty-four (24) businesshours after the actualimpairment or denial ofOperations occurs.”hours may be significant interms of the potential for lostincome, and how businesshours are calculated, e.g., 8hour days, or 24 hour days.The duration of the coveragealso differs form to form,varying from 30 days to 120days of lost income.

Policy A“We will reimburse you for the ExtortionExpenses and Extortion Monies . . . paidby you and resulting directly from anyCredible Threat . . . during the PolicyPeriod.”CommentaryThe language of this policy expressly coversmoney paid for extortion to protect orrecover your data; however, other policiesoffering the same type of coverage onlycover related expenses (e.g., forensics,recovery of the data, etc.) by do not coverthe actual extortion payment itself.Policy A“Wrongful Act means any error,misstatement, misleading statement, actomission, neglect, breach of duty, orPersonal Injury offense actually orallegedly committed or attempted by anyInsured, in their capacity as such . . .”CommentaryThis definition raises the question whethercoverage is afforded in the event that anemployee steals data or otherwiseintentionally – that is, outside the scope oftheir employment – harms the informationsystem and should be carefully considered.6. The Cyber policy marketThe good news for companies purchasing cyber risk insurance is that rates arerelatively stable and new products are coming on the market every month.March &McLennan Companies estimated the gross premium for cyber products in 2013 was $1billion; M&M estimated that would double in 2014. Rates have been relatively stable,

even decreasing slightly in late 2013. 21However, as carriers develop loss history andbetter underwriting data, industries with a high incidence of cyber events may see ratesbecome unfavorable.7. Added Benefits of Cyber Risk PoliciesIn addition to the obvious financial benefit of having an insurance carrier pay for lossesresulting from a data breach, several carriers are offering additional services to help theinsurer limits those losses. For instance, in 2009 Beazley launched Beazley BreachResponse to help organizations protect themselves from the consequences of databreaches, including addressing the concerns of customers whose personally identifiabledata had been lost or stolen. BBR uses an in-house team of experts to coordinate theforensic, legal, notification and credit monitoring services that its insureds need tosatisfy various notice requirements and to maintain customer confidence through aquick and meaningful response.Other carriers provide similar services and thoseservices should be considered in the overall evaluation of the various policies available.VI.ConclusionData breaches are now a fact of life. It is not if, but when – so, how do you protect yourcompany from significant losses? Beyond good data management policies, companieshave to employ solid risk transfer strategies, including the purchase of cyber liabilitycoverage. Careful analysis of potential risk is the first step in evaluating the coverage21 Insurers struggle to get grip on burgeoning cyber risk market, Reuters, July 14, 2014,http://www.reuters.com/article/2014/07/14/us-insurance-cybersecurity-idUSKBN0FJ0B820140714 (lastvisited January 12, 2015).

needed. Once decisions have been made in that regard, a company can “go to market”for the specific insurance it needs to cover those risks. As noted above, it is alsoimportant to consider what additional services each carrier offers, since those will affectthe ultimate out of pocket expenses in the event of a breach.

2015 INTERNATIONAL CLIENT SEMINARFAIRMONT SCOTTSDALE PRINCESSSCOTTSDALE, ARIZONAMARCH 5-8, 2015Strategies for Battling Patent TrollsEugenia “Gina” CarterWHYTE HIRSCHBOECK DUDEK, S.C.Madison, Wisconsin(608) 234-6076gcarter@wdhlaw.comRonald S. KatzMANATT, PHELPS & PHILLIPS, LLPSan Francisco, California(650).812.1346rkatz@manatt.comBradley S. PaulsonVice President & Corporate CounselEPIC SYSTEMS CORPORATIONMadison, Wisconsinwww.epicsysinc.com10951932.2

Strategies for Battling Patent Trolls 1I. The Problem and Some Context.The controversy over “patent trolls,” which has been simmering for years, has finally heatedup and caught the attention of state and federal legislators, attorneys general and evenPresident Obama. Patent trolls, more objectively referred to as Non-Practicing Entities(NPEs), are companies formed to purchase patents and then, without using them toproduce any products, enforce the patents through licensing programs or litigation. NPE’scan also include universities or solo inventors that hold patents but do not produce or sellany products or services using their patented inventions.NPEs normally have all or some of the following characteristics:• No intention to practice the invention• Often acquire older patents and enforce against newer technologies• Often are represented on a contingent fee basis• Use threat of litigation and associated costs to force licensing of patent• Typically NPEs look to purchase broad patents in key technology areaswithin a particular industry• NPEs select speedy, more pro-plaintiff jurisdictions for lawsuits• Those with weaker patents target small companies who they believe can’tafford a defense (in 2013, average patent infringement costs in casesbrought by NPEs when $1 million to $10 million in damages was sought was$1.2 million through discovery and $2.1 million through trial) 21 Section I-V are authored by ALFA Attorney Eugenia (Gina) Carter of Whyte Hirschboeck Dudek, S.C.and Section VI is authored by ALFA Attorney Ronald Katz of Manatt, Phelps & Phillips, LLP.2 Am. Intellectual Prop. Ass’n, Report of the Economic Survey, I-129-30 2013.10951932.2 1

• Business method and software patents are often asserted by NPEsThe more negative moniker, patent troll, no doubt arose from the NPEs’ tactics of alleginginfringement and making a license demand without providing any real analysis of whetherits target was actually infringing the claims of the patent or even disclosing the actualidentity of its owners. The recent NPE tactic of blanketing small to medium companies withcease and desist letters on a range of business method and software patents has raisedawareness of the federal and state legislative and executive branches as the NPEs havebrought their tactics and lawsuits to Main Street.The other perspective advanced by some economists and the NPEs is that the increase inlawsuits reflects a legitimate activity of facilitating markets for technology. Those touting thebenefits of NPE activities often point to the sole inventor who lacks the financialwherewithal and business expertise to exploit the invention he or she has developed or toenforce their patents. In the view of some, NPEs provide a service to the economy byacting as market intermediaries that provide liquidity to inventors and increased efficiencyto patent markets.The fundamental public policy issue is whether the proliferation of NPE patent litigation isstifling innovation or is providing market efficiency in an economy where markets are king.The furor caused by some NPEs’ recent strategies of demanding payment and threateningsuits against end users who simply use the technologies sold to them by others (e.g.,software products to run their business or architecture for their e-commerce sites) hasattracted the attention of federal and state governments. Even President Obama weighed10951932.2 2

in by issuing five executive orders in 2013 and offering seven legislative recommendationsto Congress to help curb the challenges from NPEs.Congress and the states are facing the difficulty of addressing the patent troll concernbecause it requires restricting the patent rights found in the U.S. Constitution. States aresimilarly challenged and also will be blocked by the federal preemption doctrine that leavesthe patent sphere to federal law. Finally, drawing the line to protect some patent ownerswhile restricting the rights of others is no easy feat without running afoul of the Constitution.For more on the challenges of legislating against NPEs, see Ron Katz’s article that appearsat the end of this paper.This paper will explore the effects of NPEs on businesses’ proposed federal and statelegislative and regulatory responses and effective strategies for businesses to minimize thecosts of dealing with NPEs.II.By The Numbers: Statistics of NPEs – Actions and Impacton Businesses.As an initial matter, it should be noted that reasonable minds differ on whether there is apatent troll crisis. David Kapos, who headed the United States Patent and TrademarkOffice (USPTO) from 2009-2013, asserts that there is no such crisis at hand and that NPEsare not responsible for the increase in patent litigation 3 . In addition, the Government3 James Bessen, Patent Trolling Was Up 11 Percent Last Year, The Wash. Post (Jan. 31, 2014)http://www.washingtonpost.com/blogs/the-switch/wp/2014/01/31/patent-trolling-was-up-11-percent-lastyear/.10951932.2 3

Accounting Office (GAO) issued a report in August of 2013 that was required by § 34 of theAmerica Invents Act 4 that suggests that increase in litigation by NPEs is not as dramatic asposited by certain other studies by academics 5 . Specifically, the GAO report found thatNPEs brought approximately 20% of the filed patent cases between 2007 and 2011 6 .In contrast, according to RPX Corporation, a publically traded company that offers patentrisk management and acquisition services, in 2013 NPEs initiated 63% of all new patentlitigation (measured by total defendants) 7 . In addition, in 2012, according to a study byPatent Freedom, an entity that tracks NPE lawsuits, NPEs sued more “low tech” industrieslike retailers and financial institutions than technology companies 8 . Many of the patentsasserted by NPEs against retailers and financial institutions involve software or businessmethod and process patents.Recent articles from two Boston University Professors estimate that direct costs bydefendants in patent suits by NPEs were $29 billion in 2011 9 . The same authors concludedthat NPE lawsuits caused $500 billion of lost wealth to the targeted businesses from 1990-2010.4 Leahy-Smith America Invents Act, Pub L. 112-29 Enacted September 16, 2011.5 U.S. Gov’t Accountability Office, Intellectual Prop.: Assessing Factors That Affect Patent InfringementLitigation Could Help Improve Patent Quality (Aug. 22, 2013) http://www.gao.gov/products/gao-13-465.6 Id.7 RPX Corp., 2013 NPE Litigation Report, 4 (2014), http://www.rpxcorp.com/wpcontent/uploads/2014/01/RPX-2013-NPE-Litigation-Report.pdf.,last visited 1/7/158 Patent Freedom, Exposure by Industry (July 14, 2014), https://www.patentfreedom.com/aboutnpes/industry/.9 Michael Meurer et al., The Direct Costs from NPE Disputes, (Boston University School of Law, Law andEconomics Research Paper No. 12-34, June 28, 2012) https:/www.bu.edu/law/faculty10951932.2 4

A 2014 National Bureau of Economic Research paper by professors from HarvardUniversity and the University of Texas at Dallas concluded that the substantial increase inNPE lawsuits has had a detrimental effect on innovation 10 . The findings of this researchrevealed the following:• NPEs tend to sue firms that have significant pools of cash reserves or haverecently experienced positive cash inflows: “A one standard-deviation increase incash level increases the probability of being sued by an NPE by 11%. Given thatthe mean probability is 2%, this is more than a fivefold increase”. 11• Companies with smaller legal teams and a higher number of ongoing legalcases are more likely to be sued by NPEs. This suggests that they “target firms witha higher likelihood of settling,” thus “maximizing the expected profitability ofwinning.” 12• Comparing companies involved in lawsuits brought by NPEs where targetdefendants win a dismissal to companies where lawsuits are settled or continue tofinal court adjudication, the study found that the latter group of companies spent anaverage $211 million less on research and development in the years after thelitigation compared to the firms that had won the suits by dismissal. In addition,10 Lauren Cohen et al., Patent Trolls: Evidence from Targeted Firms (Nat’l Bureau of Econ. Research,Working Paper No. 20322, 2014).11 Id. at p. 4.12 Id. at p. 3.10951932.2 5

companies forced to settle or proceed through litigation significantly reduced theirpatenting activity in subsequent years. 13The authors conclude that “The stakes of how to organize intellectual property disputes aremassive.” “If the United States becomes a less desirable place to innovate because NPEsare left unchecked, innovation and human capital and the returns to that innovation andhuman capital will likely flee overseas.” They suggest that the “marginal policy responseshould be to more carefully limit the power of NPEs or increase the cost of bringing suitagainst commercializers of innovative ideas.” 14III.How NPEs Operate.NPEs normally enforce patents that are applicable to a broad range of products or services.Prior to the passage of the America Invents Act (AIA) NPEs would join multiple defendantsin one lawsuit. Post AIA NPEs must file separate lawsuits against each defendant. Evenwith this change, NPEs often file a number of lawsuits in the same court against manyindividual defendants. While each defendant has the right to its own trial, they now find thatmany district courts such as the Eastern District of Texas have consolidated many aspectsof the pre-trial process such as discovery to conserve judicial resources.NPEs often identify defendants that have a lot to lose, such as companies whose businessis substantially dependent on the product that allegedly infringes the NPE’s patent or that13 Id. at p. 4.14 Id. at p. 26.10951932.2 6

cannot afford costly litigation in hopes of obtaining an early victory in court throughsummary judgment or a settlement. After getting a more vulnerable defendant to take alicense, the NPE hopes to encourage other companies to submit to licenses without theneed for litigation.NPEs tend to bring lawsuits in federal district courts that are seen as more friendly to patentowners, such as the Eastern District of Virginia, the District Court of Delaware, the EasternDistrict of Texas, and the Western District of Wisconsin. 15These districts tend to haveshorter time-to-trial, higher success rates for patent owners and greater median damageawards. 16More and more NPEs are suing the retail sellers of products that they claiminfringe, not just the manufacturers. This is permissible because under U.S. Patent Law,patent owners can sue any party that “makes, uses, offers to sell, or sells any patentedinvention”. 17Many smaller retailers unaccustomed to involvement in patent litigation areoften more likely than technology companies to agree to a license early on to avoid theuncertainty and unpredictability of a patent trial. NPEs are aggressively enforcing softwareand business method patents involving on-line shopping technologies and interactivenavigation features and mobile applications that permit retailers to interface with customers.A common practice for NPEs is to blanket businesses or manufacturers with cease anddesist letters before filing suits. These letters often contain general allegations ofinfringement without specifying how exactly the service or product is infringing the patent.15 PricewaterhouseCoopers LLP, 2014 Patent Litigation Study: As Case Volume Leaps, Damages ContinueGeneral Decline 17 (July 2014), http://www.pwc.com/en_US/us/forensic-services/publications/assets/2014-patent-litigation-study.pdf.16 Id.17 35 U.S.C. § 271(a).10951932.2 7

These letters contain an offer to license the patent for an amount that is significantly lessthan the fees and costs of litigation which on average are over $2 million through trial.NPEs often recite the list of well-known companies that have already taken licenses for thepatent from the NPE to encourage other companies to settle without significant delay thatcould increase the NPEs’ costs in extracting a settlement.Not surprisingly, NPEs try to reduce transactional costs in securing settlements and aremost often represented on a contingency basis by the law firms they hire to draft thedemand letters and file suits. Technical experts are sometimes hired on a contingencybasis as well.As the GAO study noted there is not “reliable data on patent assertion outside the courtsystem,” 18 therefore the full extent of payments by business to NPEs cannot be easilymeasured. The Electronic Frontier Foundation (EFF) and others are urging Congress torequire NPEs to report publically the cease and desist letters they send. 19 In the meantimethe EFF is collecting data from business that receive such letters and the information isavailable at https:/www.trollingeffects.org. Interestingly, the Federal Trade Commission(FTC) has taken on NPEs that send out cease and desist letters that contain deceptiverepresentations. Specifically, the FTC entered a settlement with MPHJ TechnologyInvestments, LLC which has contacted thousands of small businesses over its scannerpatents and alleged the businesses infringed the patents by scanning documents to e-18 Supra note 5.19 Julie Samuels, GAO Study Confirms the Obvious: Bad Patents Lead to Trolls, Electronic FrontierFoundation (Aug. 22, 2013) https://www.eff.org/deeplinks/2013/08/gao-study-confirms-obvious-badpatents-lead-trolls.10951932.2 8

mail. 20 The FTC ordered MPHJ to stop using “deceptive sales and phony legal threats” inits patent licensing demand letters.IV.Legislative and Regulatory Efforts to Curb the Certain NPEActivities.Beginning in the fall of 2013, several bills were introduced in the U.S. Congress to addresssome of the tactics of NPEs that were causing U.S. businesses concern. The InnovationAct (H.R. 3309) introduced by House Judiciary Committee Chairman Bob Goodlatte (R-Va),passed the House of Representatives but became stalled in the Senate. With the newRepublican majority in the Senate, Rep. Goodlatte and Rep. Darrell Issa (R-CA), theIntellectual Property Subcommittee Chair, have pledged to move the legislation forwardagain. The bill that passed the Congress in late 2013 had the following key features:• a requirement that the plaintiffs who are patent asserting entitles (PAEs)provide much more detail on exactly what products infringe which patentclaims• an attorney fees shifting clause that would make it easier for defendants whoprevail in the suits to recover their attorneys’ fees from the plaintiff• a limitation on core discovery from the plaintiff prior to claim construction• a customer-suit exception.The customers-suit provision allowed manufacturers and suppliers to join the lawsuits andstay the case against the customers until the other parties litigated the matter.20 In re MPHJ Tech. Invs. LLC et al, File No. 142 3003 (F.T.C., 2014).10951932.2 9

In addition to these federal legislative efforts, several state attorneys general (AGs) haveresponded to the outcry from small and medium size businesses, who are often the targetsof PAEs, who know that these business cannot afford the millions of dollars that a litigationdefense costs. The AGs of Vermont, Minnesota, and Nebraska have relied on state unfairtrade practice statutory powers to go after PAEs who engage in the mass mailing of ceaseand desist letters to smaller businesses. The Vermont legislature also passed a billpermitting the recipient of a “bad faith” infringement claim to sue the PAE in state court.The Nebraska Attorney General, using state consumer protection laws, launched a suit in2013 against NPEs MPHJ and Activision TV. In September of 2014, a federal court ruledthat the Nebraska Attorney General’s attempt to curb cease and desist letters was aviolation of the NPEs First Amendment Rights and that federal law preempts stateconsumer protection laws. It even awarded the NPE $750,000 in attorneys’ fees againstthat state. 21The Nebraska Attorney General has vowed to fight on.In contrast, the Minnesota AG obtained a consent decree from one PAE requiring that itstop sending infringement demand letters to state business unless it first gives the AGnotice and obtains its consent to proceed. The Attorney General in Vermont has faredbetter in at least one attempt to use state consumer protection laws to restrain NPEs. As ofDecember, 2014 that case is proceeding in state court in Vermont. 2221 Bernard Nash & Christopher Allen, A Tale of Two ’Patent Troll’ Cases: Contrasting RecentDevelopments in the Vermont and Nebraska AGs’ Litigations, State AG Monitor (Dec. 18, 2014)http://www.stateagmonitor.com/2014/09/05/.22 Lisa Shuchman, Vermont AG Beats Appeal By Accused Patent Troll MPGH, ALM (Aug. 11, 2014),http://www.law.com/sites/articles/2014/08/11/vermont-ag-beats-appeal-by-accused-patent-troll-mphj/10951932.2 10

As Ron Katz’s article at the end of this paper indicates, it is very difficult to legislate againstcertain NPE tactics. As mentioned earlier in this paper, reasonable minds can differ onwhether there is even a problem with NPEs at least measured by the data available on filedlaw suits and adjudications. In December of 2014 at a patent reform discussion held by theFederalist Society for Law and Public Policy Studies, former Chief Judge Paul Michel, whoheaded the U.S. Court of Appeals where patent cases are heard, stated that the push forpatent reform comes from “massive PR and what I would characterize as propaganda.” 23However, businesses across America are reporting to their elected officials and state andfederal regulators that NPEs are costing their businesses money by attempted enforcementof invalid patents.V. Strategies for Dealing with NPEs.A. Responding to the Cease and Desist Letter.It is important to review and understand the allegations in the letter sent by the NPE. If theletter is vague and lacking specifics as to what products or services offered by the businessare infringing and how they are infringing the business should seek more specifics. Thisbuys more time to conduct due diligence on the patent and the NPE. The businessreceiving the cease and desist letter and licensing demand needs to determine whether:1. It makes or uses the patented invention;23 Grant Gross, Conservative Lawyers Question Need for Patent Troll Legislation, PCWorld (Dec. 2,2014), http://www.pcworld.com/article/2854532/conservative-lawyers-question-need-for-patent-trolllegislation.html.10951932.2 11

2. The scope of the patent and when it will expire;3. Are there any ownership or assignment problems, e.g. is the NPE the actualowner of the patent?;4. Is there a third-party that provided the product or service to the business thatmight have an obligation to indemnify the business in the event of aninfringement allegation?5. Has the NPE sued anyone under the patents asserted and what has beenthe result? and6. If there are lawsuits in process has a joint defense group formed that couldbe contacted for further information on the NPE and the patent?Focusing for a moment on number 4 above, it is important especially in IT and technologylaw contracts to include indemnification provisions that require the software vendor ortechnology consultant to indemnify the business in the event of a third-party allegation ofinfringement. Such provisions should include the obligation to defend against such claimsincluding the costs and fees of any litigation. As soon as a cease and desist letter isreceived businesses should check the relevant vendor contracts and if an indemnificationprovision exists, the business should be sure to comply with all requirements for notice.Even if there is no provision in the contract a common law indemnification claim might existunder applicable state law.10951932.2 12

B. Reducing Costs of Defending NPE Suits.If the NPE has filed suits on the same patent(s) against multiple defendants, a businessshould form and join a joint defense group. Subject to a specific, written joint defenseagreement that will help maintain an attorney-client privilege among the members of thegroup, the members can divide up much of the work and spread the cost burden amonggroup members. It is important to stay active in such groups and participate in weekly callsto be sure that if a very active member settles early the remaining members are in aposition to proceed to defend the case knowledgeably.If early settlement is an option it is important to conduct an analysis to determine thestrength of the infringement claims, the likely damages if the NPE prevails and the chancesof prevailing in a summary judgment motion without a trial. Clearly the costs and businessdisruption must be considered as well. Part of this analysis should include gaining a firmunderstanding of the technology accused of infringing that includes outside counsel, insidecounsel and the relevant business and marketing staff. It is possible that a very clearargument for non-infringement might emerge that will convince the NPE to move on to itsnext target.While many businesses feel like they are being extorted by NPEs and may decide to fighton principle, if a low dollar settlement can be obtained quickly it should be considered.Businesses should be very careful in setting forth deadlines and discovery requirements incase management and discovery orders. Remember the NPE will have little or nodiscovery to provide but the defendant will have a significant burden in these cases.10951932.2 13

Finally, if the NPE comes calling, business should consider invoking the post-grantchallenge options that were expanded by the AIA. This could disrupt any court litigation.They include: a) post-grant review, 24 b) Ex parte reexaminations 25 and c) inter-partesreexaminations. 26 These new proceedings must be competed with a year. While they areless expensive than federal court legislation, they could still cost hundreds of thousands ofdollars to pursue, but not the millions that a patent case in federal court could cost.C. Tools Available at the USPTO to Challenge Bad Patents.1. Post-Grant Review. This is an administrative proceeding heard by thePatent Trial and Appeal Board (PTAB) instituted by a third party to cancel issued claims onany available statutory ground. This proceeding is only available for patents filed March 16,2013 and after and it is only available for the first nine months after the patent issues. Anyaspect of patentability can be challenged and could include: unclear claims, lack of anenabling disclosure, inadequate written description, subject matter that is not eligible forpatent and/or an invention that is already known or obvious when considering the suppliedprior art. A Post-Grant Review cannot be filed if the challenger already filed a DeclaratoryJudgment action in federal court. If a Declaratory Judgment action is filed on or afterpetitioning for Post-Grant Review, the Declaratory Judgment action will be automaticallystayed until the patent owner moves the court to lift the stay, the patent owner files a courtaction or counterclaim alleging the Post-Grant Review petitioner has infringed the patent or24 35 USC §§ 321-329.25 35 USC §§ 301-307.26 35 USC §§ 311-318.10951932.2 14

the petitioner moves the court to dismiss the court action. 27It should be noted that achallenger in a Post-Grant Review cannot reassert in subsequent Unites States Patent andTrademark Office or International Trade Commission proceedings or District Court litigation,issues that were raised or reasonably could have been raised in the Post-Grant Review.2. Reexaminations. Any person can request reexamination of a patentbased upon new prior art (printed publications). There are two types of reexaminations.(a)Ex parte. After reexamination is granted, only the patent ownercan participate in the Patent Office proceedings.(b)Inter partes. The requestor and patent owner participate inprosecution before the examiner.It should be noted that the requestor is estopped from raising in federal court litigation thesame issues or issues that could have been raised in the Patent Office proceedings. Adefendant can request a stay of an infringement litigation if reexamination of the assertedpatents is ongoing. It is advisable to file the request at an early stage of the litigation, andthe chances are better for the stay if all asserted claims are being reexamined. The grantof a stay is in the discretion of the District Court judge, and the denial of stay cannot beappealed. In addition, even if stay is not granted, the rejection of claims in reexaminationmay have significant influence on the jury.27 35 U.S.C. § 325 (a)(2).10951932.2 15

So far, these new USPTO tools have been invoked even more frequently than anticipatedto challenge patents of all sorts. 28These proceedings often result in the cancellation ofsome claims. 29VI. The Difficulties of Legislating against “Trolls”/PAE’s(Patent Assertion Entities)/NPEs (Non-Practicing Entities).Patents are crucial to technologically advanced countries like the U.S. Protectingintellectual property through strong patent rights is, therefore, significant to the economicstrength of the U.S. Consequently, it is crucial that any anti-troll/PAE/NPE legislation notaffect legitimate patent owners. Defining such patent owners can be very difficult, however,leading to proposed legislation that risks undermining “good” as well as “bad” patentowners.A. Difficulty #1: Patents Are Property Created by theConstitution.Patent rights did not originate from statute or case law but rather from the U.S. Constitution.Article I, Section 8 gives Congress the duty “To promote the Progress of Science anduseful Arts, by securing for limited Times to Authors and Inventors the exclusive Right totheir respective Writings and Discoveries.”28 Ryan Davis, AIA Reviews A Growing Worry for Patent Owners, Attys Say, Law360 (April 3, 2014),http://www.law360.com/articles/523215/.29 Id.10951932.2 16

Therefore, it is important to bear in mind that a patent is property, subject to all the relevantconstitutional protections. The basic premise of patent law is that, in exchange fordisclosing an invention publicly, the inventor receives a property right that excludes othersfrom using the invention without the inventor’s permission.To date, that property right does not vary depending on what category of person owns thepatent, e.g., troll or non-troll. Lessening a property right for some and not others presents aformidable legislative drafting problem. Exemplifying this problem is a quote from JudgeSue Robinson of the Federal District Court in Delaware, which decides many patent cases:With respect to the characterization of [Plaintiff] Cradle IP as ‘simply alitigation vehicle for Cradle Technologies,’ many businesses andacademic institutions enforce their patent rights through privatecompanies (like Cradle IP); such a business strategy is not nefarious.The court declines to treat such non-practicing entities as anythingless than holders of constitutionally protected property rights, thoserights having been legitimized by the Patent & Trademark Office. 30B. Difficulty #2: Defining Trolls.In general, trolls are defined as non-practicing entities that “do not manufacture products,but instead hold licenses to numerous patents, which they license and enforce againstalleged infringers.” 31This definition has its problems, because it would include, for30 Cradle IP, LLC v. Tex. Instruments, LLC, Case No. 1:11-cv-01254-SLR, Feb. 13, 2013, Order onDefendant’s Motion to transfer, at *4.31 Taurus IP, LLC v. Daimler Chrysler Corp. et al., 519 F. Supp. 2d 905, 911 (W.D. Wis. 2007).10951932.2 17

example, a medical school professor who invented the cure for a disease but did not havethe wherewithal to manufacture the cure.For that reason, proposed legislation has attempted to add more precision to trolldefinitions than is reflected in the definition in the paragraph above. For example, in 2013 abill was introduced in the U. S. House of Representatives, the Saving High-Tech Innovatorsfrom Egregious Legal Disputes (SHIELD) Act of 2013. 32It solves the medical professorproblem posed above by defining a non-troll, who would not be subject to the onerous feeshiftingprovisions contained in the Act: A non-troll would be (1) an inventor or originalassignee of the patent, (2) one who has made substantial investment in the exploitation ofthe patent through production or sale of an item covered by the patent or (3) a university oruniversity-associated tech transfer organization. 33This draftsmanship, however, appears to create as many problems as it solves. For one,the definition is going to create constitutional problems distinguishing one class of propertyowners from another. For another, there are substantial for-profit universities operating inthe U.S. which could be selling/licensing patents for the same motive—profit—for whichtrolls sell them. Yet another problem is that it is difficult to justify penalizing a patent ownerin a capitalist system who is selling/licensing something for a profit. That would describe99.9% of those selling/licensing patents, trolls and non-trolls alike.32 H.R. 845, 113 th Cong. (2013).33 Id.10951932.2 18

C. Difficulty #3: Diminution of the Value of Patents.There is a reason that property can be freely bought and sold in a capitalist society: freemovement of goods and services increases wealth for everyone. Therefore, making itdifficult to transfer property is a substantial problem.The proposed SHIELD Act above, however, which is typical of anti-troll legislation, doesexactly that. Making it difficult for a patent owner to enforce a patent (through onerous feeshiftingprovisions) makes the patent less valuable because it is more expensive to enforcethan a patent which is easier to transfer. For example, a start-up company’s most valuableasset is often its patents. If those patents have been purchased from a third-party and thestart-up has not manufactured its product yet, then that company will be undervalued whenit costs more to enforce those patents.Furthermore, if the start-up goes bankrupt, as many do, before manufacturing its product, itwill be harder to reap value from those patents for the investors or creditors. In short,commerce will be clogged in this important sector of the economy, the lifeblood of which isintellectual property.D. Difficulty #4: Problematic Legislation Creates MoreLitigation.It is naïve to believe that legislation can provide a magic bullet against constitutionallyprotected property and at the same time spare the legitimate patent owners that give theU.S. a strong technological comparative advantage. Litigation will still occur, and it will bemore expensive because the interpretation of problematic statutes will be part of it.10951932.2 19

The best solution to abusive litigation is to fight it. The win/loss record of trolls has declinedprecipitously in recent times. Defeating trolls in court is far more effective in the long runthan trying to legislate them out of existence.VII. Conclusion.Addressing the challenges to businesses caused by an increase in patent litigation broughtby NPEs is clearly, as this paper shows, not an easy task. At its core the problem has quitea bit to do with the issuance of questionable, weak patents. There is no question that badpatents engender more lawsuits. Limiting the scope of patentable subject matter andproviding the patent office the resources it needs to better do its job is crucial. Forexample, perhaps Congress should focus on closing the Pandora’s Box opened by the U.S.Federal Circuit Court of Appeals when it broadened the scope of patent protection byrecognizing the patentability of business methods and software. The U.S. Supreme Courthas effectively adopted this view by declining to rule, when given the opportunity, thatbusiness method patents are categorically un-patentable 34 . Ironically, the Supreme Courtin recent years has tried to fix the patent system through a series of decisions limiting thescope of patentable subject matter 35 and lowering the standard to prove invalidity byshowing that an invention is “obvious” in light of prior inventions and known science andtechnology. 3634 See e.g., In Re Bilski, 561 U.S. 593, 130 S. Ct. 3218, 177 L, Ed, 792 (2010)35 Alice Corp. Pty. v. CLS Bank Int'l, 134 S. Ct. 2347, 2349, 189 L. Ed. 2d 296 (2014).36 KSR Int'l Co. v. Teleflex Inc., 550 U.S. 398, 398, 127 S. Ct. 1727, 1728, 167 L. Ed. 2d 705 (2007).10951932.2 20

Given the constitutional constraints of limiting the patent right and the risks inherent intrying to limit certain NPEs while protecting others, e.g. individual inventors who do notcommercialize the invention or universities that generate many patentable inventionsthrough the research of faculty but do not commercialize, focusing on improving the qualityof patents by weeding out overbroad, obvious and vague patents at the issuance stageremains critical. Clearly courts have a part to play in managing patent litigation brought byany party, including NPEs, to achieve early disposition of cases before trial and managingand limiting discovery abuses that are often part and parcel of these NPE lawsuits.Legislative initiatives that improve the patent examination process to improve the quality ofpatents and the efficiency of patent litigation are also important and should be supported byall sides in this debate.10951932.2 21

2015InternationalClientSeminarALFAINTERNATIONAL2015INTERNATIONALCLIENTSEMINARFIRSTWORLDCHALLENGES:FINDINGPRACTICALSOLUTIONSIN ASHRINKINGGLOBALECONOMYTRACK3:HUMAN RESOURCES

2015 INTERNATIONAL CLIENT SEMINARFAIRMONT SCOTTSDALE PRINCESS HOTELSCOTTSDALE, ARIZONAMARCH 5 – 8, 2015Lions, Tigers, and Bears –When Compliance Officers or In-House CounselBecome WhistleblowersColleen P. LewisDINSMORE & SHOHL LLPCincinnati, Ohio(513) 977-8426CLewis@dinsmore.comSchaun D. HenryMCNEES WALLACE & NURICK, LLCHarrisburg, Pennsylvania(717) 237-5346SHenry@mwn.comDonna RobertsCRACKER BARREL OLD COUNTRYSTORE, INC.Lebanon, Tennesseewww.crackerbarrel.comJill Hamill SophaHARLEY-DAVIDSON MOTORCOMPANYMilwaukee, Wisconsinwww.harley-davidson.comJustin H. McCarthy, IIDENTSPLY INTERNATIONALYork, Pennyslvaniawww. dentsply.com

Lions, Tigers, and Bears—When Compliance Officers orIn-House Counsel Become WhistleblowersI. IntroductionAmong the most difficult category of cases for employers to defend are whistleblowerand other retaliation claims brought by employees. The proliferation of anti-retaliationlaws and the difficulty in defending this category of employment cases have forcedemployers and courts to wrestle with the effects of these laws on employers’ decisionsto take adverse employment action against a potential whistleblower. This situation iseven further exacerbated when a whistleblower turns out to be a trusted professionalsuch as in-house counsel or even a compliance officer.On the other side of the court room sit sophisticated plaintiffs pursuing such claims.Consider the following:• In August, 2014, the Occupational Safety and Health Administration(“OSHA”) ordered reinstatement and a $220,000 back pay award to aterminated environmental specialist who raised nuclear and environmentalsafety concerns to his employer, Washington River Protection Solutions, aU.S. Department of Energy nuclear waste facility contractor. Theenvironmental specialist was found to have been terminated for voicing hisconcerns, a violation of the federal whistleblower provisions of the EnergyReorganization Act. 1• In September, 2014, the Securities and Exchange Commission (“SEC”)handed out the first-ever whistleblower bounty awarded to a complianceprofessional under the Dodd-Frank Act. The SEC awarded $300,000 to a1See www.osha.gov/pls/oshaweb/owadisp.show_document?p_table=NEWS_RELEASES&p_id=26571(Aug. 20, 2014).

compliance and audit staffer who provided a tip to the SEC that ultimatelyled to an enforcement action. (The Dodd-Frank whistleblower provisionrequires a 10% to 30% payout to the whistleblower of collected sanctionsof more than $1 million dollars.) 2• An ex-Vanguard Group, Inc. attorney filed a $1 billion dollar whistleblowerlawsuit in August, 2014, alleging that he was terminated by Vanguard afterhe alleged that the company failed to pay taxes and file tax returns forseveral years in New York. 3• The SEC awarded three whistleblowers nearly $15 million dollars underthe Dodd-Frank whistleblower program. A complaint was filed as a resultof a dispute amongst the three individuals over the allocation of the awardin June, 2014. 4• In October 2014, the SEC awarded 30 million dollars to a non-US citizenwho reported a fraud that would otherwise have gone undiscovered. Therecipient was not a compliance officer, but the award is the largest ever ofDodd-Frank's 14 such awards to date. With this sort of money in play,loyalty may be in short supply. 5• An employee sentenced to 2-1/2 years in federal prison still walked awaywith $104 million dollars after being awarded such by the I.R.S. 62 Ed Beeson, SEC Strikes Fear with First Award to Compliance Pro, (Sept. 03, 2014), www.law360.com3 Kirsten Grind, Vanguard Case Tests Rights of Lawyer Whistleblowers, Wall Street Journal, Aug. 08,2014.4 See Tung v. Sears, No 14-CV-4699, complaint filed (N.D.Ill. June 23, 2014).5 Rachel Louise Ensign, SEC to Pay $30 Million Whistleblower Award, its Largest Yet, Wall Street Journal,Sept. 22, 2014.6 David Kocieniewski, Whistleblower Awarded 104 Million by IRS, New York Times, Sept. 11, 2012.

II. Retaliation Claims Enforced by the Equal EmploymentOpportunity Commission under Anti-Discrimination LawsRetaliation claims represent the largest category of claims filed with the EqualEmployment Opportunity Commission (“EEOC”). 7The EEOC is the federal agencywhich has jurisdiction to investigate charges of discrimination under several federallaws. All of the anti-discrimination laws set forth below also provide anti-retaliationprovisions which prohibit employers from taking adverse employment action against anemployee because the employee has opposed any practice made unlawful under therelevant laws, or because the employee has made a charge, assisted, or participated inan investigation or proceeding under the respective laws.1. Age Discrimination in Employment Act (“ADEA”). The ADEA prohibitsdiscrimination on the basis of age. 82. Americans With Disabilities Act of 1990, as amended (“ADA”). The ADAprohibits discrimination against qualified individuals with a disability. 93. Genetic Information – Non-Discrimination Act (“GINA”). GINA prohibitsdiscrimination on the basis of genetic information with respect toemployment and health insurance. 104. Title VII of Civil Rights Act of 1964 (“Title VII”). Title VII prohibitsdiscrimination on the basis of sex, race, color, national origin, or religion.117 See www.eeoc.gov/eeoc/statistics/enforcement/charges.cfm (last viewed Dec. 9, 2014).8 29 U.S.C. § 623(d).9 42 U.S.C. § 12203(a).10 42 U.S.C. § 2000ff-6(f).11 42 U.S.C. § 2000e(3a).

III.Retaliation Claims Enforced by the Department of LaborThe Fair Labor Standards Act (“FLSA”), which imposes minimum wage and overtimerequirements, as well as the Family Medical Leave Act (“FMLA”), which mandates thatcovered employees be permitted family and medical leave, are enforced by theDepartment of Labor (“DOL”), Wage & Hour Division. Both of these federal lawscontain anti-retaliation provisions. 12IV.Anti-Retaliation Provisions Enforced by the Occupational SafetyHealth Administration1. Affordable Care Act 132. Asbestos Hazard Emergency Response Act 143. Clean Air Act 154. Comprehensive Environmental Response, Compensation and LiabilityAct 165. Consumer Financial Protection Act of 2010 176. Consumer Product Safety Improvement Act 187. Energy Reorganization Act 1912 See 29 U.S.C. §215(a)(3) and 29 U.S.C. §2615.13 29 U.S.C. §218C.14 15 U.S.C. §2651.15 42 U.S.C. §7622.16 42 U.S.C. §9610.17 Section 1057 of the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010; 12 U.S.C.A.§5567.18 15 U.S.C. §2087.19 42 U.S.C. §5851.

8. FDA Food Safety Modernization Act 209. Federal Railroad Safety Act 2110. Federal Water Pollution Control Act 2211. International Safe Container Act 2312. Moving Ahead for Progress in the 21 st Century Act 2413. National Transit Systems Security Act 2514. Occupational Safety and Health Act, Section 11(C) 2615. Pipeline Safety Improvement Act 2716. Safe Drinking Water Act 2817. Sarbanes-Oxley Act 2918. Seaman’s Protection Act 3019. Solid Waste Disposal Act 3120. Surface Transportation Assistance Act 3221. Toxic Substances Control Act 3320 21 U.S.C. §399d.21 49 U.S.C. §20109.22 33 U.S.C. §1367.23 46 U.S.C. §80507.24 49 U.S.C. §30171.25 6 U.S.C. §1142.26 29 U.S.C. §660.27 49 U.S.C. §60129.28 42 U.S.C. §300j-9(i).29 18 U.S.C.A. §1514A.30 46 U.S.C. §2114.31 42 U.S.C. §6971.32 49 U.S.C. §31105.33 15 U.S.C. §2622.

Century 3422. Wendell H. Ford Aviation Investment and Reform Act for the 21 stV. Sarbanes-Oxley ActSection 806 of the Sarbanes-Oxley Act of 2002 (“SOX”) protects employees of publiclytraded companies who provide information, assist in an investigation, or report what theemployee “reasonably believes” to be a violation of the Securities and Exchange Act orany provision of federal law relating to fraud against shareholders. 35Employee whistleblowers who report improper conduct or who participate in relatedproceedings are protected from retaliatory action including discharge, demotion,suspension or being threatened or harassed or discriminated against for engaging insuch protected activity. Successful litigants can recover reinstatement, back pay, andany other compensatory damages, including attorney’s fees. 36To obtain relief, whistleblowers must first file a complaint with the Secretary of Laborwithin 180 days after the alleged violation, or the date on which the employee becameaware of the violation, whichever is later. If the DOL does not issue a final decisionwithin 180 days after the employee files the complaint, the employee may file an actionin federal court and is entitled to a jury trial. 37A company served with a SOX complaint must submit a position statement andsupporting documents to OSHA within 20 days of receipt of the notice of complaint.The company’s response is not kept confidential. OSHA will provide copies of the34 49 U.S.C. §42121.35 18 U.S.C. §1514A.36 Id.37 Id.

esponse to the complainant. Within 60 days of filing of the complaint, the AssistantSecretary will issue written findings as to whether there is reasonable cause to believethe company has retaliated against the complainant in violation of SOX. If “reasonablecause” is shown, a preliminary order will be issued providing relief for the complainant. 38The parties will be notified of the right to object to findings and/or the order, and torequest a hearing. If the preliminary order requires reinstatement, such relief is effectiveimmediately upon the company’s receipt of the preliminary order, regardless of anyobjections filed by the company. 39If a request for a hearing is made, the Administrative Law Judge (“ALJ”) will make a denovodetermination. The proceedings allow for pre-hearing discovery, includingdepositions. If the judge concludes that the company violated the law, an order for reliefnecessary to make the employee whole will be issued. If the judge determines thecompany did not violate the law, the judge will dismiss the complaint. An employer mayfile an appeal within 10 business days of the judge’s decision with the DOL’sAdministrative Review Board (“Review Board”). The Review Board’s decision shouldissue its decision within 120 days from the conclusion of the administrative hearing.Within 60 days after the issuance of the final order, an aggrieved party may file apetition for review with the appropriate United States Court of Appeals. 4038 Id.39 Id.40 Id.

VI.Dodd-Frank Anti-Retaliation ProvisionsSection 922 of the Dodd-Frank Act applies to publicly traded companies and providesnew incentives to whistleblowers to report corporate malfeasance. 41The incentivesinclude provisions for bounties and an anti-retaliation provision. The anti-retaliationprovision prohibits employers from taking adverse actions against a whistleblower who:(1) provides information to the SEC; (2) initiates, testifies in, or assists in aninvestigation of the SEC related to such information; or (3) makes disclosures requiredunder SOX or the Securities Exchange Act or other rule or regulation subject to theSEC’s jurisdiction. 42The bounty provision requires the SEC to pay whistleblowersbetween 10% and 30% of collected monetary sanctions for voluntarily providing originalinformation in a successful SEC enforcement action which results in the collection of atleast $1 million in sanctions. 4341 In October, 2014, the Second Circuit Court of Appeals found that the anti-retaliation provisions of Dodd-Frank do not apply to a non-citizen employed abroad by a foreign company. The case involved aTaiwanese citizen who reported Siemans China for alleged violations of the Foreign Corrupt PracticesAct. The employee alleged he was demoted then fired in retaliation for making the complaint. See LiuMeng-Lin v.. Siemens AG, 763 F.3d 175 (2d Cir. 2014).42 There is a debate over whether or not a report made only internally will suffice. See Asaid v. G.E.Energy United States, LLC, 720 F.3d 620 (5 th Cir. 2013). In Asaid, the purported whistleblower filed acomplaint alleging that G.E. Energy violated Dodd-Frank’s whistleblower protection provision when itfired him following his internal reports of possible Foreign Corrupt Practices Act violations which hemade to his supervisor. The Fifth Circuit upheld the dismissal of the complaint, holding that the Dodd-Frank whistleblower protection provision is limited “…to those individuals who provide informationrelating to a violation of the securities laws to the SEC.” Id. at 630. See also Banko v. Apple Inc., No.13-CV-02977, 2013 U.S. Dist. LEXIS 149686 (N.D. Cal. Sept. 27, 2013) and Wagner v. Bank of AmCorp., No. 12-CV-00381, 2013 U.S. Dist. LEXIS 101297 (D. Colo. July 19, 2013). But see Yang v.Navigators Group, Inc., 18 F. Supp. 3d 519 (S.D.N.Y. 2014), wherein the court refused to dismiss anaction brought by a purported whistleblower who only made an internal report of suspected securitieslaw violations. The court rejected the analysis of the Fifth Circuit, deferring to the SEC’s interpretationand holding that the “…statute does not clearly and unambiguously limit whistleblower protection toindividuals who report violations to the SEC….” Id. at 533. See also Azim v. Tortoise Capital Advisors,LLC., No. 13-2267-KHV, 2014 U.S. Dist. LEXIS 22974 (D. Kan. Feb. 24, 2014).43 12 U.S.C. §5567.

As discussed below, while there are limitations on in-house counsel’s ability to benefitfrom such bounties, the SEC may actually be encouraging such reports by attorneys.The bounty rules promulgated by the SEC do not preclude attorneys from receiving abounty for acting as whistleblowers. Indeed, SEC Chair Mary Jo White implied incomments made in 2013 that the SEC will not seek to stop attorneys from activelyreporting concerns nor from collecting bounties for reporting their clients’ missteps. 44That being said, as set forth below, there are ethical limitations on attorneys, as well aslimitations under SEC rules, on compliance officers, in-house auditors, risk managers,and other so-called gatekeepers. While other types of insiders do not have an internalreporting requirement, in most cases, the so-called gatekeepers who are tasked withkeeping their company above board must wait at least 120 days after they have broughtthe matter to the attention of a top legal or compliance officer before they may head tothe SEC. 45VII.Attorneys Serving as Compliance OfficersConsistent with the Model Rules of Professional Responsibility, the implementing rulesfor the SEC Whistleblower Program generally prohibit attorneys from using informationthat is obtained through a communication protected by the attorney-client privilege forwhistleblowing purposes. This prohibition applies to both outside counsel representinga company and in-house lawyers. However, the rules do permit an attorney to receive amonetary award under the Whistleblower Program if the privilege has been waived, or if44 Mary Jo White, Chair, SEC & Exch. Comm’n, Remarks at the Security Enforcement Forum (Oct. 09,2013).45 See SEC Rule 21F-4(b)(v)(A) and (C).

the disclosure of the otherwise confidential information is permitted by the applicableattorney conduct rules, or if permitted by SEC Rule 205.3. 46In this vein, it is vital to the analyses of a whistleblower claim brought by an attorney toaddress whether or not the disclosure of information is protected by the attorney-clientprivilege. Disclosures which are permanently protected under the cloak of the attorneyclientprivilege involve situations where (1) legal advice of any kind is sought from aprofessional legal advisor in their capacity as such; (2) the communication is related tothat purpose; and (3) the communication is made in confidence by the client. 47There are special issues related to in-house lawyers who often serve a company in bothlegal and non-legal capacities. The lines become more blurred when in-house counselperforms legal services when acting in ostensibly non-legal capacity, such as in the roleof compliance officer. In-house counsel should ask themselves: did the companyreasonably believe that counsel was performing legal services on behalf of thecompany? The attorneys should also clarify when they are serving in a legal or nonlegalrole.The authors of this article have personal experience handling matters in which thecourts have ruled the attorney client privilege either did not apply or was waived. Onesuch case did not involve a whistleblower statute, nevertheless it is instructive. Quitesimply, even the attorney-client privilege is not unassailable. In this case an attorneywho provided workers' compensation expertise to a client revealed confidences to theclient's detriment. The client was speaking to the attorney about an unrelated matter.46 See SEC Rule 205.3 and Model Rules of Professional Responsibility, Rule 1.6.47 John Henry Wingmore, Evidence in Trials at Common Law §2292 at 554 (McNaughton 1961 & Supp.1991).

The client disclosed information which was against its interest in the unrelated matter.The client believed she was safe because she was seeking the lawyer’s advice withregard to workers' compensation matters but, also because he was “her attorney.”When the matter later became the subject of an employment law claim, much to thedismay of the corporate client, the workers' compensation lawyer was called as awitness for the plaintiff. The judge ruled that the disclosure made by the client was notprotected because the workers' compensation attorney was asked to provide advice onthe matter before the Court, thus, the privilege did not apply. Similarly, when a lawyerserves the role of compliance officer, that lawyer may not be engaged to offerprofessional legal advice, potentially leaving the information the attorney may glean insuch a role unprotected.VIII. ABA Model Rule 1.13 and SEC Rule 205.3Both Model Rule 1.13 and SEC Rule 205.3 contain special rules for corporate lawyers.As referenced above, SEC Rule 205.3 requires internal, “up-the-ladder” reporting withinthe company. 48Both rules allow for making a report to the SEC. Under Model Rule1.13(c), disclosure beyond that permitted by Model Rule 1.6 is only permitted to preventharm to the corporation itself and only if the internal report is unsuccessful. 49SEC Rule205.3 permits disclosure if the lawyer reasonably believes disclosure is necessary to:(1) prevent a material violation which is likely to cause substantial financial injury to48 See Section VI Supra49 Paragraph c of Model Rule 1.13 provides that a lawyer may reveal such information “. . . only when theorganization’s highest authority insists upon or fails to address threatened or ongoing action that isclearly a violation of the law.” Seewww.americanbar.org/groups/professional_conduct/rule_1_13_organization_as__client/comment_on_rule_1_13.html (last viewed Jan. 08, 2015).

issuers or investors, or (2) prevent an issuer from committing or suborning perjury, orperpetuating fraud on the SEC; or (3) rectify the consequences of a material violation, infurtherance of which the attorney’s services were used.Significantly, state bar rules of professional conduct which have narrower disclosureprovisions are preempted by SEC Rule 205.3 under the federal preemption doctrine. 50For example, SEC Rule 205.3 preempts California’s Professional Conduct Rule whichprohibits a lawyer from disclosing information to prevent financial harm to others as aresult of client fraud.IX. Best Practices for Avoiding and Responding toWhistleblower/Retaliation ClaimsA. Define the PositionVarious state and federal statutes require compliance programs. However, they do notmandate how to prepare a job description for the position of compliance officer. When acompany finds itself in the position of having to defend a whistleblower claim, its abilityto defend based on attorney-client privilege may be impacted by how it defines thecompliance officer’s duties. For example, the duty of loyalty that the officer owes to thecompany may be a helpful concept in defending a whistleblower claim.In the Vanguard case referenced above, the attorney who asserted False Claims Actviolations against Vanguard had sought the protection of the SEC in his defense, as50 See the Supremacy Clause, U.S. Const. art. VI.

Vanguard has threatened to bring its own suit against him for violating company policyand breaching his ethical duties. 51B. Policies and ProceduresThe best defense is a good offense. Companies should invest in compliance byconsidering the following:1. Consider a critical assessment of your compliance checklist and responseplan.2. Implement, communicate and enforce an anti-retaliation policy.3. The policy should include multiple avenues for internal reporting. Thereporting process can include a hotline number to allow for anonymoustips.4. All employees should sign a written acknowledgement of receipt andunderstanding of the policy.5. Keep track of internal reports with a deadline for prompt action.6. Training. All employees should receive training on the prevention andreporting of suspected wrongdoing. The training should be documented.Training for management should emphasize supervisory responsibility inthis area. Supervisors can be a weak link when they do not understand51 Supra n. 3. Still, Vanguard's troubles stem from allegations of failure to report a 1.5 billion dollar"contingency fund" which the plaintiff claimed was funded by deductions from the company's mutualfund. The allegation was that the company was well aware of the problem and simply chose not toaddress the concerns or, as the awardee claimed, fully complicit with the alleged "wrongdoing."

their responsibility to report immediately any allegation of unlawful activityto someone in human resources or compliance.7. Act on a complaint and provide feedback to the tipster who often worriesabout what is going to happen as a result of their bringing information tothe company’s attention.8. Create a culture of integrity.9. Consider self reporting when dealing with a whistleblower. Even insituations where the company believes the complaint is untrue, orimmaterial, a company’s reporting of the allegations to the SEC first andexplaining why the allegations are unfounded may avoid or shorten whatotherwise could be a protracted investigation.10. Evaluate how to deal with the individual who made the complaint. Takesteps to ensure the whistleblower is treated the same as all others underthe company’s policies.11. Review and evaluate company contracts. Some companies require theiremployees to execute employment agreements or non-competitionagreements which contain as a condition of employment a requirementthat employees make an internal complaint of wrongdoing prior to going toan outside agency.While there may be situations where suchagreements would be considered enforceable, the SEC and othergovernment agencies have taken the stance that such an agreement is an

unlawful constraint on the employee and on the agency’s ability to enforcethe law. 52C. Counterclaims against WhistleblowersFollowing the lead of Vanguard’s counsel in the matter set forth above, a companyfaced with an SEC whistleblower lawsuit should consider counterclaims against theaccusing whistleblower as part of its vigorous defense. In Vanguard, the companyannounced that it might sue its former attorney for violating the company’s policy andstate laws which dictate the attorney’s professional and ethical responsibilities. Insupport of the potential counterclaims the company stated that its ex-attorney had sentcompany records to a personal e-mail address while he was still working for thecompany and that upon a demand that he return the documents, he refused. 53X. MUCH ADO ABOUT EVERYTHINGIn these post Dodd-Frank days, recent developments have drastically altered thelandscape for internal compliance. The once hypothetical scenario that a gatekeepercharged with ensuring compliance by a company could become a whistleblower hasarrived. Companies must take proactive steps to implement policies and procedures toaddress internal reporting and effectively deal with whistleblower.52 See SEC Rule 21F-17 which makes it a separate violation of the law to take action to “impede anindividual from communicating directly with the Commission staff about a possible securities lawviolation, including enforcing or threatening to enforce, a confidentiality agreement”. See also EEOC v.CVS, No.1:14-CV-0863 (N.D. Ill. Oct. 07, 2014). While the case was dismissed by the Court, the EEOCcontinues to argue that attempts to limit an employee’s reporting to the Agency are unlawful.53 Supra n. 3

2015 INTERNATIONAL CLIENT SEMINARFAIRMONT SCOTTSDALE PRINCESS HOTEL –SCOTTSDALE, ARIZONAMARCH 5 - 8, 2015WORKPLACE TRENDS – WHAT IS HOT ANDWHAT IS NOTJoel R. HlavatyFRANTZ WARD, LLPCleveland, Ohio(216) 515-1614jhlavaty@frantzward.comLisa A. KrupickaBURCH, PORTER & JOHNSON, PLLCMemphis, Tennessee(901) 524-5121lkrupicka@BPJLAW.comJennifer LippmanAssistant General Counsel - EmploymentTEXTRON, INC.Providence, Rhode Islandwww.textron.comW. Paul TubervilleSenior Counsel, Labor & EmploymentINTERNATIONAL PAPER COMPANYMemphis, Tennesseewww.internationalpaper.comMarch 8, 2014© 3-8-2014 ALFA International

Workplace Trends – What Is Hot and What Is NotIn today’s business world employers are faced with many challenges and an everevolvinglegal landscape, such as new pregnancy rules under the ADA, ban-the-boxproposals relating to criminal convictions on employment applications, franchisees andfranchisors being found to be joint employers, protests to increase the minimum wage,and social media issues. This article discusses recent court and administrativedecisions, along with pending and proposed legislation and enforcement guidanceissued by various governmental agencies, and discusses their effect on employers. Italso provides some practical advice for employers in dealing with the difficulties anduncertainty they face in the ever changing work environment.I. The Use of an Applicant’s Criminal HistoryThe EEOC’s Guidance of 2012On April 25, 2012, the Equal Employment Opportunity Commission (EEOC) issued anupdated Enforcement Guidance on the Consideration of Arrest and Conviction Recordsin Employment Decisions Under Title VII (the “Guidance”). 1Although the Guidancepurported to build on the EEOC’s long-held positions, it made several key changes thataffected how employers were to inquire about and treat an applicant’s criminal history inmaking employment decisions. More specifically, the Guidance refused to acceptpolicies that automatically excluded an applicant and tasked employers with conducting1 EEOC, Enforcement Guidance On The Consideration Of Arrest And Criminal Conviction Records InEmployment Decisions Under Tittle VII of the Civil Rights Act of 1964, As Amended, 42 U.S.C. Sec.2000 et eq., (Apr. 25, 2012).2

an individualized assessment of an individual’s criminal history. 2According to theGuidance, there are two ways that an employer’s use of arrest or conviction records canviolate Title VII:1. Disparate treatment: A violation may occur when an employertreats criminal history information differently for different applicants oremployees based upon their race or national origin.2. Disparate impact: An employer’s neutral policy of excludingapplicants based upon certain criminal conduct may disproportionatelyimpact some individuals protected under Title VII. This would violate TitleVII if the exclusion is not job related and consistent with businessnecessity. CITATION?The EEOC takes the position that national data supports a finding that criminal recordexclusions have a disparate impact on race and national origin, and that a policy orpractice that excludes everyone with a criminal record from employment will not be jobrelated and consistent with business necessity. The Guidance further states that thereare two circumstances in which employers may demonstrate that a neutrally-appliedexclusion based on criminal history records is “job related and consistent with businessnecessity.” 31. Validation: An employer may validate its criminal conductexclusion for a position under the EEOC’s Uniform Guidelines on2 Id. at Sec. V.B.9.3 Id. at Sec. V.B.4.3

Employee Section Procedures. Validation is possible if there is data oranalysis about criminal conduct as related to subsequent workperformance or behaviors. The Guidance, however, notes that suchstudies are presently rare and acknowledges that this method will not befeasible for most employers.2. Targeted Screening with Individual Consideration: In theabsence of formal validation, an employer may develop a targetedscreening process for candidates or employees with a criminal history thatconsiders at least the nature of the crime, the time elapsed since thecrime, and the nature of the job. For those employees who are excludedby a targeted screen, the employer should then provide an opportunity foran individual assessment to determine whether the policy as applied to aparticular person is job related and consistent with business necessity.A suggested individualized assessment requires an employer to provide an applicantthe opportunity to demonstrate that the exclusion from employment should not applybased upon the individual’s particular circumstances. The employer should alsoconsider other factors, such as:• The facts or circumstances surrounding the offense or conduct;• The number of offenses for which the individual was convicted;• Whether the person was of an older age at the time of theconviction or release from prison;4

• Whether the person performed the same type of work after his/herconviction without incident;• The length and consistency of employment history before and afterthe offense;• Any rehabilitation efforts, e.g., education and training;• Employment or character references that relate to fitness for theposition; and• Whether the individual is bonded under a federal, state, or localbonding program. 4While the Guidance does not mandate the individual consideration step, it states thatdoing so can help employers avoid Title VII liability by allowing them to consider morecomplete information on individual applicants or employees. 5Nevertheless, even if anemployer is able to establish job relatedness and business necessity under one of theabove two approaches, an individual may still prevail in a disparate impact case byshowing that the employer refused to adopt a less discriminatory “alternativeemployment practice” that was available and that serves the employer’s legitimate goals“as effectively as the challenged practice.”A. “Ban-the-Box” LegislationFollowing the EEOC’s issuance of its 2012 Guidance regarding the use of an applicant’scriminal history, the Commission has been aggressively pursuing employers who utilize4 Id. at Sec. V.B.9.5 Id.5

an applicant’s criminal history in making hiring decisions. Some states, such as NewYork, also aggressively pursue employers who use an applicant’s criminal backgroundhistory in hiring decisions. Furthermore, at least twelve states and more than 66municipalities have adopted “ban-the-box” legislation, which prevents employers fromemployer a checkbox on job applications that asks whether the applicant has a criminalhistory. Such legislation has been referred to as “compassionate legislation”, andproponents of such measures state that removing the boxes allows convicts fairconsideration for jobs that will help them reintegrate into society after completing theircriminal sentences.It is estimated that approximately seventy million people in the United States havecriminal records and that nearly 700,000 of them return to communities on an annualbasis after being released from jail or prison. Advocates of “ban-the-box” note thestigma associated with having a criminal record and that “marginalizing ex-offendershelps none of us.” 6Such legislation has been referred to as a “foot-in-the-door”legislation, not “hire ex-felons” legislation.The states that have adopted “ban-the-box” legislation include: California, Colorado,New Mexico, Nebraska, Minnesota, Illinois, Maryland, Delaware, Connecticut, RhodeIsland, Massachusetts, and Hawaii. Some of the legislation extends to privateemployers, while some is restricted to public employers.In addition to these states, several municipalities have also adopted varying forms oflegislation, such as Baltimore, Maryland; Louisville, Kentucky; and Washington, D.C.6 Delaware Governor Jack A. Markell, State of the State (Jan. 23, 2014).6

II.The NLRB’s Joint Employer Test and FranchiseesIn June, 2014, the National Labor Relations Board (“NLRB” or the “Board”) filed amicusbriefs in the matter of Browning-Ferris Industries of California, Inc., which is arepresentation case raising joint employer issues. 7While stating that it took no positionregarding the merits of the representation case at issue, NLRB General CounselRichard F. Griffin urged the Board to adopt a new standard for determining whether ajoint employer relationship exists. The Board is advocating that a joint employerrelationship should be found if, under the totality of the circumstances, including the waythe separate entities structured their commercial relationship, the putative joint employerwielded sufficient influence over the working conditions of the other entity’s employeessuch that meaningful bargaining could not occur in its absence. Griffin went on to statethat current law unfairly precludes local employees from dealing with nationalcompanies that may effectively control many of their working conditions, and that thecurrent standard ignores Congress’ intent that the term “employer” be broadly construedin light of economic realities and the underlying goals of the National Labor RelationsAct, which inhibits meaningful collective bargaining with respect to the contingentworkforce and other nontraditional employment arrangements.In the amicus brief filed by General Counsel Griffin, he argued that some franchisors arereally the employers of a franchisee’s employees, as they keep track of data on sales,inventory and labor costs, they calculate the labor needs of their franchisees, they setand police employee work schedules, track wages paid, and how long it takes7 Browning-Ferris Industries of California, Inc., NLRB No. 32-RC-1096847

employees to fill customer orders, and they accept employment applications forfranchisees through their systems and even screen applicants. Griffin argued that all ofthese go beyond the protection of the franchisor’s product or brand.Following the filing of his amicus brief in June, in July, 2014, General Counsel Griffinannounced that he had authorized regional directors of the NLRB to issue complaints in43 of 181 unfair labor practice cases pending against McDonald’s USA LLC. 8 Thecomplainants in these cases have alleged that McDonald’s was a joint employer with itsfranchisee. McDonald’s has approximately 2,500 independent franchisees.After efforts to resolve some of the matters, on December 19, 2014, the NLRB issued13 unfair labor practice complaints against McDonald’s and some of its franchisees inRegion 2, Manhattan, Region 4, Philadelphia, Region 7, Detroit, Region 10, Atlanta,Region 13, Chicago, Region 14, St. Louis, Subregion 17, Kansas City, Region 15, NewOrleans, Region 18, Minneapolis, Region 20, San Francisco, Region 25, Indianapolis,Region 28, Phoenix, and Region 31, Los Angeles. Hearings have been set beforeadministrative law judges, with some of the matters being consolidated into one hearing.Unions and their supporters are extremely happy with the efforts of General CounselGriffin. The Service Employees International Union is particularly pleased, as itsofficials have been targeting workers at McDonald’s, and other brands that use thefranchise model, for top-down organizing, including the use of coercive card checkorganizing that bypasses a secret ballot vote.8 Richard F. Griffin, National Labor Relations Board Office of the General Counsel (July 29, 2014).8

Opponents of General Counsel Griffins’ efforts on the joint employer standard forfranchisors and franchisees have stated that it is nothing more than a thinly veiledattempt to increase union membership, and that the NLRB’s stance provides a “HappyMeal” for union bosses hungry for union dues. They also argue that expanding jointemployer liability will require franchisors to decide whether to become more involved ina franchisee’s day-to-day operations and employment decisions, or whether to back offcompletely. If franchisors are not involved in a franchisee’s day-to-day operations, theyrisk some of the uniformity in products and services that enhance the value of thefranchisor-franchisee relationship by giving customers a uniform product.III.Developments in Protections for LGBT EmployeesIn July, 2014, President Barack Obama issued Executive Order 13,672, which prohibitsfederal contractors from discriminating against lesbian, gay, bisexual, and transgender(“LGBT”) employees and job applicants. In mid-August, 2014, the Department of LaborOffice of Federal Contract Compliance Programs (“OFCCP”) released a directiveclarifying that sex-based job discrimination includes bias based on gender identity andtransgender status, and on December 9, 2014, the OFCCP issued a final rule thatimplements the President’s July, 2014 Executive Order. 9In September, 2014, the Equal Employment Opportunity Commission (“EEOC” or the“Commission”) filed two landmark suits, one against a funeral home in Michigan and theother against an eye clinic in Florida, in which it alleged discrimination against male-to-9 79 Federal Register 72,985 (Dec. 9, 2014).9

female transsexual workers in violation of Title VII of the 1964 Civil Rights Act. 10Thisfollowed a 2012 administrative ruling in which the EEOC held that Title VII’s ban on sexdiscrimination prohibits bias based on transgender status and gender identity, Macy v.Holder, EEOC No. 0120120821, and is the latest in a growing list of legal developmentsthat recognize civil rights for transgender workers.For example, in October, 2014, the EEOC filed an amicus brief with the U.S. Court ofAppeals for the Seventh Circuit in which it urged the Court to reconsider a decision inwhich it held that Title VII does not bar sexual-orientation discrimination. 11This brief setforth the Commission’s broad view of the gender-stereotyping theory that it haddeveloped in federal sector cases.This theory and these cases arise out of the U.S. Supreme Court’s decision in PriceWaterhouse v. Hopkins. 12In Price-Waterhouse, the Court held that job actions takenon the belief that an employee does not conform to society’s expectations for persons ofthat gender are prohibited under Title VII. Although Price Waterhouse was not a genderidentity or sexual orientation case, it has been used by the EEOC and courts to increaseprotections for the LGBT community.In October, 2014, the Commission announced that it was adding two new chargecategorization codes for charges filed with the EEOC, specifically, “GO” for genderorientation bias and “GT” for gender identity bias. This stems from the fact the10 EEOC v. R.G. & G.R. Harris Funeral Homes, Inc., E.D. Mich., No. 2:14-cv-13710; EEOC v. LakelandEye Clinic, P.A., M.D. Fla., No. 8:14-cv-02421.11 See Muhammad v. Caterpillar, Inc., 7 th Cir., No. 12-1723, 2014.12 Price Waterhouse v. Hopkins, 490 U.S. 228 (1989).10

Commission received 834 charges alleging gender orientation discrimination and 199charges alleging gender identity bias in 2013. As of June, 2014, it had received 459and 81 charges.On December 18, 2014, Attorney General Eric Holder announced that he had issued amemorandum to the Department of Justice stating that the department will no longerassert that Title VII’s prohibition against sex discrimination excludes discriminationbased on gender identity per se, including transgender discrimination. Thus, theDepartment of Justice will now take the position that Title VII’s prohibition against sexdiscrimination includes bias based on gender identity and transgender status.Seventeen states and the District of Columbia now ban gender identity bias in theworkplace. In addition, the Employment Nondiscrimination Act, which would coverprivate employers nationwide and prohibit employment discrimination based on genderidentity or sexual orientation, has been pending before Congress for many years. It haspassed the Senate, but has failed to gain sufficient support in the House ofRepresentatives.While these developments mark huge advancements for the LGBT community, someproponents have argued that being openly gay or lesbian may actually be harmful to alegal claim under Title VII. If the applicant is openly gay or lesbian, the courts can thenfind that any bias resulted from sexual orientation, which remains unprotected underfederal law. Hence, it is better to bring a claim stating that a person was discriminatedagainst due to his/her failure to conform to gender stereotypes.11

Some best practices advocated for employers in order to avoid claims of discriminationon the basis of gender identity or transgender status include:• Update nondiscrimination policies to expressly include LGBT bias;• Provide training on LGBT bias to all employees and managers;• Provide equal employee benefits to same-sex couples, potentiallyincluding coverage of gender reassignment surgery;• Form diversity and inclusiveness committees and implementdiversity and inclusiveness initiatives;• Permit and encourage LGBT workers to form workplace affinitygroups;• Ensure that nondiscrimination policies provide best practices forworkers who are transitioning from male to female or vice versa,including policies regarding name changes, restroom use, anddress codes;• Ensure that manager performance is linked to LGBT diversitymetrics;• Have employee data collection include voluntary self-disclosure ofLGBT status;• Actively recruit LGBT workers;12

• Provide financial and other support to the LGBT community; and• If and where appropriate, retain a diverse group of suppliers.IV.Social Media Developments and the NLRBPrior to the Obama Administration, the National Labor Relations Board (“NLRB”) was afairly low-key federal agency with little public name recognition. However, since therecess appointment in June 2010 of Acting General Counsel Lafe Solomon, the NLRBhas been anything but low-key. We can expect that trend to continue with the Senateconfirmation of Richard F. Griffin as General Counsel and the confirmation of PresidentObama’s nominees for all five positions on the Board. Griffin, former general counsel ofthe International Union of Operating Engineers, also served a brief term as a recessappointee to the NLRB before such appointments were ruled invalid by the SupremeCourt.Griffin shows every intention of continuing to assert the application of the National LaborRelations Act (“NLRA”) in non-union settings, as the agency had done under ActingGeneral Counsel Solomon. Nowhere has that effect been more prominent than in theBoard’s assertion of jurisdiction in cases involving non-union employers’ social mediapolicies.Beginning in the Fall of 2010, the NLRB began issuing unfair labor practice complaintsagainst employers for taking adverse employment actions, including termination,against employees making derogatory remarks about coworkers and supervisors on the13

employees’ personal Facebook pages, and other social media settings, in violation ofthe employers’ social media policies. In many of the complaints, the NLRB has allegedthat the employer’s social media policy is overbroad and the application of the policyinterferes with the employee’s rights under the NLRA provision protecting employees’right to engage in “concerted, protected activity,” which includes communicating withcoworkers about the terms and conditions of employment. 13The opening salvo came with the issuance of the ALJ’s opinion in Hispanics United ofBuffalo, Inc. 14in 2011. In that case, five employees engaged in a Facebook discussionafter a coworker posted that the company’s employees were not sufficiently helpful tothe company’s clients. The ensuing discussion included some derogatory remarkstoward the original poster, including “What the f. ..Try doing my job I have 5 programs,”and “Tell her to come do [my] f--king job n c if I don’t do enough, this is just dum [sic].”The employer terminated the posting employees on the ground that the postsconstituted “bullying and harassment” of the original poster and violated the company’sharassment policy. The ALJ determined that the employees were terminated inviolation of their right to engage in protected concerted activity. The ALJ noted theemployees “have a protected right to discuss matters affecting their employmentamongst themselves.”The NLRB has shown a willingness to go over employers’ social media policies line-bylineand invalidate those it deems to chill workers’ rights to engage in protected13 See 29 U.S.C. § 157 (“Employees shall have the right … to engage in other concerted activities for thepurpose of collective bargaining or other mutual aid or protection….”).14 NLRB No. 3-CA-27872, 2011 WL 3894520 (Div. of Judges Sept. 2, 2011).14

concerted activity under Section 7 of the NLRA. Policy provisions that no longer passmuster include:• General prohibitions on disparaging, ridiculing or defaming the companyon social media;• Blanket prohibitions against displaying photos of the workplace or usingthe company logo on social media;• Broad bans on criticizing company management, even by name and/or byusing intemperate language;• Blanket prohibitions on the disclosure of “confidential” information onsocial media unless sufficient examples are given to demonstrate thatinformation about working conditions, pay, benefits, supervisors and coworkersare not covered by the policy;• Prohibition of “inappropriate” conduct or language on social media, as thatterm is thought to be too vague for employees to know whether it includesprotected activity;• Requiring employees to include a disclaimer on every social media postabout the company stating that the employee is not speaking for thecompany, as this requirement is thought to unduly burden the exercise ofSection 7 rights.The Board has approved an employer’s social media policy that prohibited the use ofsocial media to post or display comments about co-workers or supervisors, and thosethat are “vulgar, obscene, threatening, intimidating, harassing, or a violation of the15

Company’s workplace policies against discrimination, harassment, or hostility onaccount of age, race, religion, sex, ethnicity, nationality, disability, or other protectedclass, status, or characteristic.” 15The Board has also made clear that mere vulgarity in social media postings does notdeprive such postings of the protection of the Act, as long as they discuss workingconditions. In Triple Play Sports Bar & Grille, 16 employees’ posts on Facebook thatincluding calling their supervisor an “asshole” and repeated use of the “F” word did notlose the protection of the NLRA because the comments were made in a discussion ofthe employer’s errors in its tax withholding policy.In light of the growing popularity of social media and the NLRB’s recent activity,employers should carefully review their social media policies, or consider whether todevelop a social media policy if they do not have one in place. Employers should alsotake into account all possible implications before engaging in adverse action against anemployee for conduct on social media sites. A proper social media policy shouldaddress the use of company time and resources for social networking, protect theemployer’s confidential information and trademarks, and prohibit discriminatory orharassing conduct based on a protected category. The policy should also banemployees from using company computers or company time for social networking,unless the social networking site involves the company or company business. Toaddress privacy concerns, the policy should also specifically advise employees that any15 Office of the General Counsel Memorandum, OM 12-91 (January 24, 2012) at 16.16 NLRB No. 34-CA-12915 (Div. of Judges Jan. 3, 2012).16

material posted, exchanged or discussed on social media sites may be accessed at anytime without advance notice to the employee. In addition, the policy should prohibitposting material that is obscene, vulgar, discriminatory, personally harassing, or abusiveto another individual. It is important to give specific examples of broadly describedconduct such as “confidential information” so that employees do not understand it toinclude things like pay and working conditions.V. ADA and Pregnancy DevelopmentsThe Pregnancy Discrimination Act was passed in 1978, in part, to overturn a 1976Supreme Court decision, General Electric Co. v. Gilbert, 17which had rejected theEEOC’s broad reading of Title VII b to cover pregnancy bias as a form of sexdiscrimination. The PDA added “pregnancy, child-bearing or related medical conditions”to Title VII’s definition of sex discrimination, 18 and directs that pregnant women “betreated the same for all employment-related purposes ... as others persons not soaffected but similar in their ability or inability to work.” 19New EEOC Chair Jenny R. Yang plans to target what she characterizes as “blatantpregnancy discrimination” still prevalent in the workplace. In July 2014, the Commissionupdated its Pregnancy Discrimination Guidelines with the following key points:• Although pregnancy is not a disability, pregnancy related complicationscould be;17 429 U.S. 125 (1976).18 42 U.S.C. § 2000e(k).19 Id.17

• Reasonable accommodations available to pregnant workers withimpairments that constitute disabilities might include allowing a pregnantworker to take more frequent breaks, to keep a water bottle at a workstation, or to use a stool; altering how job functions are performed; orproviding a temporary assignment to a light duty position;• The PDA prohibits discrimination not only because of current pregnancybut because of future plans to become pregnant, use of fertility treatments,having an abortion, using contraception, and lactation and breastfeeding;• An employer may not refuse to treat a pregnant worker the same as otheremployees who are similar in their ability or inability to work by relying ona policy that makes distinctions based on the source of an employee'slimitations (e.g., a policy of providing light duty only to workers injured onthe job).The EEOC Guidelines are being put to the test before the U.S. Supreme Court in Youngv. United Parcel Service, argued December 3, 2014. In that case, a pregnant part-timedelivery driver gave her supervisor a doctor’s note saying she could not lift more than 20pounds in her first twenty weeks of pregnancy and nothing more than 10 poundsthereafter. Her job description required her to be able to lift up to seventy pounds,although she spent most of her time delivering overnight letters and small packages.UPS’s light duty policy provided light duty work for four categories of workers: (1) thoseinjured on the job; (2) those with an impairment recognized under the Americans with18

Disabilities Act (“ADA”); (3) those who lost their driver’s license because they weretemporarily unqualified to drive; and (4) those with pregnancy-related lifting or otherphysical restrictions “in compliance with state or federal law, if applicable.” UPS takesthe position that the pregnancy clause, which is taken from its collective bargainingagreement with drivers, applies only in states that have passed their own laws requiringsuch accommodations, and that federal law requires nothing more than not singling outpregnancy for disparate treatment.The United States District Court for the District of Maryland and the Fourth Circuit foundthat UPS had crafted a “pregnancy-blind policy” 20 and that Young’s restriction “wastemporary and not a significant restriction on her ability to perform major life activities.” 21The Obama Administration urged the Supreme Court to not take up the matter, arguingthat although pregnancy in and of itself does not qualify as a disability, the expandeddefinition of “substantially limited in a major life activity” under the amended ADA mayrequire the accommodation of employees like Young.The trend certainly seems to be in favor of expanded protection for pregnant workers.The U.S. government, which previously defended the Postal Service’s light duty policy,which is virtually identical to the UPS policy at issue, now says that this older view is nolonger the view of the United States and that the Postal Service is “considering itsoptions” in light of the amended ADA and the new EEOC Guidelines. UPS itself hasannounced that, beginning January 1, 2015, it will make temporary light duty workavailable to more of its pregnant employees with lifting restrictions. Maryland, where20 707 F.3d 437,450 (4th Cir. 2013).21 Id. at 445.19

Young was based when she worked for UPS, passed a law mandating suchaccommodations in 2013 and is one of at least nine states that have done so.VI.Minimum Wage DevelopmentsIncreasing the minimum wage has long been a goal of the Obama Administration and2014 saw much activity towards that goal, although a change in the federal minimumwage was not achieved. In February, President Obama signed an Executive Orderraising the minimum wage for federal contractors from $7.25 an hour to $10.10 an hour.In March 2014, Senator Tom Harkin, Democrat of Iowa, introduced S. 460, the FairMinimum Wage Act, which would amend the Fair Labor Standards Act to raise thefederal minimum wage to $8.20 an hour on the first day of the third month afterenactment of the bill; to $9.15 after the first year; to $10.10 after two years; and anamount to be determine annually by the Secretary of Labor based on the ConsumerPrice Index after three years. The minimum wage for tipped employees would increaseto $3.00 an hour from $2.15.The bill has been read twice and is currently languishing in committee. With theRepublicans taking control of the Senate in 2015, it seems unlikely the bill will come to avote.At the state level, however, there are currently 23 states and the District of Columbiathat have a minimum wage higher than the federal level. Increased rates range from$7.75 in Maine to $9.50 in D.C.20

Organized labor has also been pushing hard for increases in the minimum wage,particularly in the fast food industry. The Summer 2014 strikes by fast food workers aspart of the “Fight for $15” campaign drew much media attention and has spurredincreases in the minimum wage in most major cities in California, as well as Seattle andChicago.VII.Labor & Employment Cases Pending Before the U.S.Supreme CourtThere are several labor and employment cases of interest on the U.S. Supreme Court’s2014-2015 calendar, including the following:Integrity Staffing Solutions v. Busk, 713 F.3d 525, 20 WH Cases2d 937 (9th Cir.2013) (71 DLR AA-1, 4/12/13). The issue presented is whether time spent bywarehouse workers in security screenings at the end of their work shifts is compensableunder the Fair Labor Standards Act, as amended by the Portal-to-Portal Act. Thematter was argued on October 8, 2014. On December 9, 2014, the Court held that suchtime was not compensable.M&G Polymers USA, LLC v. Tackett, 733 F.3d 589, 56 EBC 1829 (6th Cir. 2013) (155DLR A-1, 8/12/13). The issue presented is whether, when construing collectivebargaining agreements in Labor-Management Relations Act cases, courts should followthe Sixth Circuit and presume that silence concerning the duration of retiree health-carebenefits means the parties intended those benefits to vest (and therefore continue21

indefinitely). One alternative view from the Third Circuit is that a CBA should require aclear statement that health-care benefits are intended to survive the termination of theCBA. A second view espoused by the Second and Seventh Circuits is that a CBAshould require at least some language in the agreement that can reasonably support aninterpretation that health-care benefits should continue indefinitely. The matter wasargued on November 10, 2014.Dep't of Homeland Sec. v. MacLean, 714 F.3d 1301, 35 IER Cases 821 (Fed. Cir.2013) (83 DLR A-5, 4/30/13). The issue presented is whether certain statutoryprotections codified at 5 U.S.C. 2302(b)(8)(A), which are inapplicable when a federalemployee makes a disclosure “specifically prohibited by law,” can bar an agency fromtaking an enforcement action against an employee who intentionally discloses sensitivesecurity information. The matter was argued on November 4, 2014.Perez v. Mortg. Bankers Ass'n; Nickols v. Mortg. Bankers Ass'n., 720 F.3d 966, 20WH Cases2d 1527 (D.C. Cir. 2013) (127 DLR AA-1, 7/2/13). The issue presented iswhether a federal agency must engage in notice-and-comment rulemaking under theAdministrative Procedure Act before it can significantly alter an interpretive rule thatarticulates an interpretation of an agency regulation. The matter was argued onDecember 1, 2014.Mach Mining, LLC v. EEOC, 738 F.3d 171, 121 FEP Cases 327 (7th Cir. 2013) (247DLR AA-1, 12/23/13). The issue presented is whether and to what extent a court mayenforce the Equal Employment Opportunity Commission's duty to conciliatediscrimination charges before filing suit.22

Young v. United Parcel Serv., Inc., 707 F.3d 737, 116 FEP Cases 1569 (4th Cir.2013) (08 DLR A-2, 1/11/13). The issue presented is whether, and in whatcircumstances, an employer that provides work accommodations to nonpregnantemployees with work limitations must provide work accommodations to pregnantemployees who are “similar in their ability or inability to work,” as provided by thePregnancy Discrimination Act, which amended Title VII of the 1964 Civil Rights Act.The matter was argued on December 3, 2014.EEOC v. Abercrombie & Fitch Stores, Inc., 731 F.3d 1106, 120 FEP Cases 212 (10thCir. 2013) (192 DLR AA-1, 10/2/13). The issue presented is whether an employer canbe liable under Title VII of the 1964 Civil Rights Act for refusing to hire an applicant ordischarging an employee based on a “religious observance and practice” only whereemployer has actual knowledge that a religious accommodation was required based ondirect, explicit notice from the applicant or employee.Tibble v. Edison Int'l, 729 F.3d 1110, 56 EBC 1245 (9th Cir. 2013) (57 DLR A-5,3/25/13); amended opinion (149 DLR A-9, 8/2/13). The issue presented is whethernotwithstanding the ongoing nature of the Employee Retirement Income Security Act'sfiduciary duties, does the statute of limitations under 29 U.S.C. §1113(1) immunize401(k) plan fiduciaries for retaining imprudent investments that continue to cause theplan losses if the funds were first included in the plan more than six years ago.23

2015 INTERNATIONAL CLIENT SEMINARFAIRMONT SCOTTSDALE PRINCESS HOTELSCOTTSDALE, ARIZONAMARCH 5 – 8, 2015Building a Better Mousetrap –Protecting Company AssetsJames PetersonHIGGS, FLETCHER & MACK, LLPSan Diego, CA 82101peterson@higgslaw.com(619) 236-1551Eva KnipschildKENNEDY VAN DER LAANAmersterdam, NetherlandsEva.Knipschild@kvdl.nl31 20 550 6840J. Burke McCormickSenior CounselWELLS FARGOGlen Allen, Virginiawww.wellsfargo.comDavid M. RoyerGeneral CounselAREVA, INC.Charlotte, North Carolinawww.areva.comRonald WasingerVice President and DeputyGeneral CounselSONY ELECTRONICS, INC.San Diego, Californiawww.sony.com3082723.3

Building a Better Mousetrap –Protecting Company AssetsIntroductionCompanies throughout the world rely on confidential, commercially-valuable informationas part of their business, which increasingly are becoming some of their most valuableintangible assets. To protect this confidential and proprietary business information,employers often utilize trade secret laws and restrictive covenants. This articleanalyzes the various means by which a company can (and cannot) protect trade secretor other confidential information. Part 1” focuses on the protection of trade secrets andother confidential information in the United States, and reviews a growing trend inlitigation involving “anti-poaching” agreements. “Part 2” outlines how those issues areaddressed abroad; in the Netherlands, the United Kingdom, Germany, Belgium, Franceand Italy.I. Protection of Employer’s Confidential Information in the UnitedStates. 1A. Trade Secrets.1. Defining a Protectable Trade Secret.Trade secret laws generally protect secret, valuable business information from theft andmisuse. Although it has been said that an “exact definition of a trade secret is not1 By James M. Peterson (peterson@higgslaw.com) of the ALFA San Diego firm of Higgs Fletcher & MackLLP.3082723.3

possible,” 2protectable trade secrets are generally comprised of confidential,commercially valuable information. 3According to the Restatement,A trade secret may consist of a formula, pattern, device, orcompilation of information which is used in one’s business,and which gives him an opportunity to obtain an advantageover competitors who do not know or use it. It may be aformula for a chemical compound, a process for a machineor other device, or a list of customers. 4The question of whether information will qualify as a protectable “trade secret” understate or federal law is typically a question of fact for a judge or jury. 5The trier of factmust consider several factors in assessing whether the information is a protectabletrade secret, including:• the extent to which the information is known outside thecompany;• the extent to which it is known by employees and othersinvolved in the company;• the extent of measures taken by the company to guard thesecrecy of the information;• the value of the information to the company and to itscompetitors;• the amount of effort or money expended by the company indeveloping the information; and• the ease or difficulty from which the information could beproperly acquired or duplicated by others. 62 RESTATEMENT (FIRST) OF TORTS, § 757, comment (b) (1939).3 Uniform Trade Secrets Act § 1(4).4 Id.5 4-15 Roger M. Milgrim, MILGRIM ON TRADE SECRETS § 15.01.6 Restatement (First) of Torts, § 757, comment (b) (1939).3082723.3

Unlike other protectable information (copyrights, trademarks, patents), there is no setduration for the protection of trade secrets. As such, trade secret protection may extendindefinitely, lasting as long as the subject material remains commercially valuable and iskept confidential. 7On the other hand, the trade secret status of information may be lostimmediately if the information is disclosed to outsiders or competitors (accidentally orintentionally). 8However, the necessary element of secrecy is not lost “if the holder ofthe trade secret reveals the trade secret to another ‘in confidence, and under an impliedobligation not to use or disclose it.’” 9Disclosure of trade secrets for certain, limitedreasons do not waive trade secret protections, so long as the trade secret owner takesreasonable measures to maintain its secrecy before and during disclosure (such asrequiring non-disclosure or confidentiality agreements from recipients of confidentialinformation).2. Legal Landscape for Trade Secret Protection in United States.a. State LawIn the United States, trade secrets are primarily protected by individual state laws. If atrade secret is misappropriated, the individual or corporation who owns the trade secretmay seek injunctive relief and civil damages under a common law tort action formisappropriation, or through a specific state statute. Although these laws vary slightlyfrom state-to-state, a total of 47 states (plus the District of Columbia) have adopted7 United States v. Dubilier Condenser Corp., 289 U.S. 178, 186 (1933) (noting that, rather than seekpatent protection, an inventor “may keep his invention secret and reap its fruits indefinitely”).8 See Religious Tech. Ctr. V. Netcom On-Lien Communication Servs., 923 F. Supp. 1231, 1256-1257(N.D. Cal. 1995).9 Kewanee v. Bicron, 416 U.S. 470, 475 (1974) (citations omitted).3082723.3

versions of the Uniform Trade Secrets Act (the “UTSA”), which codifies the basicprinciples of common law trade secret protection. 10The state laws provide definitions for key terms such as “trade secret,”“misappropriation,” and “improper means,” 11and outline the various forms of relief(monetary and injunctive) which may be available in a civil action for misappropriation ofa trade secret. Some states have even gone further, and recognize the theft of tradesecrets as a crime. 12 b.Federal LawWhile state laws provide the vast majority of available protection for trade secrets, tradesecrets also receive some help from federal laws. The Trade Secrets Act (enacted in1948) is of limited applicability, as it prohibits employees of the federal government andgovernment contractors from making unauthorized disclosure of confidentialgovernment information, including trade secrets. 13The Economic Espionage Act of1996 (the “EEA”) goes further, and, as relevant here, defines criminal offenses for: (1)theft of trade secrets for the benefit of a foreign entity 14 ; and (2) theft of a trade secret toconfer an economic benefit to another party. 1510 Only Massachusetts, New York, and North Carolina have not enacted the UTSA, although they do offertrade secret protection through common law and other statutes.11 Uniform Trade Secrets Act § 1.12 See, e.g., CAL. PENAL CODE § 499c (providing that anyone who acquires, uses, or discloses tradesecrets without authorization shall be punished by imprisonment of up to one year in a county jail, by afine of up to $5,000, or by both penalties).13 18 U.S.C. § 1905.14 18 U.S.C. § 1831.15 18 U.S.C. § 1832.3082723.3

To constitute a violation of the “theft of trade secrets” prohibition, the prosecution mustshow: (1) the intentional and/or knowing theft, appropriation, alteration, or duplication oftrade secret; (2) the trade secret is related to a product or service used or intended foruse in interstate or foreign commerce; (3) intent to convert the trade secret; and (4)intent or knowledge that such action will injure the owner. 16In this context, establishingthe necessary intent to injure the trade secret owner “does not require the governmentto prove malice or evil intent, but merely that the actor knew or was aware to a practicalcertainty that his conduct would cause some disadvantages to the rightful owner.” 17Unfortunately, the EEA does not provide a private, civil right of action to victims of tradesecret theft. However, federal penalties for theft of trade secrets in violation of the EEAare substantial. Theft of trade secrets for commercial advantage is punishable by a fineof up to $250,000 for individuals, as well as imprisonment of up to 10 years, andorganizations can be fined up to $5 million. 18The EEA also authorizes the forfeiture of“any property used, or intended to be used … to commit or facilitate” an EEA violation,as well as “any property constituting, or derived from, any proceeds obtained directly orindirectly as a result of” an EEA offense. 19Offenders may be required to pay restitutionto victims of their trade secret theft. 20Finally, federal district courts are required to enter protective orders or take othermeasures “as may be necessary and appropriate to preserve the confidentiality of trade16 18 U.S.C. § 1832.17 H.R. Rep. No. 104-788, at 11 (1996).18 18 U.S.C. § 1832.19 18 U.S.C. §§ 1834; 2323.20 Id.3082723.3

secrets, consistent with the requirements of the Federal Rules of Criminal and CivilProcedure, the Federal Rules of Evidence, and all other applicable laws.” 21The EEAalso allows the Attorney General to bring a civil action to obtain “appropriate injunctiverelief” again any violation of the EEA provisions regarding the protection of tradesecrets. 22 3. Enforcement of Trade Secret Rights.Enforcement of trade secret laws is generally the responsibility of the trade secretowner, who can file a civil suit in state court against the individual or organization whohas misappropriated a trade secret. Generally, the trade secret owner can obtaincompensatory and punitive damages, and obtain injunctive relief to prevent the use ordisclosure of said trade secret.On the federal side, the Economic Espionage Unit (located within the FBI’sCounterintelligence Division) has the primary responsibility for investigating offensesunder the EEA. 23The Economic Espionage Unit works with private sector partners toinvestigate and prosecute trade secret theft. According to the FBI, this unit’s caseloadhas increased every year since its formation, and during the 2009-2013 time period21 18 U.S.C. § 1835.22 18 U.S.C. § 1836.23 See http://www.fbi.gov/about-us/investigate/counterintelligence/economic-espionage, last visited Jan.13, 2015.3082723.3

alone, the number of trade secret theft cases overseen by the unit increased by morethan 60%. 24B. Restrictive CovenantsEmployment contracts, policy manuals, and confidentiality agreements are often (withincreasing frequency) drafted by employers to contain post-employment “restrictivecovenants”—provisions which are designed to limit an employee’s ability to competewith the employer after the employment relationship ends. These covenants are helpfulto employers to protect their investment in employees and safeguard trade secrets andconfidential information.However, because they (by their very nature) inhibitcompetition in the employment marketplace, they are often disfavored by the courts.This section identifies the common types of restrictive covenants used by employers,and validity and enforceability issues regarding such provisions.1. Common Types of Restrictive Covenants.Restrictive covenants most often appear in the employment context and typicallyattempt to control an employee’s actions post-employment. Generally, there are threetypes of restrictive covenants that may apply to an employment relationship: (a) acovenant not to compete with the employer post-departure; (b) a covenant not to solicitor deal with the employer’s customers or employees; and (c) a covenant not to disclosean employer’s confidential or trade secret information post-departure.24 Randall C. Coleman, Statement Before Senate Judicial Committee, Subcomittee on Crime andTerrorism, Washington D.C., May 13, 2014 (available at http://www.fbi.gov/news/testimony/combatingeconomic-espionage-and-trade-secret-theft,last visited Jan. 13, 2015).3082723.3

2. Validity of Restrictive Covenants.In the United States, nearly all laws governing the enforceability of restrictive covenantsare state-based. These laws vary, widely, from state-to-state. 25Accordingly, a court’schoice of law will often be decisive. 26To understand the varying schools of thought on the enforceability of post-employmentrestrictive covenants in the United States, it is most efficient to look at examples of statelaws from three divergent states: Delaware, California, and Virginia. Delawarerepresents the majority view on the enforcement of covenants not to compete in theUnited States. That is, in Delaware and most states, court’s will closely scrutinize andnarrowly construe a non-competition agreement, but will generally enforce them if it ispart of a valid agreement that is supported by consideration, is reasonable in time andscope, and serve to protect the employer’s legitimate economic interests. 27These“economic interests” typically include the employer’s confidential information andgoodwill. 28Delaware courts have also adopted a “reasonable alteration” approach,meaning that if a non-competition agreement is found to be overbroad andunenforceable as written, the court may enforce the non-competition agreement in part,25 See, e.g., Brian M. Malsberger, COVENANTS NOT TO COMPETE: A STATE-BY-STATE SURVEY (8 th ed. 2012);Viva R. Moffat, Making Non-Competes Unenforceable, 54 ARIZ. L. REV. 939, 943-952 (2012)(summarizing major variations among states); Gillian Lester & Elizabeth Ryan, Choice of Law andEmployee Restrictive Covenants: An American Perspective, 31 COMP. LAB. L. & POL’Y J. 389, 392(2010) (“states vary widely in their friendliness to employee non-compete agreements”); Cynthia L.Estlund, Between Rights and Contract: Arbitration Agreements and Non-Compete Covenants, 155 U.PENN. L. REV. 379, 391-396 (2006).26 E.g., Curtis 1000, Inc. v. Suess, 24 F.3d 941, 947-948 (7th Cir. 1994) (affirming denial of preliminaryinjunction; refusing to honor covenant’s selection of governing state law where chosen state hadminimal connection to the parties’ relationship).27 Faw, Casson & Co. v. Cranston, 275 A.2d 463, 466-467 (Del. Ch. 1977).28 TriState Courier & Carriage, Inc. v. Berryman, 2004 Del. Ch. LEXIS 43, at *10 (Del. Ch. Apr. 15, 2004).3082723.3

to the extent it finds it reasonable to do so, rather than finding it completelyunenforceable. 29California has taken a very different approach to non-compete agreements. Unlike themajority of other states, California courts disfavor covenants that restrain competitionand generally refuse to enforce them. 30The rationale for this prohibition is that “[t]heinterests of the employee in his own mobility and betterment are deemed paramount tothe competitive business interests of the employers.” 31However, there are limitedexceptions to the prohibition where non-competition agreements are connected to thesale of a business, or dissociation of a partner from a partnership. 32Some Californiacourts have also acknowledged an exception for agreements that are necessary toprotect the employer’s trade secrets. 33Further, unlike Delaware law, California courtswill typically refrain from re-writing non-competition agreements to make themenforceable. 34Virginia law lies somewhere in the middle. More specifically, Virginia courts considerrestrictive covenants to be restraints on trade that are to be carefully examined and29 Knowles-Zeswitz Music, Inc. v. Cara, 260 A.2d 171, 175 (Del. Ch. 1969).30 See CAL. BUS. & PROF. CODE § 16600 (“every contract by which anyone is restrained from engaging ina lawful profession, trade, or business of any kind is to that extent void.”)31 Diodes, Inc. v. Franzen, 260 Cal.App.2d 244, 255 (1968).32 CAL. BUS. & PROF. CODE §§ 16601, 16602; Fillpoint, LLC v. Maas, 208 Cal.App.4th 1170, 1177 (2012);see also CAL. BUS. & PROF. CODE § 16602.5 (covenants not to compete arising in conjunction with saleof limited liability company).33 See Muggill v. Reuben H. Donnelley Corp., 62 Cal.2d 2396, 242-243 (1965); Edwards v. ArthurAndersen LLP, 44 Cal.4th 937, 946, fn. 4 (2008).34 Hill Medical Corp. v. Wycoff, 86 Cal.App.4th 895, 908 (2001) (“To rewrite the covenant wouldundermine California’s public policy of open competition as embedded in section 16600”); Kolani v.Gluska, 64 Cal.App.4th 402, 407-408 (1998).3082723.3

strictly construed. 35The inclusion of these provisions in employment contracts isdisfavored, and they are generally construed in favor of the employee—not theemployer. 36Nevertheless, Virginia courts will typically enforce a non-competitionagreement if the employer shows that the restraint (including time and geographicrestrictions) is no greater than necessary to protect some legitimate business interest; isnot unduly harsh and oppressive in curtailing the employee’s legitimate efforts to earn alivelihood; and is reasonable from the standpoint of a sound public policy. 37Legitimatebusiness interests, in this context, include trade secrets, customer contacts, knowledgeof methods of operation, and other confidential information. 38Due to the substantial differences in enforcement on a state-by-state basis, it is criticalfor employers to understand what they can and can’t do by way of restrictive covenants(specific to the locations where they operate). Further, these variations in state lawsmean that, when parties are considering whether to sue, choice of law will be a powerfulfactor in analyzing the risks and benefits of litigation, and the choice of forum may proveto be critical in the success or failure of the action. 393. Enforceability of Restrictive Covenants and Remedies.Just as state laws differ on the validity of restrictive covenants, so too do they differ onthe extent of remedies available for breach of those covenants. These remedies vary35 Northern Virginia Psychiatric Group, P.C. v. Halpern, 19 Va. Cir. 279, 282 (1990); Richardson v. PaxonCo., 203 Va. 790, 795 (1962).36 Richardson v. Paxon Co., 203 Va. 790, 795 (1962).37 Paramount Termite Control Co. v. Rector, 238 Va. 171, 174 (1989).38 Id. at 175.39 See David A. Linehan, Due Process Denied: The Forgotten Constitutional Limits on Choice of law inthe Enforcement of Employee Covenants Not to Compete, 2012 UTAH L. REV. 209, 210-211 (2012).3082723.3

from traditional injunctions and damages to interesting application of liquidateddamages, disgorgement of monies, and attorneys’ fees. Not only are these remediesavailable to employers, but certain employees may also assert claims for damages inconnection with overreaching restrictive covenants. 40Injunctive relief is one of the most-utilized remedies in employment restrictivecovenants. 41Injunctive relief, in this context, fulfills the premise of the restrictivecovenant, because it is used to restrict the employee’s ability to compete, solicit, etc. 42Employers should also note that some states are stricter than others in consideringinjunctive relief. Colorado, for example, requires that injunctions be narrowly drawn,and may only operate based on the terms of the underlying restrictive covenant (i.e., ifthe agreement has a 1-year restriction, the injunctive relief will have the same timelimit). 43North Carolina, by contrast, allows broader injunctive relief that may includetolling for periods of breach or pending litigation. 44In addition to injunctive relief, employers can typically also seek damages for breachesof restrictive covenants. While enjoining the offending behavior is the first step, anemployer may also suffer damages by way of lost customers, lost profits, loss ofgoodwill, and training expenses (among other things). Specific monetary damages canprove difficult, if not impossible, to prove in this context, but they are nevertheless40 See Osborn v. Bell Helicopter Textron, Inc., 828 F. Supp. 446, 449 (N.D. Tex. 1993); ApplicationGroup, Inc. v. Hunter Group, Inc., 61 Cal.App.4th 881, 884 (1998).41 See DBA Enters., Inc. v. Findlay, 923 P.2d 298, 302 (Colo. Appl. 1996) (noting that injunctions are thepreferred remedy for breach of non-compete).42 Id.43 E.g., Phoenix Capital, Inc. v. Dowell, 176 P.3d 835, 843 (Colo. App. 2007).44 E.g., Manpower of Guilford County, Inc. v. Hedgecock, 257 S.E.2d 109, 115 (N.C. Ct. App. 1979).3082723.3

ecoverable for the breach of a valid noncompete agreement. Because damages areoften uncertain (or difficult to prove) in this context, liquidated damages clauses areoften used and are typically enforceable, provided that the number is reasonably relatedto the harm to be suffered, reflects a tie to compensation or the value the formeremployee could or would obtain from competing, or be based on suspected oranticipated losses. 45Finally, attorneys’ fees may be appropriate in restrictive covenant cases, and can goeither way. By way of example, Colorado allows for an award of attorneys’ fees andcosts to the prevailing party even where the actual damages award is minimal. 46Florida allows its courts the discretion to award fees and costs to prevailing party evenwhere the parties did not specifically authorize such an award in the underlyingagreement. 47And in Texas, the courts are allowed to award fees and costs toemployees where the employee establishes the employer knew at the time of executionthat the noncompete was not reasonable, that the restrictions were greater thannecessary to protect legitimate business interests, and the employer attempted toenforce the agreement to a greater extent than necessary. 4845 See, e.g., Calhoun v. WHA Med. Clinic, P.L.L.C., 632 S.E.2d 563, 567-573 (N.C. Ct. App. 2006) ($1.5million liquidated damages provision was reasonable estimate of anticipated losses, and thus not voidagainst public policy as a restrain on the ability to perform one’s profession); Amex Distrib. Co, v.Mascari, 724 P.2d 596, 599 (Ariz. Ct. Appl. 1986) (liquidated damages clause of “75% of [employee’s]billing of [employer’s customers] during the first year, 60% the second year, and 50% the third year”);Restatement (Second) of Contracts § 356, comment (b) (1981) (liquidated damages provision isreasonable if it “approximates the loss anticipated at the time of the making of the contract, even thoughit may not approximate the actual loss.”); Checkers Eight Limited Partnership v. Hawkins, 241 F.3d 558,561-562 (7 th Cir. 2001) (liquidated damages clause unenforceable if it constitutes a penalty).46 See, Saturn Sys., Inc. v. Militare, 252 P.3d 516, 529-530 (Colo. App. 2011) (granting attorneys’ feeswhere damages award totaled $525).47 FLA. STAT. § 542.335(1)(k) (2012).48 TEX. BUS. & COM. CODE ANN. § 15.51(c) (West 2011).3082723.3

C. Litigation Arising From “Anti-Poaching” AgreementsIn addition to requiring employees to sign confidentiality agreements, some employershave also attempted to implement “anti-poaching” or non-solicitation agreements as ameans to protect an employer’s investment in employees and to shield the disclosure ofconfidential information between competitors. By way of example, two or more regionalcompetitors might agree to refrain from interviewing or hiring each other’s employees.However, because these agreements implicate antitrust concerns, there is a growingtrend in litigation involving these alleged “anti-poaching” agreements.One of these cases is In Re: High-Tech Employee Antitrust Litigation, currently pendingbefore Judge Koh in the Northern District of California, Case No. 11-CV-02509-LHK. Inthat case, the plaintiffs alleged that Google, Inc., Apple, Inc., Intel Corp., and AdobeSystems, Inc. illegally agreed not to poach each other’s engineers. This lawsuit wasfiled in May 2011, and seeks damages for antitrust violations stemming from thecompanies’ alleged agreements to provide each other notice whenever one made anoffer to another company’s employee. The plaintiffs also contend that the defendantsagreed to cap pay packages for prospective hires to prevent bidding wars, and toabstain from recruiting one another’s personnel entirely. The parties entered into atentative agreement to settle the class claims for $324.5 million, but Judge Koh rejectedthe settlement in August 2014, finding it offered class members proportionally less thandeals that were struck by other companies that were initially targeted by the DOJ forantitrust allegations. The defendants are seeking Ninth Circuit review of the decision toreject the settlement, but as of the date these materials were finalized, no decision hasbeen made on that appeal and the case is set to start trial on April 9, 2015.3082723.3

That lawsuit was followed by multiple other lawsuits asserting substantially similarclaims. In September of 2014, a putative class action was filed against DreamWorksAnimation SKG, the Walt Disney Co., and other Hollywood companies accusing them ofsimilar antitrust violations stemming from agreements not to poach each other’semployees. 49The following month, two more class actions were filed against the samegroups of defendants, asserting similar claims on behalf of additional groups ofemployees. 50These lawsuits stand are good examples of when an employers’ efforts to protectconfidential information went “too far.”Although these alleged anti-poachingagreements (if they did, in fact, exist) likely helped to prevent the disclosure ofinformation between competitors, they are also alleged to have had an anticompetitiveeffect which resulted in the payment of below-market wages across the industry. Thus,while an “anti-solicitation” agreement between an employer and an employee—barringthe employee from soliciting other employees to quit and join a competing venture—may be enforceable (depending on what state you are in), agreements between twodifferent employers to refrain from hiring each other’s employees are much more riskyand could violate the antitrust laws.49 See Nitsch v. DreamWorks Animation SKG, Inc, USDC, NDCA, Case No. 14-CV-04062-LHK.50 See Wentworth v. Lucasfilm LTD, LLC, USDC, NDCA, Case No. 14-CV-04422-JCS; see also Cano v.Pixar, et al, USDC, NDCA, Case No. 14-CV-04203.3082723.3

II.Trade Secrets, Non-Competes and Other Restrictive Covenantsin the Netherlands, the United Kingdom, Germany, Belgium,France and Italy.A. The Netherlands. 511. Trade Secrets in GeneralIn the Netherlands, an employer’s confidential and proprietary information will generallybe protected through express and implied terms of the employment contract. Even inthe absence of an express confidentiality clause, an employee will be subject to animplied duty of confidentiality, based on “good employeeship” (the principle ofreasonableness and fairness). 52As a result, as well as during employment as afteremployment has ended, an employee will be under an obligation not to use or disclosethe employer’s confidential information.2. Restrictive Covenantsa. Non-Compete ClauseThe current provisions on non-competition clauses are set forth in the section of theDutch Civil Code (DCC) on employment agreements.51 By Eva Knipschild (Eva.Knipschild@kvdl.nl) of the ALFA The Netherlands firm Kennedy Van der Laan.52 Article 7:611 of the Dutch Civil Code.3082723.3

1. ValidityFor the validity of a non-compete, section 7:653 (1) and (2) of the Dutch Civil Code(DCC) determines three criteria. The first criterion to a clause between an employerand an employee, restricting the latter’s rights after termination of the (employment)agreement to work in a certain capacity, is that the employer had agreed such clause inwriting. As, by agreeing to a non-competition clause, an employee’s rights to work in acapacity that he may desire after termination of the employment agreement areconsiderably restricted, the legislator has set stringent requirements for the validity of anon-competition clause. For example, a non-competition clause not agreed in writing isnull and void. The requirement that the clause be agreed in writing is interpreted verystrictly in case law: non-competition clauses in staff handbooks or non-competitionclauses not signed by the employee are very likely to be nullified by the court. 53Furthermore, if the position of an employee has changed significantly, case law requiresthat such a non-competition clause be re-agreed. 54The second criterion is that a non-compete is only valid if it has been agreed upon withan adult employee.The third criterion is only applicable in case of a fixed term employment contract.Pursuant to section 7:653(2) DCC, which has some into force on 1 January 2015, inprinciple, it is prohibited to agree upon a non-compete clause in a fixed termemployment contract, unless the employer has substantial business or service interests53 Supreme Court 28 March 2008, LJN BC0384 (Philips/ Oostendorp).54 Supreme Court 5 January 2007, LJN AZ2224 (AVM Accountants/Spaan).3082723.3

that justify to do so anyway. When including such clause, the employer mustsubstantiate these interests in writing, either in the employment contract itself or in anappendix to the contract. When at the end of the employment contract the employerrelies on the non-compete clause, he must be able to prove that these interests stillexist. Failing such written substantiation, the non-compete clause will be void. If theclause is not required because of substantial business or service interests, the courtmay declare the clause void in its entirety.2. EnforceabilityThe DCC also contains criteria which are relevant to the enforceability of a noncompetitionclause: the non-competition clause may not be unfairly detrimental to theemployee as compared to the employer’s interest to be protected.Therefore, theinterests of the employer and the employee have to be weighed. The court may nullifyall or part of the non-competition clause if it is of the opinion that the clause is unfairlydetrimental to the employee. In the event of a partial nullification, a restriction on theprohibited activities or a restriction as to the duration or geographic scope of the clausemay be considered. The restriction that is deemed reasonable will depend, inter alia, onthe relevant industry and the position held by the employee, as well as on the durationof the relevant employment agreement.b. Business Relationship ClauseThe DCC does not contain specific rules regarding a business relationship clause.Pursuant to case law, a business relationship clause in principle qualifies as a non-3082723.3

compete clause. As a consequence, the same criteria for validity and enforceabilityapply.c. Confidentiality ClauseIn practice, it is common for an employer to include a confidentiality clause in theemployment contract, that prevents the employee from disclosing any confidentialinformation, data, documents, etc. regarding the company or the group’s business toany third party during the performance of the employment contract and after itstermination. The DCC does not contain specific rules regarding a business relationshipclause. However, the DCC does contain a clause regarding penalties.d. Other Restrictive ClausesOther restrictive clauses, such as a non-poaching clause or an intellectual propertyclause, are common in The Netherlands. No specific statutory rules apply.e. Penalty ClauseIn general, the aforementioned clauses may contain a penalty clause. 55 It is advisable toadd such a clause for the situation of non-compliance with the restrictive covenants. Incase of an amicable settlement (a termination agreement by mutual consent), it isadvisable to explicitly state that both the restrictive covenant(s) and the penalty clausewill remain in force and will not be waived.55 Article 7:650 of the Dutch Civil Code3082723.3

B. The United Kingdom. 561. Trade SecretsIn the UK, an employer’s confidential and proprietary information will generally beprotected through express and implied terms of the employment contract. Even in theabsence of an express confidentiality clause, an employee will be subject to an impliedduty of confidentiality. As a result, during employment, an employee will be under anobligation not to use or disclose their employer’s confidential information. Afteremployment has ended, this implied term still serves to protect confidential information,but a narrower category of confidential information; essentially information with thesame degree of confidentiality as to amount to a trade secret. 57Generally, therefore, rather than merely relying on the implied term, employers will alsoinclude express confidentiality clauses. The purpose of these is to specify exactly whatinformation is regarded as confidential and which should be treated as such, which canassist evidentially in demonstrating information is protectable. Case law also suggeststhat an express clause may widen the categories of confidential information, which canbe protected post-employment. 58Additionally, employment contracts will frequently contain other provisions designed toassist protecting confidential/proprietary information.For example, an express56 By Bob Mercrate-Butcher (Bob.Mercrate-Burcher@crsblaw.com) of the ALFA London firm CharlesRussell Speechlys.57 Faccenda Chicken Ltd v Fowler [1986] IRLR 69.58 Lansing Linde Ltd v Kerr [1991] IRLR 80; Lancashire Fires Limited v SA Lyons [1997] IRLR 113; CrayValley Ltd v Deltech Europe Ltd [203] EWHC 728 (CH).3082723.3

obligation on termination requiring delivery up of all information and deletion from anypersonal computers, etc.Certain categories of confidential information may be additionally protected in the UKthrough intellectual property rights and/or in relation, for example, to customer lists,database rights.Where an employer suspects an employee/former employee of misusing its confidentialinformation/proprietary data frequently, evidence of breaches will be first obtainedthrough use of computer forensics. Once evidence has been obtained, this will usuallybe followed by lawyers’ letters, seeking full details of disclosure and use made andappropriate undertakings. In the absence of a satisfactory response, this will usually befollowed by initiation of legal action, seeking injunctive remedies and/or damages. Incertain circumstances, where there is evidence that an employee/former employee hasmis-used confidential information and, as a result, obtained an unfair head start it maybe possible to obtain a “springboard injunction” which may for example, prohibit theformer employee from dealing with customers contacted using a wrongly takencustomer list for a particular period.2. Restrictive Covenantsa. Basic Legal PositionThe starting position in the UK is that restrictive covenants are void on the basis ofbeing “in restraint of trade”; i.e. anti-competitive.Restrictive covenants withinemployment contracts will only be enforced by UK courts where an employer can3082723.3

demonstrate that a particular covenant is necessary to protect its legitimate businessinterests (traditionally confidential information, clients, stability of its workforce nondisruptionwith supplies) and that, in addition, the covenant is drafted to provide no morethan the minimum necessary level of protection to those interests. 59In short the ambitof the covenant, is not too wideand the length of the covenant is not too long. Notethere is no obligation to pay an employee during a period over which a restrictivecovenant applies and, therefore, within the UK there is generally no provision forpayment.b. Prevalence of Restrictive CovenantsRestrictive covenants will generally be found within contracts for senior executives andalso within the contracts of more junior employees within many industries. For example,restrictive covenants will often be found in the contracts of employees within thefinancial services sector, particularly for employees in broking and other front office,sales and marketing roles. Restrictive covenants will often also be contained withinother sectors for those in middle management or involved in direct dealings with clientsor where protection of trade secrets and other proprietary information is regarded ascrucial.c. Types of Restrictive CovenantsIn the UK it is common to find the following types of covenant.1. Non-Solicitation Restriction59 Allied Dunbar (Frank Weisinger) Ltd v Weisinger [1988] IRLR 60.3082723.3

This should be the easiest type of covenant to justify and, therefore, enforce foremployees with direct dealings with clients. It is drafted to restrict a former employeefrom “soliciting”; i.e. taking steps to bring in the business of, clients with whom they havedealt for a particular period. Covenants will also, on occasions, be drafted to coverprospective clients; i.e. business contacts who have not yet become clients.2. Non-Deal RestrictionThis prohibits “dealing”; i.e., doing any work for clients regardless of whether there wassolicitation. This is more difficult to justify than a non-solicitation restriction, but it is notunusual to find non-dealing restrictions which employers will seek to justify on the basisof the difficulty of policing non-solicitation restrictions.3. Non-Compete RestrictionThis seeks to preclude a departing employee from working with a competitor for aparticular period. Whilst more difficult to justify, UK courts will enforce a non-competerestriction in appropriate circumstances. Particularly where these restrictions arenecessary to protect non-client specific confidential/proprietary information as may bethe case for senior executives with particular knowledge of business strategy.4. Poaching RestrictionsA clause which seeks to preclude the departing employee from playing any part inrecruiting former colleagues. It is important that such a clause is not drafted to cover allcategories of employee, particularly in the case of large employers. Ideally, therefore,such a clause should be drafted to cover classes of employees who have had particular3082723.3

levels of client connection/access to trade secrets/proprietary information. Generallyhowever, provided necessary and appropriately drafted, will be enforced by UK courts.5. OtherIn addition to the above, there may also be covenants which seek to preclude a formeremployee from taking steps which might disrupt the former employer’s relationship withits suppliers. Again this type of restriction is potentially enforceable.Covenants may also be drafted, particularly in the financial services sector, so thatrather than prohibiting an employee from taking steps, they provide that certain deferredcompensation/stock/options will be forfeited. The same principles apply regardingenforceability.d. Garden LeaveIt is common in the UK to also seek to protect an employer’s business interests through“garden leave.” This is the use of a contractual right to require an employee to stay outof office and have no contact with clients or colleagues during their contractual noticeperiod. It is common for an employer to exercise this right where a senior employeeresigns to join a competitor. Often, restrictive covenants are also drafted so that anyperiod of garden leave served reduces the period of the covenants.e. Enforcement of Restrictive CovenantsIt is fairly standard where a senior employee is leaving to join a competitor, or issuspected of doing so, for the employee to be reminded, in writing, of the existence of3082723.3

the covenants on termination. Additionally, employment contracts frequently contain acontractual obligation on an employee to make a potential new employer aware of theexistence of the restrictive covenants with a view to supporting an “inducement” actionagainst a prospective employer. An inducement action is on the basis that the newemployer has induced or encouraged/facilitated a breach of contract by the individualsubject to the restrictive covenants.In the event of finding evidence that suggests breach by a former employee, thefirst stage is ordinarily, lawyers “warning shot” letters to the former employee and thenew employer highlighting what seem to be breaches and seeking appropriateundertakings that covenants will be complied with.In the absence of suchundertakings, the next step would be to apply to the UK High Court seeking injunctiverelief; i.e., a Court Order requiring employee/potential new employer to comply, and/ordamages. In order to obtain an injunction it would be necessary to produce substantiveevidence of the breach, in support of the covenants being appropriate and necessary toprotect the employer’s legitimate business interests and of the need for an injunctiveremedy to prevent a real risk of damage.3082723.3

C. Germany 601. Protection of Trade Secretsa. General IntroductionThere is no explicit statutory provision relating to any non-disclosure obligation of theemployee regarding to trade secrets of the employer. However, such an obligation isgenerally acknowledged.The acknowledged obligation is flanked by statutoryprovisions 61 regarding unlawful competition and tort law,. Additionally, there exist somespecial non-disclosure obligations for specific secret carriers within a company.Trade secrets are defined as all facts connected to the running of the business whichare only known by a specific group of people, which are not in the public domain andwhich are kept secret based on the expressed or implied will of the employer due tojustified economical reasons. 62Trade secrets are protected through Sec. 17 UWG, which is a criminal provision duringthe employment relationship. Moreover, due to the employee´s duty to secure theinterests of hi or her employer there exists a broader obligation of the employee to notdisclose any non-disclosure interests of the employer no matter of their kind. Thisobligation is limited by constitutional means. By weighing the parties´ interests withinthe employment relationship the employee is entitled to disclose information insofar as60 By Géro Schneider (Schneider@tiefenbacher.de) of the ALFA Germany firm Tiefenbacher.61 Secs. 17 UWG subs. (Act Against Unfair Competition).62 Hoeren, Der Schutz von Betriebs- und Geschäftsgeheimnissen, p. 106 subs.3082723.3

his or her freedom of speech outweighs the employer´s interest in the secrecy of ancompany-related topic.There exists a controversy in the legal practice of whether – and to which extent – anobligation to not disclose trade secrets is applicable after the termination of anemployment relationship. The German Federal Labour Court has not finally decided onwhether a general obligation not to disclose may be drawn from the general duty tomutual consideration. It seems to be undoubted that “justified” trade secrets areprotected after the termination of the employment relationship. 63However, this is onlytrue insofar the employee is not infringed in his or her constitutional freedom to choosean occupation. Further protection of the employer may only be reached by contractualagreements, i.e,. non-disclosure agreement and clause not to compete.b. Legal Remedies In Case of any Infringement?As legal remedies in case of an infringement of the obligation not to disclose labour law,civil law and criminal law consequences may be at hand as follows:The employer may be entitled to a termination of the employment relationship withimmediate effect or at least obtaining the contractual/statutory notice period. Theemployer may claim an obligation to cease by the employee for the future. Furthermore,damages may be claimed, but have to be proved by the employer. Finally, theemployee may be sentenced according to Sec. 17 UWG.c. Recommendation.63 Lingemann / von Steinau-Steinrück / Mengel, Employment & Labor Law in Germany, p. 29.3082723.3

It is very common to introduce a non-disclosure agreement in the employment contract.Such agreement should especially be applicable even after the termination of theemployment relationship. The non-disclosure obligation should be flanked by acontractual penalty on case of any infringement. According to German law a contractualpenalty of one monthly gross salary for each infringement may be validly agreed.2. Restrictive CovenantsAfter termination of the employment, a confidentiality clause is enforceable withoutobligation to pay compensation, whereas a post contractual restrictive covenant will beenforceable only if:• it does not exceed a period of two years• it is concluded in writing• it is necessary to safeguard a justified commercialinterest of the employer• it does not unfairly jeopardize the employee´s futurecareer• the employer obligates himself to pay compensationfor the duration of the restrictive covenant in theamount of at least one-half of all contractual benefitsthe employee last received. 64Other earnings are only deducted if they, together with the compensation, exceed 110%of the employee´s previous remuneration. If the employee must change his residence64 Sec. 74 German Commercial Code.3082723.3

due to the restrictive covenant, the limit is 125%. 65 . If one party has provided groundsfor terminating the employment relationship for cause the other party may declare,within one month, that it is no longer bound by the restrictive covenant. 66 . The sameapplies in favor of the employee if the employer terminates the employment agreementwithout justification. The employer may waive the restrictive covenant at any timebefore the employment agreement expires. However, in this case it must pay thecompensation for one more year. Consequently, if it waives the restrictive covenant oneyear or more before the employment agreement comes to an end, no compensation willneed to be paid since it will be set-off against the paid contractual remunerationanyway.D. Belgium 671. Non-Competition Agreements:• It is only possible to agree upon a non-compete foremployees, who earn more than EUR 40K gross per annum;• The non-competes should be limited to the region where theworker was active during his employment;• The maximum duration of a non-compete is 12 months;• A non-compete can only be enforced in case the employeeresigns or the employer terminates the employmentagreement for serious cause;65 Sec. 74c German Commercial Code.66 Sec. 75 German Commercial Code.67 By Bruno Blanpain (Bruno.blanpain@mvvp.be) of the ALFA Belgium firm Marx Van Ranst Vermeersch& Partners.3082723.3

• The non-compete must provide for a lump sumcompensatory payment that is at least equal to 50% of thenormal salary and benefits over the period during which therestrictive covenant will be enforced;• The employer can waive part or whole of the covenant’sapplication within a period of 15 days post termination byregistered mail; after that period the lump sum is due. 682. Non-solicitation clausesNon-solicitation clauses are sometimes included in non-competition clauses or standalone. It is uncertain whether these restrictions can be enforced since the labor marketis in principle free. The inclusion of a non-competition clause offers the best possibilityof enforcement whereas the employee is compensated and the prohibition is limited intime.3. IP-IT clausesIntellectual Property/Information Technology clauses are regularly instated in contractsby which the employee confirms:• (that he did not have previous knowledge of the subjectmatter);• that he will not work for his own or the competition in thesubject matter;• that he transfers all IP and IT rights regarding his work;68 Article 65 of the Statute of July 3 rd 1978 respecting contracts of employment.3082723.3

• that respecting new exploitation modes of his creations, hewill be compensated with 1% of the profits with a maximumof EUR 500 per annum.International companies with sensitive know-how are able to conclude an exceptionalnon-competition agreement for employees that are aware of these trade secrets if theseemployees earn more than EUR 68K per annum:• The duration of the non-compete may be extended to 24months;• The scope may be wider than Belgium and may includeother countries where the company is active;• The lump sum may be 12 months’ salary and benefits 69 .E. Italy 701. Restrictive Covenantsa. Non-Competition CovenantsUnder Italian law non-competition covenants are allowed both during and after thetermination of the employment contract.69 Collective Labour Agreement #1bis extending the conditions under which a restrictive covenant may beagreed as concluded in the National Labour Council on December 21 st 1978;70 By Davide Boffi (Dboffi@unlaw.it) of Ughi e Nunziante – Studio Legale.3082723.3

i. During the Employment ContractDuring the employment contract, the non-competition restriction automatically derivesfrom the general obligations of employees towards their employers provided for by Art.2105 of the Italian Civil Code 71 .ii.After the Termination of the Employment ContractPursuant to Art. 2125 of the Italian Civil Code 72 , after the termination of the employmentcontract, the non-competition covenant is allowed only if the following legalrequirements are met:a) written form;b) specification of the forbidden activity;c) specification of the duration (5 years for executives and 3 years forother categories of employees);d) specification of the limits of territory;e) compensation for the employee.The amount of the compensation is not provided for by the law. However, such amountmust be fair in relation to the activity, the territory, and the duration, with the71 Art. 2105 of the Italian Civil Code (Royal Decree 16 th March 1942, n. 262) provides that «The employeecannot engage in business, either on his own account or on that of third persons, in competition with hisemployer, nor disclose information regarding the organization and methods of production of thecompany, nor use it in such a manner as may be prejudicial to the employer».72 Art. 2125 of the Italian Civil Code (Royal Decree 16 th March 1942, n. 262) provides that «Agreementsaccording to which the employee’s working activities are limited for the time after the termination of thecontract are null and void unless they are in writing, a compensation for the employee is provided for,and the obligation is subject to a pre-established limit of activity, time and place. The length of theobligation cannot be longer than 5 years, in the case of executives, and 3 years in other cases. If alonger period is agreed, it will be reduced to the above mentioned measure».3082723.3

consequence of otherwise rendering the entire non-competition covenant null and void.On this matter, case law has set out that the compensation cannot be considered fair ifit is manifestly unfair and disproportionate to the sacrifice requested from the employeeand to his/her reduced possibilities of income, independently from the benefit that couldderive to the employer from such limitation.iii.EnforcementIn case of violation of a post-employment non-competition agreement, the employer canrequest a preliminary injunction preventing the employee from working for thecompetitor for the duration of the non-competition agreement. If the employee does notcomply with the injunction, these actions constitute a criminal offence. In any case, it isalso possible to insert a specific clause in the non-competition agreement providing that,in case of complete or partial failure to comply with the covenant, the employee has torepay the money received from the employer and will also be liable to pay a penalty. Inthis regard, according to Art. 1382, second paragraph, of the Italian Civil Code 73 thepenalty is due regardless of proof of damage this means that if a clause providing for apenalty is inserted into the non-competition covenant, the employer is automaticallyentitled to the amount referred to in the penalty clause. If, however, the employerwishes to claim damages in addition to those provided for in the contract, it needs toraise a court action and prove the additional damages.73 Art. 1382, 2 nd par., of the Italian Civil Code (Royal Decree 16 th March 1942, n. 262) provides that «Thepenalty is due regardless of proof of damage».3082723.3

. Non-Solicitation CovenantsDuring the employment relationship the non-solicitation restriction automatically resultsfrom the general obligations of the employees towards the employer as provided for byArt. 2105 of the Italian Civil Code.It is also possible to provide this obligation after the termination of employment, by aspecific clause inserted in the contract or by a specific agreement, although there are nolegal provisions specifically regarding non-solicitation. No compensation is due for nonsolicitationrestriction.i. Trade Secretsa) DefinitionDuring the employment contract the disclosure of confidential information constitutes aviolation of the duty of loyalty provided for the Italian Civil Code (Art. 2105). This articleprovides that the employee can neither divulge information regarding the organizationand methods of production of the company, nor use it in such a manner as mayprejudicial to the employer.Furthermore, the disclosure of trade secrets also represents a criminal offence. Indeed,under Art. 622 of the Italian Criminal Code 74 states that anyone who knows a secret forreasons related to his position, office or profession, and discloses it, without just cause,74 Art. 622, 1 st par., of the Italian Criminal Code (Royal Decree 19 October 1930, no. 1398) provides that:“Any person who, due to his status or office, or his profession or art, becomes aware of a secret andreveals it without just cause, or uses it on his own behalf or to the benefit of someone else, shall bepunished, if harm can be caused by such act, with imprisonment of up to 1 year, or with a fine from 30to 516 Euro.”3082723.3

or uses it for his own profit or for the profit of a third party, is punishable withimprisonment of up to 1 year or with a fine of up to 516 Euro, if the fact has causeddamage. In addition, Art. 623 of the Italian Criminal Code states that “anyone whoknows, for reasons related to his position, office or profession, news to be keptconfidential regarding discoveries or scientific inventions and discloses them for his ownprofit or for the profit of a third party, is punishable with imprisonment of up to 2 years.”b) EnforcementDuring the employment contract the violation of the obligation to confidentiality canentail the adoption by the employer of disciplinary sanctions resulting even in dismissalfor just cause, as a violation of the duty of loyalty.After the termination of the contract, the use of confidential information by a company incompetition could constitute a case of unfair competition. Therefore, the employer canbring an action asking the Court to prohibit the continuation of the unfair competitionand make the appropriate provisions in order that its effects be counteracted, with apreliminary injunction. (Art. 2599 of the Italian Civil Code). Furthermore, the employercan also claim for damages, if acts of unfair competition are performed with malice ornegligence (Art. 2600 of the Italian Civil Code).3082723.3

F. France 751. Protection of Trade Secrets by the Law.a. Infringements Protecting the Manufacturing Secret.Under French law, there is no general infringement provided for by the Criminal Codethat would punish the disclosure of any trade secrets. However, the French labour Codeprovides for a specific infringement in order to protect the disclosure of anymanufacturing secret (which does not cover any trade secret) 76 . If an employee or acompany representative discloses or attempt to disclose a manufacturing secret, he orshe could be exposed to criminal prosecutions (2 years imprisonment and a fine of €30,000). The Company could also claim for damages because of such disclosure.b. Company’s Intellectual Property Rights throughInventions of an Employee.Any invention made by an employee in the performance of his functions implying aninventive mission, or in the course of studies and researches devoted to him by theemployer, belongs to the company. A company can ask for the property of any otherinvention made by one of its employees during the performance of his employmentcontract, whatever his functions are, if such invention was made by the employee:• In the scope of the activity of the Company; or75 By Kim Campion (Kim.Campione@crsblaw.com) of Charles Russell Speechlys.76 Article L.1227-1 of the Labour Code: “the disclosure or the attempt to disclose any trade secrets ispunished by two years imprisonment and a fine of €30,000. The Court is also allowed to decide, as anadditional sentence, deprivation of civil, civic or family rights for a period that cannot exceed 5 years”.3082723.3

• Thanks to the knowledge, means or data theCompany has provided him with.In return, the employee is paid a “fair price” decided upon an agreement 77 .2. Validity and enforcement strategies for restrictive covenantsIn France, several clauses are inserted in the employment contracts in order to ensurethe non-disclosure of any trade secret in the course of the employment contract asmuch as at the termination of the employment contract.a. Confidentiality ClauseIn practice, the employment contracts provide for a confidentiality clause that preventsthe employee to disclose any confidential information, data, document, etc. regardingthe company or the group’s business to any third party during the performance of theemployment and pursuant to its termination. Such clause is particularly useful at thetermination of the employment contract. Indeed, in the course of the employmentcontract, the employee is subject to a loyalty obligation that forbids him any way tobreach any confidentiality obligation. In case of such breach, the employee could bedismissed for gross misconduct. Pursuant to the termination of the employment77 Article L.611-7-2° of the Intellectual property Code: “when an invention is made by an employee in thecourse of the performance of his functions, or in the field of the company’s activities, or thanks to theproper knowledge or the use of technics or tools belonging to the company, or thanks to data furnishedby it, the employer is allowed, in the conditions and the deadline provided for by a decree, to claim forthe property or the enjoyment all or part of the rights related to the patent protecting the invention of theemployee.The employee has to be provided with a fair price which, except in case of an agreement between theparties, is fixed by the conciliation commission implemented in accordance with the article L.615-21 orby the Civil Tribunal : the latter will take into consideration any elements that may be given by theemployer and the employee, in order to calculate the fait price taking into account the initialcontributions of the employee and the employer and the industrial and business utility of the invention”.3082723.3

contract, if an employee is subject to a confidentiality clause, he will be forbidden todisclose any information, document or data regarding the business trade to any thirdparty.In case of disclosure, he could be ordered to pay damages to his formeremployer to repair any suffered harm.b. Non Solicitation ClauseIn France, employment contracts provide for non-solicitation clauses. Such clausesforbid the employer from hiring any employee of the Company during a limited period.In practice, such clauses do not trigger many disputes. However, from a legal point ofview, it cannot be totally excluded that an Employment Court could consider these nonsolicitationagreements as non-compete clauses between the company and its currentemployees. Indeed such clauses limit the freedom of work of the current employees ofthe Company in case of termination of their employment contract.c. Non-Compete ClauseUnder French law, non-compete clauses can be enforced under the followingconditions. The non-compete obligation has to:• be justified by the protection of the legitimate interests of thecompany;• take into account the specificity of the functions of theconcerned employee;• be limited in time and space; and• provide for a non-competition indemnity.3082723.3

In any case, the non-compete clause has to comply with the provisions of the applicableCollective Bargaining Agreement 78 (CBA) If the non-competition fails in meeting one ofthe above conditions, the non-competition clause would be null and void. Theemployee would be allowed to compete with the company unless such competition isdisloyal.If an employee complies with a non-compete clause that does not comply with theabove conditions, the Company would be ordered to pay damages to the employee.At the termination of the employment contract, the Company is allowed to release theemployee from the non-compete obligation, if such withdrawal right is provided for bythe employment contract or the applicable collective bargaining agreement.78 Under French law, an industry-wide CBA applicable to a company is determined in consideration of itsmain activity (e.g. main turnover or highest number of employees). As soon as the main activity of acompany is covered by the scope of application of an extended industry-wide CBA, the latterautomatically, compulsorily and immediately applies to the said company, without any delay. Inaddition, the application of a CBA is mandatory when the employer is a member of an employer’sorganisation which is a party to such an agreement.3082723.3

2015 INTERNATIONAL CLIENT SEMINARFAIRMONT SCOTTSDALE PRINCESS HOTELSCOTTSDALE, ARIZONAMARCH 5 – 8, 2015SEX, DRUGS AND ROCK & ROLL –IS THIS VH1’S “BEHIND THE MUSIC”OR MY OFFICE?Deborah P. KellyDickstein Shapiro LLPWashington, DC202-420-4772kellyd@dicksteinshapiro.comAmy S. GareCapgemini North AmericaNew York, NYwww.capgemini.comJane E. BrownPaine HamblenSpokane, WA509-455-5067jane.brown@painehamblen.comSarah K. JohnsonNordstrom, Inc.Seattle, WAwww.nordstrom.comDavid A. KochmanO.pen VAPEDenver, COwww.openvape.com

Medical Marijuana and Employment Law 1Marijuana is legal in 24 jurisdictions and more are expected to join those ranks. Thefederal government hasn’t budged. Your company is in a state where employees canlawfully use marijuana either recreationally or when prescribed by a doctor. You havea drug-free workplace policy. Now what? 2While the specifics will be the subject of thepanel discussion, this paper summarizes the landscape in which these questions will beconsidered.I. BackgroundA. Medical MarijuanaPresently 23 states and the District of Columbia permit marijuana either for recreationaluse (Colorado, Washington, Oregon, Alaska, District of Columbia) or to treat designatedmedical conditions like cancer and Parkinson’s Disease.Statutes differ, but to make sure the relevant states don’t become Amsterdamequivalenttourist draws among other reasons, there are certain common registrationrequirements for a potential user to obtain a license or identification card for medicaluse:1 Materials prepared by Deborah Kelly and Lyndsay Gorton of the ALFA Washington DC firm DicksteinShapiro LLP; Jane Brown and Anne Schroeder of the ALFA Spokane, WA firm Paine Hamblen LLP.2 http://www.forbes.com/sites/theemploymentbeat/2014/12/02/medical-marijuana-and-the-workplacewhat-employers-need-to-know-now/.

○The applicant must be a resident of the state and have proof of such in theform of a driver’s license or passport and recent electric/cable/ gas bill.○ The applicant must be over the age of 18.○○○The applicant must pay an annual fee for the license.The applicant must reapply on an annual basis.The applicant’s physician must provide confirmation that the applicant hasa “debilitating medical condition” the effects of which would be eased bymarijuana.○ But, most states do not require a “prescription” for medical marijuana. 3B. Recreational MarijuanaCurrently, four “states” allow people to use “recreational marijuana”. 4In 2014, theDistrict of Columbia voted to permit the use of “recreational marijuana,” but when it goesinto effect is anyone’s guess since Congress seems hell-bent on making sure cannabisdoes not come to the nation’s capital (though it has already been decriminalized there).What these statutes have in common is that:1. User must be over 21 years old.3 E.g. http://dhss.delaware.gov/dph/hsp/medmarhome.html4 Alaska, Colorado, Oregon, Washington.

2. The amounts that a user may possess or grow are small.○For example, under the DC recreational marijuana bill, a user maypossess up to 2 ounces and grow up to six plants. 5○In Colorado, a user may possess up to one ounce of recreationalmarijuana. 6○In Washington, a user may possess up to one ounce of useablemarijuana; or 16 ounces of marijuana infused product in solid form;or 72 ounces of marijuana infused product in liquid form. 7II.Conflicts Between Federal and State LawsMarijuana regulation began in the United States with the passage of the 1937 MarijuanaTax Act. 8 It is speculated that this tax act was spearheaded by Andrew Mellon, WilliamRandolf Hearst, and the Du Pont family who did not want the hemp business toencroach upon the timber, paper pulp, or nylon industries respectively. 9 In 1969, the Act5 http://www.mpp.org/states/district-of-columbia/summary-of-dcs-initiative.html.6 https://www.colorado.gov/pacific/marijuanainfodenver/residents-visitors.7 RCW 69.50.3608 Under the 1937 Marijuana Tax Act, a $1 levy tax existed for those who dealt with marijuanacommercially, possessed, or prescribed marijuana.9 http://www.herbmuseum.ca/node/1578, http://en.wikipedia.org/wiki/Marihuana_Tax_Act_of_1937

was called into question by Leary v. United States. 10 The following year the Act wasrepealed and replaced with the 1970 Controlled Substance Act (CSA)States’ approval of marijuana use is going to run into the buzz saw of the federalgovernment’s disapproval of marijuana use. The feds will argue that, under the doctrineof preemption, in a battle with the states, the federal government wins because a statemay not pass a law in direct opposition to a federal law if the federal legislature intendedto regulate that area. Based on this doctrine of preemption, no state law may require afederal contractor or grantee to accommodate state-legal medical marijuana use.In 2005, this conflict came to a head in Gonzales v. Raich. 11There, the Supreme Courtheld that the Commerce Clause of the Constitution includes the power to prohibitmarijuana from being cultivated and used even though it was in compliance withCalifornia law. In Gonzales, the petitioners argued that the “CSA's categoricalprohibition of the manufacture and possession of marijuana as applied to the intrastatemanufacture and possession of marijuana for medical purposes pursuant to Californialaw” exceeded Congressional authority under the Commerce Clause. 12The Courtdisagreed and stated,[L]imiting the activity to marijuana possession and cultivation “inaccordance with state law” cannot serve to place respondents' activitiesbeyond congressional reach. The Supremacy Clause unambiguously10 Leary v. United States, 395 U.S. 6, 89 S.CT. 1532 (1969). The Court found that compliance with the1937 Marijuana Tax Act would have a substantial risk of self-incrimination11 Gonzales v. Raich, 545 U.S. 1, 125 S.Ct. 2195, 2196 (2005).12 Id. at 15.

provides that if there is any conflict between federal and state law, federallaw shall prevail. It is beyond peradventure that federal power overcommerce is ‘superior to that of the States to provide for the welfare ornecessities of their inhabitants,’ however legitimate or dire thosenecessities may be.” 13As demonstrated by Gonzales, the federal government’s preemptive authority remains,and employers that expect to be in the clear when abiding by state laws, should insteadremain vigilant about federal regulatory authority.Marijuana is governed primarily under two federal statutes:1. Federal Controlled Substances Act. 14The Federal Controlled Substances Act (CSA) considers marijuana a Schedule Icontrolled substance because it has three characteristics: (1) a high potential for abuse;(2) no currently accepted medical use in treatment in the United States (although thatisn’t true anymore); and (3) there is a lack of accepted safety for use of the drug or othersubstance under medical supervision (again, no longer true).As a Schedule I controlled substance, the CSA prohibits “manufacture, sale,dispensation, and possession” of marijuana even if state law permits its use forrecreational or medical reasons.In 2009, The Deputy Attorney General addressed the issue of the enforcement of theCSA in states that allow for medical marijuana. The memorandum stated that the13 Id. at 29.14 21 U.S.C. § 801 et seq.

priority was to prosecute traffickers of illegal drugs as opposed to those sick withcancer. 15 This stance was later reaffirmed in another memorandum by Deputy AttorneyGeneral Cole.In 2012 both Colorado and Washington State voted to allow the use of recreationalmarijuana. The Department of Justice issued two memorandums regarding marijuanaenforcement. In 2013, the first “Cole Memo” stressed that the federal government’sguidance for marijuana enforcements entails eight priorities:○preventing the distribution of marijuana to minors;○preventing revenue from the sale of marijuana from going to criminalenterprises, gangs, and cartels;○preventing the diversion of marijuana from states where it is legal understate law in some form to other states;○preventing state-authorized marijuana activity from being used as a coveror pretext for the trafficking of other illegal drugs or other illegal activity;○preventing violence and the use of firearms in the cultivation anddistribution of marijuana;○preventing drugged driving and the exacerbation of other adverse publichealth consequences associated with marijuana use;15 “Ogden Memo” 10/19/2009

○preventing the growing of marijuana on public lands and the attendantpublic safety and environmental dangers posed by marijuana on publiclands; and○ preventing marijuana possession or use on federal property. 16 Theguidance emphasized that it expected states who authorize marijuana tohave “strong and effective regulatory and enforcement systems.” 17 Theymust be effective in practice in addition to the procedural and regulatoryeffect. 18The second memorandum, issued in February 2014, highlightedthe federal government’s priorities on financial crimes associate withrecreational marijuana. 19Finally, in October 2014, the Department of Justice issued a guidance for tribal lands.Enforcement would be determined on a case by case basis with consultation with tribalpartners and will focus upon the eight priorities from the “Cole Memo. 202. Federal Drug Free Workplace Act. 21The Federal Drug Free Workplace Act requires all federal grantees and some federalcontractors 22 to implement a “zero tolerance” drug policy. 23This means that once an16 “Cole Memo” 06/29/201317 “Cole Memo” 06/29/201318 “Cole Memo” 06/29/201319 “Cole Memo” 02/14/201420 Policy Statement Regarding Marijuana Issues in Indian Country. 10/28/201421 41 U.S.C. § 8101 et seq.

employer learns that an employee has been convicted of possessing or using an illegaldrug (including marijuana) in the workplace, the employer has two options:○Take an adverse employment action up to termination; or○ Referral to a rehabilitation facility. 24Keep in mind, however, that which options the employer chooses, and the severity ofthe employee’s punishment, are left to the employer’s discretion.III.So Now What: Tough Questions for EmployersCan an employer give a pre-conditional offer of employment drug test? 25○NO. An employer may only give a drug test following a conditional offer ofemployment.Can an employer fire an employee or take any other negative employment action if anemployee fails a drug test?22 A federal contract valued at over $100,000 is subject to the Act.23 http://www.dol.gov/elaws/asp/drugfree/screenfq.htm (last visited January 22, 2015).24 The regulation requires only that, in case of a conviction for a criminal drug offense resulting from aviolation occurring in the workplace, the employer take one of two types of action. The employer may takedisciplinary action (which may be termination or a less severe penalty) or may refer the employee forrehabilitation or drug abuse assistance program. The choice of which basic course to choose, as well asthe specific discipline or treatment option, is left to the employer’s discretion and may be on a case-bycasebasis—provided all state and local laws are followed.25 http://www.sapaa.com/page/wp_dfwp_dt

○Generally, the answer is yes. However, because medical marijuana uselaws are still new, stay tuned to see if this is found to violate theAmericans with Disabilities Act (“ADA”).Can an employer institute a zero tolerance drug policy in states where medical orrecreational marijuana use is decriminalized?○○Generally, yes, if it is enforced without discrimination across the board.Some states, including Arizona, Delaware, Maine, and New York, includecarve outs to exempt federal contractors from any requirement toaccommodate employees’ medical marijuana use.Can an employer terminate an employee who possesses medical marijuana legally ifthat employee (1) uses medical marijuana on duty, (2) in the workplace, or (3) isintoxicated in the workplace?○Probably yes. In fact, some states have included express clauses to allowemployers to discharge employees who are intoxicated or use marijuanain the workplace but again some will argue this may violate the ADA.Can an employer terminate an employee who tests positive for drugs if that employeehas a valid medical marijuana registration card?○There are no clear answers.

○Some states, including Arizona, Delaware, and Minnesota, expresslyprohibit an employer from terminating an employee for a positivemarijuana drug test if the employee holds a valid registration card.○But, other states, including California, Montana, Oregon, and Washingtonallow employers to have a zero tolerance drug policy if an employee testspositive for marijuana even if that employee holds a valid registration card.Can an employer terminate an employee who receives accommodation under the ADAfor non-work hour, off-site medical marijuana use?○○For now, the answer appears to be, YES.The ADA, 26 requires that employers make “reasonable accommodations”for qualifying individuals.○However, currently, because marijuana is a Schedule I substance underthe federal CSA, and the ADA is a federal statute, an employer mayterminate an employee for a positive marijuana drug test for off-site, offdutymedical marijuana use.The Colorado Case Study26 42 U.S.C. § 12101 et seq.

○On January 27, 2014, the Colorado Supreme Court granted certiorari tohear Brandon Coats v. Dish Network, LLC. Oral arguments took place inSeptember, 2014, but no decision has been issued.○In Coats v. Dish Network, LLC, Brendan Coats was fired after testingpositive for marijuana even though he is a quadriplegic with a validmedical marijuana card. The Colorado Court of Appeals affirmed the trialcourt’s determination that the termination was not discriminatory underColorado law because, “[T]he term “lawful activity” in section 24-34-402.5,means that the activity – here, plaintiff’s medical marijuana use – mustcomply with both state and federal law.” 27○On May 21, 2014, the state of Colorado submitted an amicus brief to theColorado Supreme Court in support of Dish Network, LLC. The Statecites to the Drug Free Workplace Act of 1988 and argued that thepetitioner’s argument, that the State lawful activities statute coversconduct illegal under federal law, would undercut zero toleranceworkplace drug policies. The State’s amicus brief concludes, “The State ofColorado and other employers should not be put in the burdensomeposition [of] having to litigate a prohibition of the use of marijuana resultingin job impairment caused by an employee’s choice to consume marijuana27 Coats v. Dish Network, LLC, 303 P.3d 147, 150 (Colo. Ct. App. 2013).

in violation of a contract with an employer that they entered intovoluntarily.” 28Examples of Washington State Regulations for Recreational Marijuana1. Marijuana licenses are divided into three categories: 1) producer; 2) processor;and 3) retailer. Each category is taxed at a 25% excise tax. 292. A license will not be issued if the premises is within one thousand feet of an“elementary or secondary school, playground, recreation center or facility, child carecenter, public park, public transit center, or library, or game arcade admission to whichis not restricted to persons age twenty-one or older” 303. The applicant and financier must undergo a criminal history and backgroundcheck. The Liquor Control Board will investigate the funds used to finance the start-upbusiness and verify its source. 314. Changes to a business or ownership must meet the Liquor Control Boardapproval before continuing. 3228 State of Colorado Amicus Br., Case No. 2013SC394 at 6 (May 21, 2014).29 RCW 69.50.325 - 54530 RCW 69.50.331(8)31 WAC 314-55-02032 WAC 314-55-120 - 135

5. Marijuana products are tracked from seed to sale. The Licensee must provideinformation to the Liquor Control board from the seed of the marijuana to marijuanawaste. All products and sales should be traceable. 33Issues and Hypotheticals1. Insurance: In Washington, all marijuana licensees are required to providecommercial general liability insurance. 34Oftentimes, insurance policies will haveexclusions for criminal acts. This creates a problem when the marijuana business islegal in a state but illegal federally.2. Transportation: What happens if there is an accident while transportingmarijuana between a producer, processor, or retailer? Would the insurance not coverthe transportation if it is considered a criminal act federally?3. Real Estate: Buying, selling, or renting properties where marijuana wasproduced or processed.4. Contracts: Would a contract be enforceable between a marijuana business in astate where recreational marijuana is legal and a business in another state? A likelyoutcome would be the state court would enforce the contract but not the federal court.33 WAC 314-55-08334 WAC 314-55-082

5. Setting Up Companies: Can attorney advise in the creation of a company orLLC doing marijuana business when it might violate the ethics code?6. Advertising: In Washington, there are strict regulations on advertising marijuanaproducts. The Washington State Liquor Control Board FAQ page directs interestedparties to obtain advice from their attorney. Can an attorney advise the client when thebusiness is illegal federally?7. Immigration: How do you advise a client who is an immigrant and workinglegally in the marijuana business?8. Immigration: How would you advise a client who is investing money in the legalmarijuana business and would like to use that investment to reach the threshold forimmigration?9. Vetting Process: How do you vet potential clients who are in the marijuanabusiness to be assured that the funds are not tied to organized crime?10. IOLTA: How do you handle clients who can only pay in cash?11. IP: Brand protection is not eligible for federal trademark protection because it isan illegal drug. Could possibly register ancillary products that contain no marijuana. Canapply for State only protection. No patent protection exists for marijuana products.12. Tax: May not consider drugs a legitimate business expense. Could possiblydeduct cost of goods sold but not deduct includables.13. Ethics: MRPC 1.2(d) A lawyer shall not counsel a client to engage, or assist aclient, in conduct that the lawyer knows is criminal or fraudulent, but a lawyer may

discuss the legal consequences of any proposed course of conduct with a client andmay counsel or assist a client to make a good faith effort to determine the validity,scope, meaning or application of the law.MRPC 8.4(b) commit a criminal act that reflects adversely on the lawyer's honesty,trustworthiness or fitness as a lawyer in other respects. Would this MRPC not beviolated if is legal in the state and is not reflecting adversely on the lawyer’s honesty?14. Oath of Attorney: In Washington, the oath of attorney states that you aresubject to both state and federal law. Check all applicable and ethics opinions forguidance.In short, caution is the rule. Land mines are everywhere until this area of the lawdevelops further.

2015InternationalClientSeminarALFAINTERNATIONAL2015INTERNATIONALCLIENTSEMINARFIRSTWORLDCHALLENGES:FINDINGPRACTICALSOLUTIONSIN ASHRINKINGGLOBALECONOMYTRACK4:EMERGINGCHALLENGES

2015 INTERNATIONAL CLIENT SEMINARFAIRMONT SCOTTSDALE PRINCESSSCOTTSDALE, ARIZONAMARCH 5 – 8, 2014Navigating Insolvency Issues in the EU:German, French, UK, and American PerspectivesFrédéric CohenCOURTOIS LEBELParis, France+33 1 58 44 92 92fcohen@courtois-lebel.comJohn SykesCHARLES RUSSELL, LLPLondon, England+44 (0)20 7203 5131John.Sykes@crsblaw.comMarcello Di StefanoTIEFENBACHERHeidelberg, Germany+49 361 65928-22DiStefano@tiefenbacher.deJohn A. RobertsSEMMES, BOWEN & SEMMES, P.C.Baltimore, Maryland410-539-5040jaroberts@semmes.com1

Navigating Insolvency Issues In The EU:German, French, UK, and American Perspectives 1I. IntroductionA. The insolvency of a company has a significant impact on the insolventcompany’s customers, vendors, suppliers, lenders, landlords, tenants, and otherparties to the company’s contracts. A creditor of an insolvent company has enoughproblems when the bankruptcy or insolvency proceeding has been filed in the samecountry in which the creditor operates. When the bankruptcy or insolvencyproceeding is pending in another country, the creditor’s problems are multiplied.B. The increasing level of international trade has led to greater use ofcross-border insolvency proceedings in the European Union. Recent developmentsin international law may have made the use of insolvency proceedings as a businesstool more common. Currently, the laws for dealing with insolvency vary from countryto country within the EU and, indeed, from country to country around the world.II.Insolvency law not unified in EUA. The United Nations Commission on International TradeLaw (UNCITRAL) adopted its Model Law on Cross-Border InsolvencyIn 1997, the United Nations Commission on International Trade Law (UNCITRAL)adopted its Model Law on Cross-Border Insolvency to help national legislatures draft1 Materials prepared by John Roberts of the ALFA Baltimore, Maryland firm Semmes, Bowen, and Semmes, PC,and John Sykes of the ALFA London, England firm of Charles Russell, LLP.2

their insolvency laws within a modern, harmonized framework that might addressmore effectively instances of cross-border insolvency. Each country is free to omit ormodify provisions of the Model Law in their own statutes.The UNICITRAL Model Law is beyond the scope of this paper, inasmuch as only afew EU member countries have conformed their insolvency statutes to the ModelLaw. 2Thus, the insolvency statutes within the EU remain quite different. Suchdifferences make it more attractive for a business to open insolvency proceedings ina country whose insolvency laws are more favorable to that company’scircumstances.To address such “forum shopping,” the European Unionpromulgated an Insolvency Regulation mandating the insolvency proceedings to beopened in the EU member country where the “centre of main interests” – or COMI –of the insolvent person or company is located.B. European Union Insolvency Regulation1. IntroductionThe European Union Insolvency Regulation 3applies to all countries that aremembers of the European Union. 4The Regulation is designed primarily to helpdetermine whether a particular EU member country has jurisdiction to openinsolvency proceedings. The Regulation also outlines a uniform approach todetermining the choice of substantive law that will govern, once the insolvencyproceedings are opened.2 Greece, Poland, Romania, Slovenia, Great Britain and Northern Ireland (the United Kingdom). TheUnited States has also adopted the Model Law, enacted as Chapter 15 of the U.S. BankruptcyCode. 11 U.S.C. Sec. 1501 et seq. For a clear, concise description of Chapter 15 of theBankruptcy Code, see the website of the U.S. Federal Courts athttp://www.uscourts.gov/FederalCourts/Bankruptcy/BankruptcyBasics/Chapter15.aspx.3 Council Regulation (EC) No 1346/2000 of 29 May 2000 on Insolvency Proceedings, O.J (L160/1).4 Except Denmark, which negotiated an exemption from this and certain other EU Regulations.Citation.3

When the proper forum and governing law have been determined, the proceduralrules of the country in which the proceeding has been opened will generally apply tothe proceeding.In addition, the rulings and orders entered in the insolvencyproceeding by the EU member country’s insolvency Court will be recognized by theCourts of other EU member countries.2. Application of the EU Insolvency RegulationEU Insolvency Regulation applies only to a company that has its “centre of maininterests” (explained below) in an EU member country. This includes a companythat was not incorporated in an EU member country, but whose centre of maininterests is within a member country.The Regulation does not apply to the insolvency of a company that has itscentre of main interests outside of the European Union. The insolvency of acompany with its centre of main interests in a jurisdiction other than a membercountry of the EU will be treated in accordance with the local laws and procedures ofthe member country in which the proceeding is opened.The Regulation covers both individuals and businesses, including corporations,trading companies, special purpose vehicles and group treasury companies.However, the Regulation does not apply to banks, credit institutions, insurancecompanies, investment undertakings holding funds or securities for third parties, orcollective investment schemes.4

3. Centre of main interests (COMI)The Regulation does not define COMI. An explanatory note 5 to the Regulation isonly somewhat helpful:The ‘centre of main interests’ should correspond to theplace where the debtor conducts the administration of hisinterests on a regular basis and is therefore ascertainableby third parties.The absence of an adequate definition of COMI in the Regulation has allowed Courtsin several EU countries to take inconsistent approaches to determing the COMI ofeach company that seeks relief under the insolvency laws of the particular country.a. Centre of main interests for individualsIn most cases, the COMI of an individual will be the country in which the individualprimarily conducts his or her trade or profession. If the individual does not trade orcarry on a profession, the country in which he or she primarily resides is consideredto be the COMI. If the individual resides in one country but does business inanother, the country in which the individual primarily conducts business is the COMI.Where a person’s only connection with a country is that he or she is employed thereby another person or company (that is, the individual is not self-employed), then theCOMI will generally be in the country in which the debtor lives. Presumably, this iswhere the individual operates a household and keeps assets.b. Centre of main interests for companiesThe place of a company’s registered office is presumed to be the COMI. Thispresumption may be rebutted by proof to the contrary. The Regulation contains littlefurther guidance to help identifiy the COMI of a company. Local Courts are thus free5 The Regulation calls the explanatory notes Recitals.5

to decide this important issue. The local Courts have not been consistent in theirapplication of the Regulation’s guidance on determining the COMl.The COMI is determined at the date the insolvency petition is filed. The Courtsshould not consider where the company has historically carried out its business. Thelocation of creditors and the country in which debts were incurred are not materialissues in determining a COMI.4. Officer in charge of insolvency proceedingsOnce an insolvency order is entered, a Court will often appoint one or more officersto administer the insolvent company’s assets and business. This person might becalled a receiver, a trustee, or something similar. In this paper, the officer is oftencalled the insolvency administrator.The insolvency administrator may be required to consider whether the COMI of theinsolvent company is in the Court’s jurisdiction. The insolvency administrator isempowered to seek further information needed to assess whether investigation ofthe COMI is warranted. If the insolvency administrator determines that proceedingsopened in one member country of the EU should have been opened in anothercountry, the insolvency administrator may seek a review of the insolvency order.Once the insolvency administrator is satisfied that insolvency proceedings have beenopened in the proper jurisdiction, the insolvency administrator must administer theestate in accordance with the laws of the country in which the proceedings arepending. The insolvency administrator is under a duty to notify known creditors thathave their registered offices in EU member countries of the procedures for filingclaims against the insolvency estate.6

The Regulation does not mandate advertisement of the opening of proceedings inEU member counties, other than the country in which the proceedings are opened.The insolvency administrator should, however, determine whether the bankruptcyorder will be published in a local newspaper in accordance with the publicationprocedures provided for in the country in which the insolvency proceedings arepending. Any member country in which the insolvent company has an establishmentmay require publication. If this is the case, the insolvency administrator is requiredto arrange for such publication.5. Proceedings opened in a country other than the country inwhich the insolvent company has its COMIA proceeding opened in the country where the insolvent company has its COMI isknown as the “main insolvency proceeding.” Only the main insolvency proceedingcan generate rulings that must be recognized by the Courts in other EU membercountries. Only one main insolvency proceeding is allowed under the Regulation.If the insolvent company has a place of business in an EU member country otherthan the country where the COMI is located, a creditor based in the country of theestablishment may open proceedings against the insolvent company in that countryto administer assets of the insolvent company in that country. A proceeding of thistype that is opened before the main insolvency proceedings is called a “territorialproceeding.” One that is opened after the main insolvency proceeding is known as a“secondary proceeding.”In an effort to forum shop, an insolvent company (or its creditors) might attempt toopen a main proceeding in more than one EU member country, or in the wrongcountry. When this occurs, the Court in each involved country may decide that theinsolvent company’s COMI is in each Court’s respective jurisdiction. Such conflicting7

ulings may be referred to the European Court of Justice, which is empowered tosettle the dispute.6. Potential changes to the Insolvency RegulationOn February 5, 2014, Members of the European Parliament voted to update theEuropean Regulation on Insolvency. Most legislators, attorneys, and commentatorsagree that changes are required to ensure that the Regulation reflects the economictimes, and lessons learned since the enactment of the Regulation in May of 2002can be implemented in the amendments.III.Comparison of European Insolvency LawsA. Overview on German, French and English insolvencylaw1. Bankruptcy by many other namesa. GermanyUnder German insolvency law, there exists no “bankruptcy” as a technical term.German law recognizes only the “insolvency” of a company.Final insolvency proceedings 6 will be opened if the Court finds that (i) the debtor isilliquid – that is, unable to pay its debts when they fall due, 7 (ii) if the debtor is overindebted– that is, the fair value of the debtor’s assets is less than its liabilities. 86 Insolvenzordnung [InsO] [Insolvency Statute], Oct. 5, 1994 [Bundesgesetzblatt] (BGBl.] 2866, aslast amended by Art. 6 G of the Act of August 31, 2013 [BGBl.], 3533, §§ 16ff.7 A company is presumed to be illiquid if it is unable to pay more than 10% of its debts as they comedue for a period three weeks.8 Commercial debtors only. This does not apply to natural persons.8

Occasionally, a company’s management will determine that, in all likelihood, thecompany will become unable to meet its payment obligations when they fall due inthe near future. In such a case, the company itself can voluntarily file a petition onthe grounds of its pending illiquidity.b. FranceUnder French law, a company must file for insolvency proceedings within 45 daysfollowing the date on which it has become insolvent. A company is deemedinsolvent when the amount of its cash and similar resources available is lower thanits current liabilities.The insolvency proceedings available are the redressement judiciaire 9 (when there isa possibility that all or part of the company will recover) or liquidation proceedings 10(when the possibility of recovery does not exist).c. England and WalesUnder English law (and Welsh law – hereafter simply referred to as “English” law forbrevity) 11 the term “bankruptcy” refers only to the insolvency of individuals. There isno specific insolvency term for corporate entities.Corporate insolvency proceedings are usually commenced in one of three ways: byorder of the Court (following a petition for compulsory liquidation by a creditor), bythe holder of a Qualifying Floating Charge 12 (allowing an “out of Court” appointment9 Code de commerce [C. com] art. L.631-1 et seq.10 Code de commerce [C. com] art. L.640-1 et seq.11 Although they are also part of the United Kingdom of Great Britain and Northern Ireland, bothScotland and Northern Ireland have their own insolvency laws.12 A “floating charge” is a security interest in, or charge over, all of the assets – or class of assets –owned by a company or limited liability partnership. The floating charge is granted by the companyor LLP to secure indebtedness. The floating charge does not fix on any particular assets until theoccurrence of an event of default, at which time it “crystallizes” – that is, becomes a “fixed charge”9

of an administrator by the charge holder), or by the company itself (if the company isinsolvent, or the directors are concerned about becoming personally liable forwrongful trading).The primary English insolvency proceedings are:• liquidation (compulsory by the Court or voluntarily by the company),• voluntary arrangement (a statutory scheme of debt compromiseapproved by the majority of creditors in value), or• administration (a procedure aimed at rescuing the company with theaid of a moratorium).2. Initiating the insolvency proceedingsa. GermanyThe insolvent company itself or, under certain conditions, any creditor of theinsolvent company is entitled to file an insolvency proceeding with the InsolvencyCourt. 13 b. FranceThe insolvency proceeding (redressement judiciaire or liquidation judiciaire) may beopened upon request of the company itself, a creditor, or the public prosecutor.The pre-insolvency proceeding (mandat ad hoc, conciliation, sauvegarde) may onlybe opened upon request of the company.over specific assets. A qualifying floating charge is created by a security agreement or otherdocument that clearly states either that paragraph 14 of Schedule B1 of the Insolvency Act of 1986applies to the floating charge, or that otherwise states that the holder of the charge is authorized toappoint an andministrator or administrative receiver under the Insolvency Act.13 Insolvenzordnung [InsO] [Insolvency Statute], Oct. 5, 1994 [Bundesgesetzblatt] (BGBl.] 2866, aslast amended by Art. 6 G of the Act of August 31, 2013 [BGBl.], 3533, § 13.10

c. England and WalesProceedings can be commenced by a Court application for administration orcompulsory liquidation (usually at the instigation of a creditor), by a meeting of thecompany’s board/shareholders/creditors, or by a chargeholder.3. Preliminary and final proceedingsa. GermanyThe insolvency proceeding can be divided into the preliminary insolvencyproceeding 14 and the final insolvency proceeding. 15Both stages are supervised bythe Insolvency Court.The preliminary insolvency proceeding is that period of time after the insolvency filingduring which the Insolvency Court decides whether an insolvency ground exists.During the preliminary insolvency period, the Court will appoint a preliminarycreditors’ committee. The Court will generally appoint a creditors’s committee,unless the debtor is a small company and does not reach certain economicthresholds, or where its business operations have been discontinued. The Court isrequired to appoint a creditors’ committee if two of the following three criteria exist:• The company has more than 50 employees;• The company has annual revenues of more than € 9,680;000.• The company has total assets of more than € 4,480,000. 1614 Insolvenzordnung [InsO] [Insolvency Statute], Oct. 5, 1994 [Bundesgesetzblatt] (BGBl.] 2866, aslast amended by Art. 6 G of the Act of August 31, 2013 [BGBl.], 3533, § 21.15 Insolvenzordnung [InsO] [Insolvency Statute], Oct. 5, 1994 [Bundesgesetzblatt] (BGBl.] 2866, aslast amended by Art. 6 G of the Act of August 31, 2013 [BGBl.], 3533, § 27.16 Insolvenzordnung [InsO] [Insolvency Statute], Oct. 5, 1994 [Bundesgesetzblatt] (BGBl.] 2866, aslast amended by Art. 6 G of the Act of August 31, 2013 [BGBl.], 3533, § 22 a.11

During the preliminary insolvency period, the creditors’ committee may nominate apreliminary insolvency administrator (or in case of self administration, a preliminaryinsolvency trustee) to be appointed by the Court. The Court must approve thisnomination if the decision but the committee is unanimous and the candidate issuitable.The Insolvency Courts will usually appoint lawyers as preliminaryadministrators or preliminary insolvency trustees.When the Court appoints the preliminary insolvency administrator, it will usually enteran order mandating that some or all of the debtor’s transactions be subject to thepreliminary administrator’s consent. The debtor’s legal representatives remain incharge of conducting the debtor’s business. However, the Court has discretion togrant further powers to the preliminary administrator. The Court may go so far as totransfer to the preliminary administrator the power to run the debtor’s business. TheCourt usually grants the debtor protection from creditors’ collection attempts.Even if the Insolvency Court determines that grounds exist for the company to be inan insolvency proceeding, it will open final insolvency proceedings only if the Courtconcludes that the debtor’s estate has enough assets to cover the costs of theinsolvency proceedings. 17If the estate does not have sufficient assets to pay for theinsolvency proceedings, the Court will not open final insolvency proceedings.b. FranceFrance does not recognize the concept of a preliminary insolvency. When reviewinga petition for opening insolvency proceedings, the Court will determine whether thecompany is insolvent based on the information and documents provided with theinsolvency petition either by the company or by the other petitioning party .17 The Insolvency Court will often consult with the preliminary insolvency administrator to determine whetherinsolvency grounds exist, and whether the estate has sufficient assets to pay for the proceedings.12

In its order opening the insolvency proceeding, the Court will appoint officers to takeover all or part of the management responsibilities of the company and to administerthe proceedings (as described in Paragraph III. A. 5. b., infra).c. England and WalesAs with France, there is no English equivalent of preliminary proceedings. However,it should be noted that both administrations and (failed) voluntary arrangements cantransition into a liquidation.4. Appointment of officers in the Insolvency proceedingsa. GermanyThe Insolvency Court usually appoints a final insolvency administrator when the finalinsolvency proceeding is initiated. 18The Court will dismiss the preliminaryadministrator, unless the same person is appointed as the final administrator. Theformer management of the company is stripped of power. The insolvencyadministrator takes control of the debtor’s assets and business.Until the first creditors’ meeting is held, 19 the administrator may choose to continueto operate the business. With the Court’s approval, the administrator may choose toshut down all or part of the company’s business.At the first creditors’ meeting, the administrator will report on the state of theinsolvent company. Based on this report, the creditors will decide whether thecompany should be liquidated or provisionally continued and restructured. If an18 Or, in case of self administration, a final trustee.19 The first creditors’ meeting is to be held no more than three months after the final proceedings areopened.13

insolvency plan has not been submitted before the first creditors’ meeting, thecreditors may ask the administrator to prepare such a plan.b. France:If a redressement judiciaire (receivership) is open, the Court will appoint:• an administrateur judiciaire (a receiver) who will draft a report regardingthe current situation of the company and assist (or replace) thecompany’s management during the reorganization;• A mandataire judiciaire, who will make sure the employees are paid,and will establish the exact amount and nature of the company’sliabilities; and• A juge-commissaire, a member of the Court who will closely monitor theproceedings and approve certain transactions.If a liquidation judiciaire is open, the Court will appoint:• A liquidator, who will manage the company in lieu of the currentdirectors and CEO, and who will act as a representative of thecreditors;• A juge-commissaire, a member of the Court who will closely monitor theproceedings and approve certain transactions; and• If the company is allowed to continue operating its business duringliquidation, the Court may also appoint an administrateur judiciaire,who will manage the company, prepare the company’s liquidation sale(plan de cession), and undertake any action necessary for itsimplementation. 2020 For companies with more than 20 employees and annual revenue of more than € 3,000,000.14

All the officers appointed in the insolvency proceeding are specific registeredprofessionals. No private entity, such as an accounting firm or a lawyer, may havean official appointment in a French insolvency proceeding.The filing for redressement judiciaire leads to the opening of a 6 month observationperiod (renewable once) during which:• Generally, no debt existing prior to the date of opening of theproceedings may be paid;• No claim for payment of a debt existing prior to the date of opening ofthe proceedings may be initiated or continued;• All interest due with regard to debt existing prior to the date of openingof the proceedings is frozen. This is effective from the date of openingof the procedure.If, during the observation period, there appears no reasonable likelihood of recovery,the redressement judiciaire may at any time be converted into a liquidationproceeding.If a liquidation proceeding is opened, there will be no observation period. The Courtopening the liquidation proceedings will appoint a liquidateur, who will sell the assetsof the company subject to liquidation proceedings. The sale of the assets can bemade either by auction or by private contract. The Court will decide, in the orderopening the liquidation proceedings, whether to cease the business of the Companyimmediately, or allow it to continue temporarily during liquidation. The officers of theCompany will be relieved of all their management powers. The liquidateur willdismiss the employees and pay the creditors of the Company according to thepriority of competing creditors.15

The opening of liquidation proceedings will trigger the same creditor rights as theopening of a redressement judiciaire.c. England and WalesAn administrator, liquidator or Supervisor of a voluntary arrangement (collectively,“office holders”) must be a “licensed insolvency practitioner’” who holds aninsolvency licence obtained after passing specialist examinations. Theadministrator, liquidator or Supervisor is regulated by a recognized professionalbody. There are currently four such bodies, which have the power to discipline theinsolvency practitioner, impose conditions on the practitioner, or ultimately removethe practitioner’s licence.Unlike certain other jurisdictions, English insolvency procedures are not superviseddirectly by the Court, although creditors and certain other parties have the right tochallenge the office holder’s conduct in Court and seek orders (by way of injunctionor an application for directions) that the office holder do (or refrain from doing) acertain act or pursue a cause of action.16

5. Role of Creditorsa. GermanyCreditors act both independently (at the creditors’ meeting) and as a group throughthe (preliminary or final) creditors’ committee. 21For example, the creditors have theauthority to replace the final insolvency administrator at the initial creditors’meeting. 22In addition, at the initial creditors’ meeting the creditors get to decidewhether to affirm the Court’s appointment of the preliminary creditors’ committee. Ifno preliminary creditors’ committee has been appointed, the creditors must decidewhether to form a creditors’ committee.The administrator must submit certain major decisions to a vote of the creditors atthe creditors’ meeting. 23Decisions are made by the creditors that hold the majorityof the value of the claims against the insolvent company. As a result, creditorsholding the largest claims can force their will upon the creditors holding smallerclaims. To counterbalance the power of the creditors holding the largest claims, theother creditors may seek the intervention of the Court to overturn a vote that that iscontrary to the common interests of the creditor body as a whole.21 Insolvenzordnung [InsO] [Insolvency Statute], Oct. 5, 1994 [Bundesgesetzblatt] (BGBl.] 2866, aslast amended by Art. 6 G of the Act of August 31, 2013 [BGBl.] 3533, § 67 ff.22 Insolvenzordnung [InsO] [Insolvency Statute], Oct. 5, 1994 [Bundesgesetzblatt] (BGBl.], 2866, aslast amended by Art. 6 G of the Act of August 31, 2013 [BGBl.], 3533, § 56 a.23 Insolvenzordnung [InsO] [Insolvency Statute], Oct. 5, 1994 [Bundesgesetzblatt] (BGBl.] 2866, aslast amended by Art. 6 G of the Act of August 31, 2013 [BGBl.] 3533, § 160.17

. Francei. Creditors’ CommitteesIf certain threshold conditions ar met, 24 or at the debtor’s or administrateur’s request,creditors will be represented by two committees. One committee will consist offinancial creditors, including banks and other institutional lenders. The othercommittee will be made up of trade creditors. The committees are formed to discussthe possible terms of the restructuring of the insolvent company’s debts, which mayinclude a rescheduling of the debt, a reduction of its amount, or a conversion of all orpart of the debt into equity or convertible securities. 25Each committee will deliberate over the proposals made by the administrateurjudiciaire. A proposal may be approved by the affirmative vote of creditors holdingclaims valued at two-thirds of the total amount of claims of the class represented bythe committee. Any bondholders affected by the proposals will hold a meeting toapprove the proposals, in accordance with applicable rules of French commerciallaw.If the creditors and the bondholders approve the proposals, the Court will ratify themif the interests of the creditors are appropriately protected. Upon Court approval, theproposals will become enforceable against all the members of the two committees.24 The insolvent company has financial records certified by a statutory auditor or issued by achartered accountant, and either employs more than 150 employees or had revenue (VATexcluded) exceeding € 20,000,000 the previous fiscal year. Code de commerce [C. com] art.L.626-29 and R. 626-52.25 Where the conditions are not met for the appointment of creditors’ committees, the administrateurjudiciaire will consult with creditors either individually or collectively.18

ii.LiquidationIf the creditors and Court decide that the insolvent company will not continue, theassets of the business will be liquidated and the proceeds distributed to the creditors(see Paragraph III. A. 8. b., infra, for a more detailed description of the distribution).After the proceeds have been distributed, the company is dissolved, and anyresidual claims of the creditors are essentially of no value.iii.Plan de CessionIn the alternative, the Court may decide that the interests of creditors are betterserved by the sale (plan de cession) of the insolvent company’s business to one ormore purchasers. In the sale proceeding, the Court will assess the merits of theoffers based upon the following criteria, which are listed in order of importance:• Sustainability of the jobs attached to the business sold;• Payment of the creditors; and• Reliability in complying with the covenants made in the offer. 26Under the plan de cession, the bidders selected by the Court will acquire some or allof the insolvent company’s assets. In addition, the successful bidders may takeaboard a limited number of the insolvent company’s employees. All other liabilitiesremain with the company, which is liquidated.c. England and WalesGenerally, an office holder must act in the best interests of creditors as a whole. Ifhe fails to do so, he may be personally liable for breach of fiduciary duty26 Code de commerce [C. com.] art. L. 642-5.19

(misfeasance). Against this background, office holders are largely not obliged toconsult with creditors regarding the continued conduct of the insolvency proceeding.Put simply, if creditors don’t like it, they can challenge it in Court, or sue the officeholder for misfeasance.Specifically, unsecured creditor involvement in or influence on the proceeding islargely limited to:• Choosing the liquidator at the outset (usually by creditors holding amajority of the value of the claims against the insolvent company);• Providing sanction and non-binding guidance (only if a creditors’committee is formed in a liquidation);• Approving an administrator’s statement of proposals (failing which theadministrator must apply to Court);• Approving a voluntary arrangement proposal (vote of creditors holding75% in value of claims against the insolvent company required).Secured creditors have stronger rights, which often cannot be affected without theirconsent.6. Termination of Executory Contractsa. GermanyThe administrator is authorized to attempt reorganization of the insolvent company’sbusiness. The Insolvency Code 27 contains provisions to make reorganization a biteasier. Upon the opening of insolvency proceedings, certain types of agreements 2827 Insolvenzordnung [InsO] [Insolvency Statute], Oct. 5, 1994 [Bundesgesetzblatt] (BGBl.] 2866, aslast amended by Art. 6 G of the Act of August 31, 2013 [BGBl.], 3533, § 103 ff.28 For example, assignment contracts and agency agreements.20

inding the insolvent company are automatically terminated. The administrator mayalso refuse further performance of certain executory agreements 29which theinsolvent company signed before the insolvency proceedings were opened. Thesecontracts might include financing arrangements, rent and lease contracts, contractsfor the purchase of goods subject to retention of title agreements, employmentcontracts, and service contracts. A claim arising out of the termination of thecontract might be a preferential claim or a general unsecured claim, depending onthe type of contract.In most cases, a solvent party to a contract may also exercise its rights to terminatethe contract when the other party opens an insolvency proceeding. If the only basisfor termination of the contract is the other party’s insolvency, however, that provisionof the contract might be deemed void if it conflicts with the Insolvency Code. 30b. FranceIn a redressement judiciaire, the company continues to operate its business duringthe observation period. Provided that the company complies with its undertakings,and notwithstanding any provision to the contrary, no contract in progress may beterminated by a third party without the prior consent of the administrateur judiciaire.However, all payment obligations by the company must be settled on a cash basis,unless otherwise agreed by the third party concerned.c. England and WalesContracts are unaffected by administration, and remain binding on the company (inthe absence of an insolvency termination clause). However, if a contract is not29 Agreements that have not been fully performed by both parties.30 Similar to the “ipso facto” clause in the U.S. Bankruptcy Code.21

performed, the non-insolvent party to the contract may seek a Court Orderinstructing the office holder to perform the company’s obligations (“specificperformance”). In the alternative, that party will have a right to claim and prove thedamages arising from the breach of contract (likely to be an unsecured claim).A liquidator has an express right to disclaim onerous or unprofitable contracts, againleaving the creditor to prove the claim for breach of contract in the liquidation.7. Avoidable transfers – ‟Claw Back” provisionsa. GermanyThe administrator can seek to avoid a preferential transfer of company assets thatoccurred shortly before insolvency proceedings were opened. A preferential transferis one that allows one creditor to receive more than other creditors, and has anadverse impact on creditors as a whole. 31The repayment of a shareholder loan or apayment to an affiliate company can be challenged if it occurred within the yearbefore filing for insolvency.The administrator may also seek to avoid gratuitous transfers of assets made by thedebtor, as well as transfers of assets made by the debtor with the intention ofinflicting damages on other creditors. A gratuitous transfer is a payment or othertransfer of assets made to a party that is not a creditor, and is not entitled to receivethe money or asset transferred by the insolvent company. The administrator may bechallenge gratuitous transfers if they were made within four years before the31 Insolvenzordnung [InsO] [Insolvency Statute], Oct. 5, 1994 [Bundesgesetzblatt] (BGBl.] 2866, aslast amended by Art. 6 G of the Act of August 31, 2013 [BGBl.], 3533, §§ 129 ff. This “claw back”right is similar to a U.S. Bankruptcy Trustee’s right to avoid preferential transfers.22

insolvency filing. The administrator may challenge a transfer made with the intentionof harming creditors within ten years before the insolvency filing. 32b. FranceIf the Court determines that a company is insolvent, it will open insolvencyproceedings and will set out the “date of insolvency”. Such date may be set up to 18months before the date of the judgment opening the liquidation. The period betweenthe date of insolvency and the date of the judgment opening the liquidationproceeding is referred to as the “Période suspecte.” Certain decisions made duringsuch period are automatically void (e.g., granting of a mortgage) or may be voided(e.g., payment of a debt due and payable while the creditor was aware of thesituation of debtor’s insolvency) by the Court.c. England and Walesi. PreferenceThe office holder can challenge a transfer made by an insolvent company that putsthe transferee in a better position than it would otherwise be in the insolvency, whereany recovered assets would be shared pro-rata with other creditors. The “look back”period for the transfer is six months from the commencement of insolvency,extended to two years if the transferee is connected to the insolvent company. 3332 Often called avoidable fraudulent transfer or fraudulent conveyances in U.S. law.33 The company must be insolvent at the time of the transfer, or rendered insolvent as a result of thetransfer.23

ii.Transaction at an undervalueThe insolvency administrator can challenge a gift or other disposition of property forless than market value. The “look back” period is within two years prior to thecommencement of the insolvency proceeding, and again the office holders mustprove that the company was insolvent at the time of the transaction, or renderedinsolvent as a result of the transaction.iii.Transactions putting assets beyond the reachof creditorsThis is very similar to transactions at an undervalue, except there is no defined “lookback” period. The affected part or office holder must prove that the “dominantintention” of the company was to remove assets from the reach of creditors.iv.MisfeasanceMisfeasance is usually alleged against directors for any breach of their fiduciary orany other duty owed to the company.v. Wrongful tradingA director of an insolvent company can be made personally liable for the debts of thecompany if the director continues to trade while the company is hopelessly insolvent.8. Creditors and Claimsa. GermanyA creditor’s rights against the insolvency estate depends on the type of claim thecreditor holds. A creditor with a secured claim has the right to demand the24

surrender of its collateral. If the collateral has been sold by the administrator, thesecured creditor should be entitled to the net proceeds of the sale. 34A preferential claim is a claim that arose during the insolvency proceeding. Theseclaims might include the administrator’s fees and expenses, court costs, claims ofcreditors that loaned money or extended credit to the administrator, and claims ofsocial plans for costs incurred during the insolvency under employment laws.Creditors with preferential claims are paid in full before any payment is made toholders of unsecured claims.An unsecured or general insolvency claim is a claim held by a creditor against theinsolvent company before the insolvency proceedin was opened.Generalinsolvency claims are often held by banks holding unsecured notes, bondholders,trade creditors, and contracting parties. A creditor holding a nonpreferential,unsecured general insolvency claim must file its claim with the administrator in orderto receive any payment in the insolvency proceeding. 35The administrator eitherrejects the filed claim or registers it with the insolvency schedule. If the administratorrejects the claim, 36 the creditor can bring a legal action to enforce the administratorto accept it.If the administrator accepts the claim, the unsecured creditor is entitled to a paymentfrom the insolvency estate on a pro rata basis with other unsecured generalinsolvency creditors, This payment will be made in accordance with the “insolvencyquota” that is determined by the insolvency administrator at the end of the insolvency34 Insolvenzordnung [InsO] [Insolvency Statute], Oct. 5, 1994 [Bundesgesetzblatt] (BGBl.] 2866, aslast amended by Art. 6 G of the Act of August 31, 2013 [BGBl.], 3533, §§ 47 ff.35 Insolvenzordnung [InsO] [Insolvency Statute], Oct. 5, 1994 [Bundesgesetzblatt] (BGBl.] 2866, aslast amended by Art. 6 G of the Act of August 31, 2013 [BGBl.], 3533, § 38.36 The administrator may reject the claim for reasons specified in the insolvency law, such as whenthe creditor has received a preferential transfer that the administrator can recover, or for generalreasons, such as the creditor’s failure to provide proof of the debt.25

proceedings. 37The insolvency quota is calculated by dividing the remaining assetsof the insolvency estate (the amount remaining from the liquidation of the company’sassets after paying secured creditors from their collateral and all preferential claims,including Court fees and the administrator’s fees) by the total amount of acceptedand unsecured general insolvency claims.A subordinated claim ranks lower than even the unsecured general insolvencyclaims. A claim for repayment of a shareholder loan is generally a subordinatedclaim. 38A claim might also be subordinated by contractual agreement. Asubordinated claim will not be paid unless all higher ranking claims have been paidin full – that is, almost never.b. FranceCreditors must declare their debts against the company in order to establish theamount and nature of the claims. Most of the company’s creditors (except thecompany’s employees) must declare the amount and nature of their claim againstthe insolvent company within 2 months after the publication in the Official Bulletin ofCivil and Commercial Announcements (BODACC) of notice of the judgment openingthe proceedings.Creditors who are not located in metropolitan areas of France may declare theirclaims within four months from the announcement in the BODACC. Except for thetime period for filing their claims, creditors from outside of metropolitan France (and37 The administrator’s determination of the insolvency quota is subject to review by the creditors’committee and the Insolvency Court.38 The two exceptions to this rule are (i) a claim by a shareholder who is not a director of the company andwho does not hold mor than 10% of the registered capital, and (ii) a claim by a shareholder who became ashareholder and made a loan in an attempt to rescue the company from insolvency, when that shareholderdid not hold 10% or more of the stock of the company before the rescue attempt.26

even from outside of the EU) are treated the same as creditors that are located inFrance.Creditors are paid according to their order of priority:• Superprivileged creditors (including AGS 39 and Court expenses),• Privileged creditors (debt contracted after the opening of theproceedings, secured debts),• Unsecured creditors.Certain creditors are excluded from this order of priority of claims, and are thereforetreated without regard to their priority. These creditors include:• A creditor that may set off its claims against a related debt that it owesthe insolvent company;• A seller of goods with a reservation of title clause in the sales contract,provided the insolvent company agreed in writing to the reservation oftitle clause on or before the date of delivery of the good; the seller isentitled to the return of the goods, or to payment of the sale price of thegoods;• A creditor with a claim secured by a “gage” 40 may petition the Court forthe return of the goods;• A finance lease lessor (crédit-bailleur) may receive the unpaid rentsdue on the leased goods if the liquidator decides to exercise thepurchase option, provided such payment does not exceed the marketvalue of the goods.39 Assurance Générale des Salaires, a special state insurance scheme.40 A security interest or pledge.27

c. England and WalesThe English statutory order of priority in distribution is (i) secured creditors, (ii)preferential creditors (now very restricted to capped employment claims), and (iii)unsecured creditors. There is a slight variation to this order, in that a proportionof floating charge realizations (as opposed to the other type of secured creditorwith a fixed lien) is made available to unsecured creditors (known as “ringfencing”).Unsecured creditors submit a “proof of debt” to the office holder, who thenadjudicates the claim for dividend purposes. The office holder may accept theproof, reject it, or partly admit it. The creditor has a right of appeal and adverseddecision to the Court. Unsecured creditors receive dividends on a pro-rata/parripassu basis with other unsecured creditors.Secured creditors have far stronger rights and can often take control orpossession of the secured assets in question. If the secured creditor cannot takecontrol or possession of the collateral, but instead the collateral is sold, the officeholder is obliged to account to the secured creditor for the funds realized andattributable to the collateral.9. Administrative Insolvencya. GermanyIf the insolvency estate lacks the assets needed to satisfy all preferential claims –that is, claims arising during the administraton of the insolvency estate – theadministrator will notify the Court that a “state of mass insufficiency” exists. 41This41 Insolvenzordnung [InsO] [Insolvency Statute], Oct. 5, 1994 [Bundesgesetzblatt] (BGBl.] 2866, aslast amended by Art. 6 G of the Act of August 31, 2013 [BGBl.], 3533, § 208.28

declaration creates an “administrative insolvency.” Any new claims arising againstthe insolvency estate after the administrative insolvency is declared are given“superpriority” status.. The “old” preferential creditors, whose claims arose after theinsolvency proceeding was opened, but before the administrative insolvency wasdeclaired, can receive payment on a pro rata basis only after the “superpriority”preferential claims are paid in full. Holders of unsecured claims will not be paid atall. In the event of an administrative insolvency, the administrator may be personallyliable to the “old” preferential creditors. The Insolvency Court will terminate theinsolvency proceeding if the assets of the estate become insufficient to cover itscost. 42 b. Francei. Debts generated after the opening of theinsolvency proceedingsThe repayment of loans made to the company after the opening of the redressementjudiciaire, as well as of debts relating to agreed deferred payment of sums due inrelation to contracts continued during the insolvency proceeding, are given priorityagainst other debts created before the opening of the redressement judiciaire(except for salaries and Court expenses incurred during the proceeding).42 Insolvenzordnung [InsO] [Insolvency Statute], Oct. 5, 1994 [Bundesgesetzblatt] (BGBl.] 2866, aslast amended by Art. 6 G of the Act of August 31, 2013 [BGBl.], 3533, § 207.29

ii.Privilège de New MoneyA creditor that has provided the insolvent company cash financing or new goods orservices pursuant to an approved agreement (accord homologué) during theinsolvency proceeding is granted a priority claim to be paid before all other creditors(except for salaries and Court expenses incurred during the proceeding) (“Privilègede New Money”).However, this privilege does not apply to the company’sshareholders who would have provided the company with cash through a sharecapital increase. 43 c. England and WalesIn English law, there is no equivalent ”insolvency within an insolvency.” When theoffice holder, acting as agent of the company, has capacity to incur new debts, suchdebts are payable as an expense of the insolvency. Those expenses take priorityover the office holder’s fees.10. Self-Administrationa. GermanyThe German Insolvency Statute allows a distressed company on the verge ofinsolvency to attempt to reorganize under self-administration. 44This proceeding iscomparable to Chapter 11 of the U.S. Bankruptcy Code in that the debtor’smanagement remains in control of the administration of the debtor’s assetsthroughout the insolvency proceedings.43 Code de commerce [C. com.] art. L. 611-11. The priority claim is available in a procédure desauvegarde, a redressement judiciaire or a liquidation judiciaire.44 Insolvenzordnung [InsO] [Insolvency Statute], Oct. 5, 1994 [Bundesgesetzblatt] (BGBl.] 2866, aslast amended by Art. 6 G of the Act of August 31, 2013 [BGBl.], 3533, § 270 ff.30

The Insolvency Court will enter an Order for self-administration requested by thecompany, only if there are no circumstances that lead to the expectation that selfadministrationcould negatively affect the company’s creditors. If the preliminarycreditors’ committee unanimously supports the company’s request for selfadministration,the Insolvency Court must grant the motion. The Insolvency Courtwill appoint an insolvency trustee to supervise the management of the selfadministeringcompany. 45The insolvency trustee will exercise many of the rightsand powers that an the insolvency administrator might weild in regular insolvencyproceedings, such as the right to avoid preferential or gratuitous transfers.The order of self-administration can be subsequently revoked by the Court. If theself-administration is to be combined with an insolvency plan, the debtor can alsoapply for a so called “combined proceeding” (see Paragraph III. A. 12. , supra).Self-administration requires thorough preparation before the company files theinsolvency petition. In order to successfully complete the self-administraton, thecompany must gain the support of its main creditors, prepare restructuringmeasures, and install new management with restructuring experience.AnInsolvency Court will delay or deny self-administration if no experienced insolvencypractitioner is part of the management team.b. FranceIn France, the concept of self-administration applies to pre-insolvency proceedingsthat may be initiated by the company. Under self-administration, the directors andCEO of the company remain in control. (See Paragraph III. A. 12. b., infra, for adiscussion of pre-insolvency, self-administration proceedings in France.)45 The company should file a motion for self-administration along with the initial insolvency petition,so the Court will appoint a preliminary insolvency trustee instead of a preliminary administrator.31

c. England and WalesThe office holder in a liquidation or administration has broad-ranging statutorypowers enabling him or her to administer the affairs of the company. However,neither a liquidator nor an administrator is appointed in a Company VolunteerArrangement (“CVA”). In a CVA, the company formulates a proposal to creditors,seeking their consent to a restructuring or discounting of their debt. The companywill try to persuade creditors that such a restructuring would result in a betteroutcome for them than a liquidation fire-sale. The company’s proposal, if acceptedby the creditors holding 75% of unconnected unsecured creditors in value, binds allunsecured creditors. The company then carries on its business, acting through itsdirectors. The insolvency practitioner (called a Supervisor) only ensures that thecompany meets its re-scheduled obligations under the proposal. The Supervisor hasthe power to liquidate the company if it breaches the terms of the proposal.Importantly, the Supervisor does not run the company.11. The Insolvency Plana. GermanyThe goal of the insolvency plan proceedings 46 is to preserve the business of theinsolvent company as a going concern. An insolvency plan provides the companywith the freedom and flexibility to provide the best result for the company and itscreditors. It also allows the insolvent company to continue as a restructurd business.An insolvency plan proceeding may be initiated if the company’s business can berestructured. An insolvency plan can be prepared before, and submitted togetherwith, the insolvency petition. In the alternative, it can be developed by the company46 Insolvenzordnung [InsO] [Insolvency Statute], Oct. 5, 1994 [Bundesgesetzblatt] (BGBl.] 2866, aslast amended by Art. 6 G of the Act of August 31, 2013 [BGBl.], 3533, §§ 217 ff.32

or the administrator after the insolvency proceeding is opened. Creditors may notpropose an insolvency plan. Creditors may, however, instruct the insolvencyadministrator to propose a plan.The insolvency plan may be a plan of liquidation, through which the company’sassets are liquidated and the proceeds distributed to creditors. If the company’sbusiness has greater value as a going concern, the plan may be a transfer plan thatprovides for the sale of all or part of the business to a new legal entity. Alternatively,the plan may be a rehabilitation plan, under which the company is reorganized anddischarged from all or part of its debts.The insolvency plan must be approved by a vote of the creditors and theshareholders. The creditors and shareholders are divided into different groups –such as employees, suppliers, senior secured lenders, or junior secured lenders –according to their type of claim or stake. The plan will almost certainly provide fordifferent treatment among different groups of creditors, but it must provide for equaltreatment of all members within one group.The plan is presented to creditors at a creditors’ meeting. The creditors vote on theadoption of the plan. In order for the plan to be adopted, the plan must receive theaffirmative vote of at least one-half of the number of creditors holding the claims inthat group. In addition, the sum of the claims held by those creditors voting in favorof the plan must exceed one-half of the total of all claims in the group. Even if agroup of creditors fails to vote for the plan, the Court may approve the plan if theCourt concludes that the plan does not worsen the position of thos creditorscompared to their situation in the absence of an insolvency plan, and if the planprovides them with a reasonable economical share of the assets that are to bedistributed on the basis of the insolvency plan. This “cram down” rule also applies to33

shareholders of the debtor who, under the former law, were able to obstruct certaincorporate measures, such as the transfer of their shares to a third party under theinsolvency plan. If the insolvency plan is approved by the creditors and the Court,the insolvency proceeding ends with the payment of the creditors pursuant to theplan.b. FranceIf it appears that the company might solve its current difficulties and continueoperating its business, the administrateur judiciaire will draw up a recovery plan (plande redressement par voie de continuation) that will be submitted to the Court forapproval. The duration of the plan may not exceed ten years. The administratormust pay particular attention to securing the debtor’s assets, collecting outstandingreceivables, and deciding whether to continue the business, based on an economicevaluation of the enterprise and the reasons for the insolvency.c. England and WalesIn an administration, the Administrator must send creditors a Statement of Proposalssetting out the strategy for dealing with the company. The Administrator has eightweeks after his appointment to send the Statement of Proposals. The proposalsmay include selling parts of the company, trading the business, seeking furtherfinance, or other options available. The proposals are made in accordance withstatutory objectives, the first of which requires the Administrator to attempt to rescuethe company as a going concern.At a meeting held within ten weeks of the appointment, creditors can vote onwhether to accept, modify or reject the Administrator’s proposals. If creditors fail to34

approve the Administrator’s proposals, the Administrator must apply to the Court fordirections as to how to proceed.12. Combined Proceedingsa. GermanyA company can also restructure its business under Insolvency Court protection bycombining an early filing for insolvency with a motion for the ordering of selfadministration.47Such an application must be based on pending illiquidity or overindebtednessand not actual illiquidity. 48The Court will set a deadline of at mostthree months for the debtor to submit a draft insolvency plan. The Court will alsoappoint a preliminary trustee. If the insolvent company requests it, the Court will stayindividual enforcement measures and grant the debtor the right to incur preferentialdebt until the deadline expires.b. FranceIn order to help a troubled company that is sliding into insolvency, French law hasdeveloped various procedures designed to assist the troubled company and itscreditors reach agreements, outside of the insolvency process, to restructure thetroubled company’s obligations to its creditors. A company choosing to use one ofthese procedures remains in control of its operations. No receiver is appointed toassume the duties of the company’s management or board of directors.i. Appointment of a Mandataire ad hoc 4947 Insolvenzordnung [InsO] [Insolvency Statute], Oct. 5, 1994 [Bundesgesetzblatt] (BGBl.] 2866, aslast amended by Art. 6 G of the Act of August 31, 2013 [BGBl.], 3533, § 270 b.48 The financial condition of the company must be endorsed by the certificate of an insolvency lawexpert.49 Code de commerce [C. com] art. L611-3.35

This scheme is the most confidential and the “lightest” in terms of proceedings andapplicable rules. When a company is experiencing specifically identified difficulties,its legal representative may request the President of the relevant commercial Court(Tribunal de commerce) or civil Court (Tribunal de Grande Instance) to appoint anexpert (mandataire ad hoc), who will help the management of the company to reachan agreement with creditors regarding a specific issue. In most cases, this issuerevolves around rescheduling payment of one or several debts. This appointment isstrictly confidential and does not affect the reputation or the financial credibility of thecompany. The mandataire ad hoc is usually an administrateur judiciaire (the Frenchequivalent of a receiver).The mandataire ad hoc has no binding authority over any party. His or her role ispurely advisory. The mandataire ad hoc will help each party understand the otherparty’s position and will propose alternative arrangements to resolve the matters atissue. If this mission is successful, the parties will prepare and execute a settlementagreement specifying the terms of their amicable arrangements.36

ii. Procédure de conciliation 50As with the mandat ad hoc, the conciliation is initiated by the company on a voluntarybasis. Management of the company remains in place. The Court appoints aconciliateur to assist the company.However, this specific procedure is less “contractual” in its operation than themandat ad hoc and has several important differences. First, the procédure deconciliation is open to a company that is not yet insolvent, or that has been in a stateof insolvency for less than 45 days. The conciliation may therefore be used whenthe company has just become insolvent, and is aimed at addressing a specific issue,the resolution of which would restore its financial situation.The role of the conciliateur may go beyond that of a mere middleman. In addition toassisting the company in negotiating with its creditors, the conciliateur may alsomake proposals regarding the preservation of the company, the continuation of itsbusiness, and the preservation of employment within the company.As with a mandat ad hoc, the company’s creditors remain free to initiate proceedingsagainst the company to recover their debts. However, the judge may imposedeferred terms of payment on them. 51In addition, the creditors cannot request aCourt to initiate insolvency proceedings (redressement judiciaire) against a companythat is subject to a conciliation.The conciliateur is also entitled by law to negotiate rescheduling (or reduction) ofdebt with the tax and social security authorities. The duration of the conciliateur’s50 Code de commerce [C. com] art. L611-4.51 Articles 1,244-1 et seq. of the French Code Civil.37

mission cannot exceed five months in total. For this reason, companies tend toapply first for the appointment of a mandataire ad hoc before initiating a conciliation.The financial recovery plan may also provide for new equity or debt contributions tobe made by existing shareholders or by new shareholders. This is achieved bysubscribing for new shares or for complex securities, such as convertible bonds, orbonds redeemable in shares. Once executed and acknowledged by the Court, theagreement with the creditors will be binding on the parties to it. The agreement andthe conciliation will remain confidential.Alternatively, the agreement may be formally approved (“homologué”) by the Court.In such a case, the agreement will not remain confidential. However, the creditorswho have signed it will be prevented from initiating any proceedings against thecompany for the payment of the debts covered by the agreement. Also, if asauvegarde or insolvency proceeding is initiated against the company at a later date,the repayment of any cash contribution made to the company in accordance with theagreement will hold a priority position against any debt existing before the opening ofthe procédure de conciliation (except salaries and Court expenses incurred duringthe insolvency proceedings). 52iii. Procédure de sauvegarde 53This procedure, introduced into French law in 2005, takes its inspiration fromChapter 11 of the U.S. Bankruptcy Code. Its purpose is to prevent a troubledcompany from becoming insolvent by providing it with strong protection fromcreditors and giving it time to draw up a recovery plan.52 See the discussion of “Privilège de New Money” in Paragraph III. A. 9. b. ii., supra.53 Code de commerce [C. com] art. L620-1, et seq.38

While the mandat ad hoc and the conciliation may be seen as amicable processesdesigned to solve specific issues, the procédure de sauvegarde is far closer in itsoperation, as well as in the solutions implemented, to the “regular” insolvencyproceedings (redressement judiciaire). The procedure is designed for companiesfacing complex difficulties. This scheme is implemented under close supervision byvarious Court-appointed bodies, which liaise with the company and its creditors toinitiate the recovery measures that are necessary to prevent the troubled companyfrom becoming insolvent.This procedure is aimed at the company that has not yet been compelled to file forinsolvency – that is, has not been insolvent for 45 days – but has significant liabilitieswith which it cannot meet. The purpose of this procedure is to develop a plan for thecompany’s reorganization. The reorganization process may include a sale of part ofthe company’s assets. By opening such a procedure, the company sends a strongmessage to its creditors that they need to agree on a restructuring of the company’sliabilities, lest the company becoming insolvent in the near future.By prohibiting the payment of all debts generated prior to the opening of thesauvegarde, as well as any legal action in relation to such debts, the procedureimmediately gives the company some breathing room. Furthermore, it may enablethe company to raise money to finance its operations. Loans made to the companyafter the opening of the sauvegarde, as well as debts arising from deferred paymentof sums due on executory contracts, receive a priority over other debts createdbefore the opening of the sauvegarde or other types of debts, such as trade debt,incurred after such opening (except salaries and Court expenses incurred during theproceeding).39

iv.Sauvegarde accélérée 54 andsauvegarde financière accélérée 55The main purpose of these procedures is to help a company already subject to aconciliation (but not to a regular sauvegarde) to arrange a restructuring plandeveloped with, and supported by, its main creditors under more flexible conditionsand in a very short period of time (one to three months). In order to be eligible forthis accelerated procedure, the company must meet the following criteria:• It is already subject to a conciliation,• It has developed with its main creditors a restructuring plan during theconciliation,• It has not been insolvent for more than 45 days,• It has either;ooconsolidated accounts; oraccounts certified by a statutory auditor or issued by a charteredaccountant, andoomore than 20 employees, andtotal revenues (VAT excluded) for the previous fiscal yearexceeding €3 million, or assets exceeding €1.5 million.The duration of the sauvegarde accélérée cannot exceed three months.Therestructuring plan must be approved by creditors participating in the conciliation thathold two-thirds of the value of the claims against the company. Once approved bythe Court, the plan will be enforceable against those creditors who participated to theconciliation, even if they voted against the plan.54 Code de commerce [C. com.] art.L.628-1.55 Code de commerce [C. com.] art.L.628-9.40

Sauvegarde financière accélérée is a specific type of sauvegarde accélérée thataffects only financial creditors – generally, financial institutions and bondholders –and not suppliers or other trade creditors. It is dedicated, in particular, to heavilyindebted companies that have obtained the support of the majority of their financialcreditors during the conciliation. Its purpose is to overcome the opposition of thatminority of the financial creditors that refuse the plan proposed.The criteria for opening a sauvegarde financière accélérée are the same as those fora sauvegarde accélérée. However, the duration of such procedure cannot exceedtwo months.c. England and WalesThere is no English equivalent of “combined proceedings.”The Englishadministration procedure and Voluntary Arrangement (for small companies) has theprotection of a moratorium for the period of the insolvency process. This allows thecompany “breathing space” from creditor actions or claims to enable the company torestructure its debts or rescue the company.13. Termination of Insolvency Proceedingsa. GermanyIf, after the completion of the liquidation, transfer or rehabilitation, the administratorhas sufficient assets to repay all of the insolvent company’s debts, the company willbe released from administration. This is a very rare occurence. In most cases,unsecured general insolvency claims are paid only a percentage of their value, if atall. Unless the administrator can pay all of the insolvent company’s debts, thecompany is either removed from the Commercial Register or released from theinsolvency proceeding, stripped of all assets.41

. FranceThe liquidation proceedings are closed after payment of all liabilities or in case ofinsufficiency of assets. The judgment closing the liquidation puts an end to theduties of the liquidator. The judgment of closing of the liquidation proceedings issubject to the same publicity formalities as the judgment opening the proceedings.Once the liquidation proceedings are closed, the company is delisted from the Tradeand Companies Register.c. England and WalesAn administration is a temporary procedure and will most likely develop intoliquidation, dissolution, or simply return back to solvency via a voluntaryarrangement, other compromise with creditors, or simply trading back to solvencywith the assistance of the moratorium.A voluntary arrangement will either be successfully complied with and then return tosolvency or, in the event of a default that cannot be remedied, the Supervisor will beobliged to petition for liquidation.A liquidation will be completed once (i) any available assets are collected anddistributed to creditors by way of a dividend, (ii) the liquidator has completed hisinvestigation into the affairs of the company and (iii) reported to creditors. Onconclusion of the liquidation proceeding, the liquidator will apply to the Registrar ofCompanies to have the company dissolved (i.e. the legal ‘death’ of the company).14. Employee Rightsa. Germany42

Employees are protected by so called “insolvency money” that covers wages for aperiod of three months. Contracts of employment are not automatically terminatedby the initiation of the insolvency proceedings, but they may be terminated with threemonths’ notice or, if applicable, with a shorter notice period. 56Certain otheremployee rights are limited in insolvency proceedings, as well.b. FranceUnder French Law, the salaries owed as of the date of the judgment, as well asthose owed after such date (including in the event that the Court has authorized thecompany to continue its business), may, be settled by the Assurance Générale desSalaires (“AGS”), a special state insurance scheme.The AGS will step into the shoes of the employees against the company in theLiquidation proceedings with respect to the amounts it pays to the employees. TheAGS will get a high priority (superprivilège and privilège) with respect to the paymentof such debt.Where it is necessary to dismiss employees, the dismissal falls within the legalregime of redundancies on economic grounds. The employees are made redundantby a simple notification letter sent by the liquidateur or administrateur (if any), subjectto the prior notice rights provided in the employment contracts or collectiveagreements. If the company is not able to pay the dismissed employees, the AGSwill pay their salaries and damages.The employees shall benefit from a priority right in case of re-employment (prioritéde réembauchage) and shall be offered a conversion contract (contrat de56 Insolvenzordnung [InsO] [Insolvency Statute], Oct. 5, 1994 [Bundesgesetzblatt] (BGBl.] 2866, aslast amended by Art. 6 G of the Act of August 31, 2013 [BGBl.], 3533, §§ 113 ff.43

econversion). The dismissals shall take place within one month from the date of thejudgment approving the plan (except for protected employees).c. England and WalesDebts owed to employees are a liability of the insolvent employer and, in mostcases, will be an unsecured debt. These debts are ranked second to bottom in theorder of insolvency priority for the purposes of calculating the proportion of debt to berepaid. Certain “remuneration” ranks as preferential debts and is third in the order ofinsolvency priority, behind secured debts and costs and expenses of the insolvencyprocess. This is subject to a cap of all remuneration owed for the four month periodbefore the start of the insolvency proceedings, up to a maximum of £800. Holidaypay, which is included within renumeration, is not limited in terms of time or financiallevel.If an Administrator decides to carry on an insolvent business, it is possible that theAdministrator will retain all or some of the employees. The Administrator has 14days to choose whether to adopt employment contracts. This means that anAdministrator is able to terminate such contracts within the first 14 days ofappointment without creating a qualifying liability. After 14 days, the Administrator isdeemed to have adopted any employment contracts that have not been terminated.44

15. Management Duties and Liabilitya. GermanyUnder German law, even a limited liability company’s managing directors may beheld personally liable if they fail to initiate an insolvency proceeding in a timelymanner. 57If a managing director has reason to believe that the company is illiquidor over-indebted, the director must take prudent action to assess the company’sfinancial situation. If the managing director determines that the company isinsolvent, the director is obligated to file for insolvency without undue delay, but inany event not more than three weeks after the company becomes insolvent. 58Thefiling may be delayed this long only if realistic options exist to avert insolvency.While the company is illiquid or over-indebted, the managing director must preservethe company’s assets. If the managing director does not act in the manner of aprudent businessman, the director may be liable for any payments to shareholdersthat render the company illiquid. The managing director has the burden of provingthat the illiquidity resulting from payments to shareholders could not have beenforeseen by a prudent businessman.The obligation to file a petition for insolvency applies equally to a German companyand a company incorporated under the law of a foreign jurisdiction if the centre ofmain interests of the foreign company is in Germany. Thus, managing directors offoreign companies with their COMI in Germany must be aware of the distinctionsbetween the German insolvency law and the insolvency laws in their home countries.57 German law requires a limited liability company to have at least one managing director. If thecompany does not have a managing director, the company’s shareholders or members of thesupervisory board may face personal liability arising out of insolvency.58 Insolvenzordnung [InsO] [Insolvency Statute], Oct. 5, 1994 [Bundesgesetzblatt] (BGBl.] 2866, aslast amended by Art. 6 G of the Act of August 31, 2013 [BGBl.], 3533, § 15 a.45

. FranceUnder French law, the company officers must file for insolvency within 45 daysfollowing the date when the company became insolvent. The company officers whofail to file for insolvency would be exposed to a “prohibition to manage” sentence.The failure to file for insolvency may also be considered a management fault, andmay trigger the officer’s liability for insufficiency of assets.i. Directors’ and Officers’ LiabilityUnder French Law, the main action against de jure or de facto managers of the entitysubject to Liquidation proceedings is the action in insufficiency of assets(“insuffisance d’actifs”). These provisions apply to the managers of private lawentities as well as to individuals who serve as permanent representatives ofmanaging legal entities.The action may be initiated within three years following the opening of theLiquidation proceedings and only by the liquidateur, the Public Prosecutor or by thecontrollers. Evidence has to be brought that:• the concerned company is facing a situation of insufficiency of assets, -- that is an excess of liabilities over assets; and• a management fault has been committed by the concerned manager;and• such management fault has contributed to the insufficiency of assets.Case law considers that a management fault does not result from a decision thatwas made in the ordinary course of business with reasonable care, and that turnedout to be a “bad decision” for the company. A management fault is generally46

acknowledged where gross negligence or acts contrary to the company’s interestcan be evidenced.If the Court determines that these conditions are met, the Court may decide that thedebts of the company subject to Liquidation proceedings will be borne, in whole or inpart, by all or some of the managers who contributed to the management fault. Ifthere are several managers, the Court may declare them jointly and severally liable.ii.Liability of shareholders in commercial CourtsWhen the insolvent company is a limited liability company, its shareholders shouldgenerally not be held liable for the insolvent company’s debts, absent personalguaranties. However, a recent decision of the Tribunal de Commerce d’Orléans is ofinterest. 59This decision has considered, in the context of the insolvency of a Frenchcompany, that the sole shareholder – a German company:• had, directly and indirectly, full control of the French company (amongother things, some executives of the sole shareholder were also theofficers of the French company);• had all powers to impose its own strategy;• was fully responsible for the decisions taken;• acted in breach of its duty by changing the name, the corporategovernance and the management of the company in order to elude alegal procedure initiated by the French company’s statutory auditors(procédure d’alerte) as a result of the financial difficulties encounteredby the French company;• acted in breach of its duty by removing the cash from its French59 Decision issued June 1, 2012 relating to former employees of the Quelle group, which was ownedand controlled by a German fund called Aurelius.47

subsidiary and putting the latter in a situation where it was not in aposition to repay a loan; and• acted in breach of its duty by favoring only its own interest to thedetriment of the other group companies.The Tribunal determined that such breaches had caused a loss to the Frenchcompany’s employees. As a result, the sole shareholder was ordered to paysignificant damages to 508 former employees of the French company.This decision, although issued by a first degree commercial jurisdiction, has createdsignificant concern among legal practitioners, as it considerably weakens theconcept of the “corporate veil” limiting the liability of shareholders.iii. Liability of Shareholders in EmploymentCourtsEmployment law tribunals have on many occasions considered that the “acquiredright directive” was applicable in similar circumstances. As a result the tribunals mayorder a transfer of the employees of the liquidated company to the new entity, or anindemnification of such employees (by the new entity and/or the shareholder of theliquidated company) for wrongful dismissal.c. England and WalesDirectors of a company have an overriding statutory duty to act in the best interestsof the company. In times of solvency, this means acting in the best interests of thecompany and its shareholders. If a company is in financial distress, however, thedirectors must act in the best interests of creditors. Failure to do so may make thempersonally liable for misfeasance.48

Also, directors may be held personally liable for the debts of the company if theyallow it to continue to trade in circumstances when they knew or ought to haveconcluded that there was no reasonable prospect of avoiding insolvency.B. Doing business with a troubled company – German andFrench perspectives1. Settlement agreement with an insolvent companya. GermanyUnder German law an amicable settlement other than a formal insolvency plan (seeParagraph III. A. 11, supra) requires the consent of each of the creditors. Suchsettlement is not binding on any creditor that is not a party to the settlementagreement. 60Furthermore, in the event of the opening of a subsequent formalinsolvency proceeding, the stipulations of the settlement agreement and theirexecution may be subject to insolvency challenge rights (see Paragraph III. A. 7. a.,supra). 61Therefore, an insolvency plan is often the preferable rehabilitationinstrument for the creditor.Compared to the formal insolvency plan, another important disadvantage of anamicable settlement is the high risk of personal liability of officers and shareholdersin case of failure of the settlement (see Paragraph III. A. 15., supra, and ParagraphIII. C., infra). Thus, debtors who act responsibly in times of crisis presumably wouldrefuse an amicable settlement.However, an amicable settlement does not require entering into a formal insolvencyproceeding, which may represent a major advantage compared to an insolvency60 Bundesgerichtshof [BGH] [Federal Court of Justice] Apr. 28, 2006, 3 U 134/05.61 Insolvenzordnung [InsO] [Insolvency Statute], Oct. 5, 1994 [Bundesgesetzblatt] (BGBl.] 2866, aslast amended by Art. 6 G of the Act of August 31, 2013 [BGBl.] 3533, §§ 129 ff.49

plan. An amicable settlement must be well balanced and must treat all creditorsequally. If the debtor does not follow these principles, creditors may withdraw fromthe settlement. 62 b. FranceUnder French Law, the validity of a settlement agreement entered into with adistressed company will depend on whether the company is already under theprotection of an insolvency proceeding. As mentioned in Paragraph III. A. 7. b.,supra, the period between the date on which the insolvency occurred (InsolvencyDate) and the date of the judgment opening the insolvency proceeding is referred toas the “période suspecte.” Certain transactions made during such period are voidper se. 63These transactions include:• Granting a mortgage,• Paying debts that are not yet due and payable,• Paying due and payable debts by abnormal means of payment,• Entering into a significantly unbalanced contract.Although settlement agreements are usually permitted, some French Courts haveruled that a settlement agreement was void per se in case it was significantlyunbalanced. 64Some transactions are not void per se, but may be voided at the Court’s discretion, if(i) the transaction occurred after the date of insolvency, and (ii) the creditor wasaware that the debtor was not making payments to creditors as they came due.Under French case law, the Court would void the transaction only if the creditor had62 Bundesgerichtshof [BGH] [Federal Court of Justice] Dec. 12, 1991, IX ZR 178/91.63 Code de commerce [C. com.] art. L. 632-1.64 Cour de cassation [Cass.] [supreme Court for judicial matters] com., July 26, 2001.50

specific knowledge that the debtor was insolvent. Such evidence might be difficult toestablish. The Court will use circumstantial evidence in order to assess whether thecreditor was aware of the debtor’s insolvency.If the distressed company is already in the “observation period” of the insolvencyproceeding, the juge-commissaire decides whether to authorize actions exceedingthe routine management of the company, including entering into a settlementagreement. 65If it would potentially have a significant impact on the outcome of theproceeding, the juge-commissaire may only authorize a settlement after consultingwith the public prosecutor.If the distressed company is already in the liquidation process, the liquidateurjudiciaire may, with the authorization of the juge-commissaire, settle claims ofcreditors. 66 2. Retention of title to propertya. GermanyRetention of title provisions are generally treated as being fully enforceable ininsolvency proceedings. 67However, such rights may be invalidated by insolvencychallenge rights (see Paragraph III. A. 7., supra).In Germany, there are only a few requirements for a valid retention of title, and aretention of title is a standard condition in practically all German terms of delivery.The retention of title implies that the seller can demand return of the goods, even inthe event of the buyer’s insolvency, if the purchase price has not been paid.65 Code de commerce [C. com.] art. L. 622-7 II.66 Code de commerce [C. com.] art. L. 642-24.67 Insolvenzordnung [InsO] [Insolvency Statute], Oct. 5, 1994 [Bundesgesetzblatt] (BGBl.] 2866, aslast amended by Art. 6 G of the Act of August 31, 2013 [BGBl.] 3533, §§ 129 ff.51

Under German law, 68the parties may agree to an extended retention of title(“erweiterter Eigentumsvorbehalt”), which means that all goods delivered serve assecurity for all claims between the parties. The parties may also agree on aprolonged retention of title (“verlängerter Eigentumsvorbehalt”). In this case, not onlythe goods delivered but also finished goods manufactured using the delivered goodsserve as security for the seller’s claim.Moreover, the retention of title can be combined with an assignment of the claimsthat will arise on resale of the goods (“Vorausabtretungsklausel”).If the buyerbecomes insolvent, the seller then has security either in the goods that are still withthe buyer, or in the receivables created by the resale of the goods. However, thereis no security for amounts already paid, as these funds cannot usually bedistinguished from other funds.In case of insolvency of the buyer, the seller is entitled to demand the return of anygoods that are still in possession of the buyer. For assigned claims arising out of theresale of the goods, the right to collect the receivables remains with the administratoror the debtor in possession. 69In such case the seller is entitled to compensation,calculated after deduction of the cost of the collection of the receivable. 70b. France68 Bürgerliches Gesetzbuch [BGB][Civil Code], Aug. 18, 1896, Reichsgesetzblatt [RGBl.] 195, asamended, § 449.69 Insolvenzordnung [InsO] [Insolvency Statute], Oct. 5, 1994 [Bundesgesetzblatt] (BGBl.] 2866, aslast amended by Art. 6 G of the Act of August 31, 2013 [BGBl.] 3533, §§ 50, 51.70 Insolvenzordnung [InsO] [Insolvency Statute], Oct. 5, 1994 [Bundesgesetzblatt] (BGBl.] 2866, aslast amended by Art. 6 G of the Act of August 31, 2013 [BGBl.] 3533, § 170.52

The seller may take legal action for recovering goods sold with a reservation of titleclause, provided the unpaid goods still exist “in nature.” This means, it has to beidentifiable and distinctive into the buyer’s hand. 71Thus, the seller must:• Identify the claimed goods, and• Prove that the debtor has not yet paid for the goods.The claim may also cover goods incorporated into other property (if the recoverydoes not damage it), as well as fungible goods (if the debtor possesses other goodsof the same type and same quality).The seller has three months from the date on which the insolvency has beenofficially announced in the BODACC to demand the return of the goods. 72receiver or the company should respond to this claim within one month.TheSuchresponse will consist of (i) either accepting the claim and returning the good coveredby the reservation of title provision, (ii) accepting the claim and paying the price ofthe goods to the creditor, or (iii) rejecting the claim. 73If the claim is rejected, or if no response is made within the one month period, thecreditor will have one month to bring his claim before the juge-commisaire. 74Thejuge-commisaire’s decision can be appealed to the Commercial Court within tendays following the notification of the decision.C. Officers and shareholders1. Liability: de facto vs “official” officersa. Germany71 Code de commerce [C. com.] art. L. 624-16.72 Code de commerce [C. com.] art. L. 624-9.73 Code de commerce [C. com.] art. L. 624-17.74 Code de commerce [C. com.] art. L. 624-13.53

In addition to directors, other persons involved in a company’s affairs may be heldpersonally liable in an insolvency proceeding. Anyone who holds the power ofrepresentation in terms of controlling or controlled companies and in legal relationsmay be designated as a responsible person. This means, first and foremost, thefollowing natural persons: in the “Aktiengesellschaft” (stock corporation), the“Genossenschaft” (co-operative), and the “rechtsfähiger Verein” (association havinglegal capacity), it is the “Vorstand” (board). In the “GmbH (Gesellschaft mitbeschränkter Haftung” – company with limited liability), it is the “Geschäftsführer”(managing director).An internal allocation of duties does not release the person responsible from his orher duty to file an insolvency proceeding.The person appointed as the agent(Organ) of the company is not exonerated by the fact that he or she is merelynominally shown to be the person responsible, even though another person isactually managing the business transactions.A distinction is drawn at this point between the “factual agent” position and the“nominee” or “straw-man” position. A “factual agent” is a person who has not beenformally appointed to an office, but nonetheless performs the functions of that office.A “straw-man” is a person who is formally appointed to a position, but is is merelyacting as an extended arm of the person behind the scenes (often with the fullknowledge of other officers or directors of the company). Under the insolvency laws,both a factual agent and a straw-man can be responsible for filing an insolvencyproceding, and both are subject to liability if they fail to carry out this responsibility. 75b. France75 Bundesgerichtshof [BGH] [Federal Court of Justice], Feb. 11, 2008, II ZR 291/06.54

The distinction between de facto and de jure (official) officers does not apply toFrench insolvency law. Both are treated equally. he de facto officers are consideredas de jure officers since they appear to be official officers in the eyes of third parties.As a matter of fact, any officers, de facto or official, can be liable regarding the actionin insufficiency of assets. 76 (see Paragraph III. A. 15. b. ii., supra).D. Opportunities offered by insolvency law1. Out of Court arrangements and pre-insolvency proceedingsa. GermanyPre-insolvency proceedings are not currently available under German insolvencylaw. This situation has been subject to massive criticism from practitioners, and maychange in the course of future common European legislative initiatives.76 Code de commerce [C. com.] art. L. 651-2.55

. FrancePre-insolvency mechanisms are available under French law and are aimed atrestoring the company’s financial viability out of the Courts.For further detailsregarding these combined proceedings, please refer to Paragraph III. A. 12., supra.In case of mandat ad hoc and conciliation, the Court is involved for the appointmentof the mandataire and conciliateur, and might be involved to acknowledge theagreement between the company and its creditors (in order for it to enter into force),or to formally approve this agreement (in which case the agreement will not remainconfidential). Under certain conditions, creditors may benefit from a “priviliège denew money,” as further explained in Paragraph III. A. 9. ii., supra.2. Taking over a company or some of its assets once theinsolvency proceedings are opena. GermanyIt is common practice in Germany to rehabilitate a business by means of an assetdeal. There are no general limitations regarding who may take over the company orits assets. The insolvency administrator (or the self-administrating debtor) is incharge of selling the company or its assets to the purchaser. As a rule, the Court isnot empowered to interfere, but the consent of the creditors is required. However,the Court may dismiss the administrator if the interests of the creditors arejeopardized by the proposed transaction.56

. FranceWith some exceptions 77 (e.g., shareholders and directors of the insolvent company),any person may file a bid for the takeover of all or part of the company’s assets bothin the context of a redressement judiciaire (when it appears that the insolventcompany cannot continue to operate its business) or of a liquidation judiciaire. TheCourt sets a deadline for offers to be submitted, and sets a date by which a reportwill be issued (by the administrateur judiciaire or the liquidateur) to the Court on theoffers received. The Court will assess the merits of the offers based upon the criteriaoutlined in the French insolvency law. (See Paragraph III. A. 5. b., supra.) Thebidders will acquire those assets identified in their offers, and will take aboard alimited number of employees in accordance with the terms of their offers. All otherliabilities will remain with the company which will thereafter be liquidated and theemployees not transferred to the bidders will be dismissed by the liquidator.3. Acquiring shares of the company with new capitala. GermanyThe German Insolvency Statute provides for a debt-to-equity-swap, which may beintegrated into an insolvency plan and which does not require the consent of the“old” shareholders. 78However, the debt-to-equity-swap as an instrument ofrehabilitation is quite complicated and therefore has not yet become very common inpractice. In addition, the insolvency plan may incorporate a share capital increaseas a method of recapitalization.77 The Court may however waive such exceptions.78 Insolvenzordnung [InsO] [Insolvency Statute], Oct. 5, 1994 [Bundesgesetzblatt] (BGBl.] 2866, aslast amended by Art. 6 G of the Act of August 31, 2013 [BGBl.] 3533, § 225 a sect, 1.57

. FranceShare capital increase might be used under a sauvegarde or plan de continuation inorder to recapitalize the company. Such share capital increase might even be acondition of the plan de sauvegarde or plan de continuation. The debtor must obtainthe prior approval of the extraordinary shareholders’ meeting, and of the specialgeneral meetings (assemblées spéciales), as the case may be. The existing or newshareholders’ commitments will only be binding after the Court acknowledges thedraft plan. This new cash contribution from shareholders will not benefit from theprivilège de New Money (see Paragraph III. A. 9. b., supra).4. Liquidating a poorly performing subsidiarya. GermanyAn insolvency proceeding can be a good and effective way to close down a poorlyperforming subsidiary in Germany. However, a company considering such a movemust remain aware of the potential risks related to any insolvency proceeding. Inorder to avoid surprises, the company must act very carefully and always use a locallawyer with highly specialized skills and experience.b. FranceInternational companies are more frequently considering closing poorly performingsubsidiaries through insolvency liquidation proceedings in order to avoid paying forredundancies. Before using liquidation proceedings, the holding company mustmake sure that the subsidiary:(i) has been properly managed and (ii) wasindependent from the other group companies as regards its management, in order toavoid any liability as shareholder and/or as de facto or de jure manager of thesubsidiary. (See Section III. A. 15. b., supra.) The holding company should also58

assess the assets that are located within the subsidiary to be liquidated, as it will inpractice lose control over such assets.IV. ConclusionThe twenty-eight members of the European Union have their own insolvency laws.Insolvency law is not consistent throughout the EU, and is certainly not consistentwith the U.S. Bankruptcy Code. Although almost all EU member countries arebound by the EU Regulation on Insolvency, this Regulation only helps determine theCentre of Main Interests of the debtor for purposes of determining the proper forumfor the insolvency proceeding. It does not provide any substantive insolvency law.A creditor involved in a cross-border insolvency proceeding set in a European Unionmember country has certain rights, but those rights might vary from country tocountry. Consequently, the creditor needs to engage professionals who are familiarwith the substantive law that controls the foreign insolvency proceeding.59

2015 INTERNATIONAL CLIENT SEMINARFAIRMONT SCOTTSDALE PRINCESSSCOTTSDALE, ARIZONAMARCH 5 – 8, 2015The Law Department of the 21 st CenturyDarryl M. BloodworthModeratorDEAN, MEAD, EGERTON,BLOODWORTH, CAPOUANO& BOZARTH, P.A.Orlando, Florida(407) 428-5131dbloodworth@deanmead.comGarrick J. HodgeDivisional VP, Asst. GeneralLegal CounselWALGREENS CO.Deerfield, Illinois(847) 315-4330garry.hodge@walgreens.comAnthony Deglomine, IIIDeputy General CounselHARRIS CORPORATIONMelbourne, Florida(321) 727-9124adeglomi@harris.comSonia M. ValdesVice PresidentMEDMARC INSURANCECOMPANYChantilly, Virginia(703) 652-1358svaldez@medmarc.comWilliam VenemaVice President & General CounselLEHIGH HANSON, INC.Irving, Texas(972) 653-5572William.venema@lehighhandson.com

The Law Department of the 21 st Century 1I. The New LandscapeThe legal world is changing rapidly, and nowhere is that more true than in the legaldepartments of corporations in America and around the world. In-house legaldepartments will have to change, and possibly restructure, to meet the dynamicchanges affecting the business world and the legal needs of their companies. Thesechanges will affect the relationships between the legal departments and their clients, thecorporations which they serve. These changes will also affect the relationshipsbetween in-house counsel and their outside counsel. I have outlined below some of thechanges coming to legal departments and the evolving issues they will face. Thesechanges, while significant, should not be a cause for alarm or fear. Rather, thesechanges and evolving issues, when properly addressed, can assist counsel in betterserving and building stronger relationships with their clients as these changes occur.The changes and evolving issues dealing with “The Law Department of the 21 stCentury” which our panel will address are:A. Becoming More EfficientAll companies, indeed all clients, have long been interested in obtaining high qualitylegal services at a reasonable cost. This can only be achieved when the lawyers andlaw firms rendering the legal services appropriately staff the matter and are efficient in1 Materials prepared by Darryl M. Bloodworth of the ALFA International firm of Dean Mead, Orlando,Florida2

the delivery of their services. The same attention that companies and their legaldepartments have given to increased efficiency by their outside counsel (albeit withmixed results according to a recent Altman Weil survey 2 which found that only fourpercent of chief legal officers are satisfied with how firms traditionally provide legalservices) is increasingly being focused on in-house legal departments.One of the trends in legal departments is to undergo a review of all legal departmentprocesses using the Lean Six Sigma methodology 3 which requires a team effort toimprove performance by systematically eliminating waste and inefficiencies. Theoriginal Six Sigma was developed by Motorola in the mid-1980s and is well knownlargely because Jack Welch made it central to his business strategy at General Electricin the mid-1990s. 4Although Six Sigma and Lean Six Sigma originally were focusedmore on manufacturing entities than service based entities, these concepts have morerecently been applied to service providers, including law firms and law departments.The focus on greater efficiencies through concepts like Six Sigma and Lean Six Sigmahas caused corporations to examine all of their operations, including the legaldepartment. One reason that improving the efficiencies of legal departments is soimportant is that 40 percent of the chief legal officers in the recent Altman Weil survey(see fn2) reported that they have recently shifted more legal work in-house that wasformerly sent to outside counsel. Thus, in-house efficiencies have become increasingly2 Altman Weil, 15 th Annual Chief Legal Officer Survey, 2014.3 George, Michael and Lawrence, Robert, Jr., LEAN SIX SIGMA Concepts Were First Published InLEAN SIX SIGMA: COMBINING SIX SIGMA WITH LEAN SPEED, 2002.4 See, What is Six Sigma, www.ge.com/en/company/companyinfo/quality/whatis.3

important as more legal work is brought in-house. Furthermore, an efficient legaldepartment will contribute more to the bottom line than will an inefficient one.An in-depth discussion of how Lean Six Sigma methodology is used to analyze andimprove the efficiencies of all processes in a legal department is beyond the scope ofthis article, but the panelists will describe briefly how selected processes andprocedures in a legal department can be broken down and analyzed to eliminate wasteand inefficiencies. The result of this project is to deliver a more efficient and morefocused legal department. Anthony Deglomine, Deputy General Counsel for HarrisCorporation, will lead the discussion by the panelists about the importance of improvedefficiency and how Harris Corporation’s legal department is achieving it.B. Using Technology and Communications Processes toExpand the Legal DepartmentOne issue commonly faced by in-house counsel when retaining outside counsel for aparticular case in litigation or a transaction is the time it takes to educate outsidecounsel sufficiently to enable him or her to understand the company’s business, and thespecific issues, goals and possible consequences involved in a particular matter. Evenif the outside counsel has represented the company previously, he or she will typicallystill not have the broad-based understanding of the company that full-time insidecounsel already has. Outside counsel simply does not have ready access to the sameinformation as in-house counsel. To have that level of knowledge and understandingoutside counsel needs to be brought in-house.4

However, bringing all outside counsel in-house would greatly increase the overhead ofthe legal department and add lawyers not needed full time. Instead, a combination oftechnology and communications shared through a managed legal provider programoffers a way to bring outside counsel functionally in-house. The managed legal providerprogram enables outside counsel to have ready access to the information needed forthe matter at hand and also provides ready access to how other outside counsel arehandling similar matters.Garry Hodge, Divisional VP and Assistant General Counsel for Walgreen Company, willlead the discussion about creating a virtual legal department by implementing aprogram in which outside counsel for Walgreen have access to information similar tothat available to their in-house counsel contacts.The program Walgreen is implementing will include a new internal matter managementsystem that will enable in-house counsel to better and more timely manage each matter.In addition, the system will serve as a resource to capture and share the experiences ofinside and outside Walgreen counsel across various practice areas to represent theirclient – Walgreen – more effectively.Properly created and managed, the virtual law department envisioned by Walgreenshould provide the increased efficiencies and knowledge of the client that in-housecounsel would be expected to have without incurring the expense of adding largenumbers of additional lawyers to the in-house legal department. Such a systemrequires a combination of information technology expertise, management expertise by5

in-house counsel and a team member approach by outside counsel to realize theanticipated benefits of such a system.C. Developing a Global PerspectiveOne change coming to most companies, and therefore to their legal departments aswell, is an increasing need for a global perspective. Even for those companies with nooffices outside the United States, many of them, if not most, are selling their goods orservices overseas or to foreign customers now doing business in the United States.Therefore, there is an increasing need for in-house counsel to have a betterunderstanding of the law and legal system of the countries in which they are doingbusiness. For example, many other countries have recently adopted foreign corruptpractices acts, which may differ from the Foreign Corrupt Practices Act of the UnitedStates. Any American company doing business in a foreign jurisdiction must have anunderstanding of such laws or the adverse consequences of failing to comply with suchlaws could be significant.There is also an increasing need for in-house lawyers, particularly in the United States,to have a better understanding of the role of the in-house lawyer in a businessenterprise in other countries. The role of the lawyer in a corporation differs from countryto country, and those differences may be subtle as well as significant. Bill Venema, oneof our panelists, is in a unique position to address some of the differences in the role ofthe in-house lawyer in the United States as compared to Europe. He is the general6

counsel for all North American operations of Lehigh Hanson, a European basedcompany. He will lead the discussion of the need for a global perspective.D. Insurance Concerns in an Increasingly Global EconomyAlthough not a new issue, the role of insurance in modern commerce and life continuesto expand and to present issues to any in-house legal department, particularly thetripartite relationship between the insurance carrier, the insured and the appointedcounsel for the insured. This relationship presents potential conflicts of interest thatmust be addressed by all parties in the relationship, and counsel for all parties mustcomply with their ethical requirements under the Rules of Professional Conduct in theapplicable jurisdiction. Sonia Valdes, Vice President of Claims at Medmarc InsuranceCompany, will address some of the issues regarding this tripartite relationship and leadthe discussion on how they might play out in the modern global economy.Most companies have insurance as a financial backstop for products litigation.Insurance Carriers strive to provide their Insureds with quality representation in a costeffective manner. Litigation Management Guidelines describe the rights and obligationsbetween Defense Counsel assigned to defend Insureds. These Guidelines also definesome cost saving requirements which affect Defense Counsel’s relationship with theCompany, and ultimately, the Carrier.What are defense counsel’s obligations to the Company (Insured) and the Carrier?What happens if there is a conflict between the Company and Carrier? Does DefenseCounsel’s obligation change? One common issue that may arise and that all parties,7

ut especially Defense Counsel, may have to consider is whether the Company isentitled to independent counsel not appointed by the Carrier. The Right to IndependentCounsel depends upon whether there is an actual conflict between the claims allegedand coverage under the policy.Another issue that in-house counsel may face is whether the Carrier is entitled toreimbursement for the cost of defense for uncovered claims where the complaintalleges both covered claims and uncovered claims. Additionally, where there are bothcovered and uncovered claims, an issue for counsel is whether counsel can ethically filea motion for summary judgment on the covered claims if the insured company would beleft to defend the uncovered claims on its own. The law in most American jurisdictionsis that this decision must be made by the insured after full disclosure of all potentialissues and outcomes.Another issue for in-house counsel in a non-insurance company is whether theappointed defense counsel can disclose information to the insurer that provides a basisfor the insurance company to deny coverage. Simply because the carrier may controlthe litigation and pay the legal bills, disclosure to the carrier is not automaticallyauthorized. Additional issues likely to arise from time to time are: (i) who controls thestrategy and settlement authority in a case, the insured or the carrier; (ii) how to dealwith the foregoing issues where the potential damages clearly exceed policy limits; and(iii) does it make a difference in considering these issues whether the appointed counselfor the insured is independent outside counsel or counsel in a captive law firm createdby the insurance company, as is increasingly the case.8

These issues are addressed on a regular basis by in-house counsel for insurancecompanies, but with the growing importance of insurance coverage, in-house counselfor the insured will likely be dealing with them as well, although from the insured’sperspective rather than from the carrier’s perspective. And as business becomes moreglobal, the issue of what jurisdiction’s rules and laws will determine the outcomebecomes increasingly important.II.ConclusionThe law department of the 21 st century must become more efficient to effectively serveits client. Part of that efficiency will be achieved through greater use of technology byboth its in-house lawyers and outside counsel that may become part of its virtual lawdepartment. At the same time, the legal department will increasingly need a globalperspective as the company’s business grows internationally. Insurance issues, whichhave always been present for companies doing business only domestically, will becomemore complex as the company’s business expands into other jurisdictions.9

2015 INTERNATIONAL CLIENT SEMINARFAIRMONT SCOTTSDALE PRINCESS, SCOTTSDALE,ARIZONAMARCH 5 – 8, 2015Where In The World? ALFA Goes Global ToCollect JudgmentsEddy HayesLEAKE & ANDERSON, LLPNew Orleans, Mississippi(504) 585-7921ehayes@leakeandersson.comBrett CowellCOWELL CLARKEAdelaide, Australia(08) 8228 1144bcowell@cowellclarke.com.auAndrew BassakMANATT, PHELPS & PHILLIPS, LLPSan Francisco, California(415) 291-7449abassak@manatt.comHakan OsvaldSr. Vice President andGeneral CounselATLAS COPCOStockholm, SwedenGero SchneiderTIEFENBACHERHeidelberg, Germany(49) 6221 3113-57schneider@tiefenbacher.de1

2015 INTERNATIONAL CLIENT SEMINARFAIRMONT SCOTTSDALE PRINCESS –SCOTTSDALE, ARIZONAMARCH 5 – 8, 2015Earth, Wind and Fire –When it’s Not a Concert InvitationMark S. ScudderSTRASBURGER & PRICE, LLPDallas, Texas(214) 651-4654mark.scudder@strasburger.comGregory J. NewmanVice President – Litigation CounselWAFFLE HOUSE, INC.Norcross, Georgiawww.wafflehouse.comBrian P. McCarthyMcDOWELL, KNIGHT, ROEDDER &SLEDGE, LLCMobile, Alabama(251) 431-8806bmccarthy@mcdowellknight.comMark E. WilkeyVice President and General CounselCENTRAL REFRIGERATEDSERVICE, LLCSalt Lake City, UtahMarch 5, 20156427256.3/SP/00009/0099/011215@ 3-5-2015 ALFA International

Earth, Wind and Fire – When it’s Not a Concert InvitationI. Catastrophic Events – When, Not IfWhat is a catastrophe? Webster’s defines a catastrophe as a momentous tragic eventfrom extreme misfortune to utter overthrow or ruin. 1Dictionary.com defines catastropheas a sudden and widespread disaster. 2Our daily news broadcasts are filled withreports of disasters and catastrophic events. The past few decades have brought arapid increase in both the frequency and severity of extreme natural catastrophes.Among the recent extraordinary natural catastrophes are: Hurricane Andrew (1992),the Northridge Earthquake (1994), the Kobe Earthquake (1995), South Asia Tsunami(2004), Hurricane Katrina (2005), the Fukushima nuclear meltdown that resulted froman earthquake and tsunami (2011), Super Storm Sandy (2012), and the Moore,Oklahoma tornado (2013). Of course, catastrophes are not always natural disasters.The world as we knew it changed as a result of the September 11, 2001 terroristattacks.Disasters such as earthquakes, hurricanes, tornadoes, floods, fires, and acts ofterrorism naturally turn our focus towards the loss of life, injury to persons, and thedevastating effect on local communities. Such events, however, can similarly devastatea business. For most businesses, a catastrophe is a very low frequency but very highseverity event. Although uncommon, it is just a matter of time until a catastrophic event1 Catastrophe, MERRIAM-WEBSTER, http://www.merriam-webster.com/dictionary/catastrophe (last visited2Dec. 9, 2014).Catastrophe, DICTIONARY.COM, http://dictionary.reference.com/browse/catastrophe?s=t (last visitedDec. 9, 2014).March 5, 2015 2 @ 3-5-2015 ALFA International6427256.3/SP/00009/0099/011215

strikes. The issue is no longer if, but when, a business will be affected by a catastrophicevent. Since most catastrophic events hit with little or no warning, businesses must beprepared.Unfortunately, the low probability of such occurrences often causesbusinesses to fail to prepare for the consequences of a catastrophic event.According to the Federal Emergency Management Agency (FEMA), 40% of businessesdo not reopen after a disaster and another 25% fail within one year. 3According to theU.S. Bureau of Labor, most businesses that experience a major disaster are no longerin business within five years. 4If a disaster struck your business tomorrow, would yoube prepared? Would your business survive?To survive a catastrophic event, businesses must invest time developing proceduresthat prevent, prepare for, and minimize the effect of a catastrophe. Businesses must beproactive in planning and resilient in responding to catastrophic events. Although thereis no way to address every type of potential disaster and every topic within the myriad ofissues associated with them, this paper will attempt to address the threshold issues ofhow your business can prepare for and respond to such events, as well as some of thepractical issues that arise as a result of such events.3 Corina Mullen, Business Planning for Disaster Survival, CHAMBER 101,http://www.chamber101.com/2programs_committee/natural_disasters/disasterpreparedness/Forty.htm(last visited on Dec. 9, 2014).4 Laura DiBiase, When Disaster Strikes – Strike Back!, 22 Feb Am. Bankr. Inst. J. 14 (2003).March 5, 2015 3 @ 3-5-2015 ALFA International6427256.3/SP/00009/0099/011215

II.Preparing for the Catastrophic EventA. Risk ManagementRisk management is defined as the identification, assessment, and prioritization of riskfollowed by coordinated and economical application of resources to minimize, monitor,and control the probability and/or impact of unfortunate events or to maximize therealization of opportunities. 5The first step in preparing for a catastrophic event is theidentification and assessment of such risk through a dedicated and proactive approachto risk management. Similarly, responding to a threat of disruption in businessoperations and services as a result of a catastrophic event begins with an effectivemanagement strategy.In a 2011 survey by Harvard Business Review Analytic Services sponsored by Zurich,the majority of surveyed business executives concluded that risk management hadbecome more important to their business over the past few years. 6According to thesurvey, 42% of businesses with 10,000 or more employees reported that they employeda Chief Risk Officer (“CRO”), compared with only 11% three years prior to the survey. 7The study found that businesses with a CRO do more advanced risk managementplanning than those without a CRO. 8Additionally, the presence of a CRO, or anindividual directly responsible for risk management who reported directly to the CEO,5 Risk management, WIKIPEDIA, http://en.wikipedia.org/wiki/Risk_management (last visited on Dec. 9,2014).6 HARV. BUS. REV. ANALYTIC SERVICES, HARV. BUS. REV., RISK MANAGEMENT IN A TIME OF GLOBALUNCERTAINTY 1 (2011).7 Id.8 Id. at 9.March 5, 2015 4 @ 3-5-2015 ALFA International6427256.3/SP/00009/0099/011215

was a key indicator of success in emerging from catastrophic events. 9Interviews withexecutives who participated in the study resulted in important lessons:(1) riskmanagement required a dedicated and empowered senior advocate to be effective, (2)risk management and corporate goals should be integrated, (3) risk must be managedproactively by businesses, and (4) businesses must search further than they have in thepast to determine their most serious risks. 10Where does a business start in its risk management assessment for catastrophicevents? First, the business must generate a list of all possible threats to the business,including natural disasters, terrorism, and other catastrophic events. Although someevents may seem remote, it is safer to include them in the initial risk managementassessment. Once the list is complete, the business must analyze the potentialconsequences of each catastrophic event and determine the potential costs associatedwith them. These costs could include damage to physical property and, moreimportantly, business interruption losses, including potential violations of contractualagreements and losing customers. Once this risk management assessment iscompleted, then the business is in a position to develop a business continuity plan tobest address the risk.B. Business Continuity PlanOne of the keys to preparing for a catastrophic event is documenting a plan for yourbusiness. A business continuity plan, or disaster recovery plan, is a written documentor manual explaining how a business will carry on with its critical business processes in9 Id. at 2.10 Id.March 5, 2015 5 @ 3-5-2015 ALFA International6427256.3/SP/00009/0099/011215

the event of a catastrophic event. 11According to one certified contingency planner withthe Disaster Recovery Institute, any such strategy must identify a plan for recovery, analternative business location, a method for accessing vital records and resources duringthe recovery, and key people assigned to the recovery effort. 12Of course, an effectiveplan will involve not only continuous development, but also testing and training on aregular basis. 13A business contingency plan may never be able to address every possible scenario thatcould occur as a result of a disaster. Thus, it is important for a plan to be flexible andadaptable. While there is no one particular way a business must draft its businesscontingency plan, there are some topics and issues that most businesses do generallyinclude in their business contingency plans. Standards often used in creating abusiness continuity plan are available on the internet, including the procedures adoptedby the Department of Homeland Security. Most of the following standards are presentin business continuity plans:1. Essential functions and processes,2. Order of succession,3. Delegation of authority,4. Alternative facilities,5. Continuity communications,6. Vital records management,11 BDA GLOBAL LLC, SURVIVING A DISASTER: A LAWYER’S GUIDE TO DISASTER PLANNING 1 (American BarAssociation, Special Committee on Disaster Response and Preparedness 2011).12 Kenneth L. Fulmer, Business Continuity Planning, A Step-By-Step Guide, The Rothstein Catalog onDisaster Recovery, (2000) (discussing business continuity plans).13 BDA GLOBAL LLC, supra note 11, at 4.March 5, 2015 6 @ 3-5-2015 ALFA International6427256.3/SP/00009/0099/011215

7. Human capital,8. Devolution of control,9. Test, training and exercise,10. Reconstitution. 14The following discussion will address some of the key aspects of a business continuityplan, many of which are listed above.Given the limited resources and personnel available in the event of a catastrophicevent, a good starting point for developing a business continuity plan is to identify thoseprocesses and operations that are critical to carrying out the business’s objectives. 15These are the operations that must continue during and after a disruption due to acatastrophic event. 16It is also important to identify the personnel and resources thatare essential in carrying out these critical operations. 17If relocation is necessary due to a catastrophe, it is vital to business continuity for analternative business location to be identified so employees can relocate and resumecritical processes and operations. Typically, the alternative facility is not as large as thecurrent operation, but it should be large enough for the key disaster recovery team tooperate. 18Though the facility is temporary, it must also be equipped to accommodate14 BDA GLOBAL LLC, supra note 11, at 2-3.15 Id. at 10.16 Id.17 Id. at 4.18 Id. at 15.March 5, 2015 7 @ 3-5-2015 ALFA International6427256.3/SP/00009/0099/011215

the personnel necessary for essential and critical operating processes. 19In theaftermath of Hurricane Katrina, some substitute accommodations included rentingundamaged buildings or leasing mobile units. 20Similarly, businesses can enter intomutual assistance agreements with one or more companies in a similar business.Among other things, arrangements can be made for the use or loan of equipment andsupplies.Businesses should also consider alternative means of getting key personnel to thebusiness location in the event that a disaster results in an interruption in publictransportation or impassable roads. For example, Waffle House, Inc. (“Waffle House”)maintains a running list of employees who drive four-wheel drive vehicles for purposesof shuttling their fellow employees to the corporate office. Of course, many employeesmay be able to work from home when a network connection is established.Even if it is not necessary to move to an alternative business location, it may benecessary to use a backup power source. After Hurricane Katrina, many businessesused portable generators powered by gasoline or propane as a primary backup powersource. 21Depending on your business requirements, you may consider havingspecialized equipment staged or ready to travel to a site hit by a catastrophic event. Forexample, when a hurricane is approaching the coast, Waffle House proactively movesits satellite-communications-equipped recreational vehicle to the site of the hurricane’s19 Id. at 14.20 Lessons Learned From Hurricane Katrina: Preparing your Institution for a Catastrophic Event, FED.DEPOSIT INS. CORP. https://www.fdic.gov/regulations/resources/lessons/index.html (last updated Apr. 1,2008).21 Id.March 5, 2015 8 @ 3-5-2015 ALFA International6427256.3/SP/00009/0099/011215

anticipated landfall. Depending on the severity of the hurricane’s potential wrath, WaffleHouse also sends other equipment, including gasoline storage/pumping trucks,generators, portable toilets, minivans and four-wheel drive vehicles, and water deliverytrucks. Although each business is different, these are examples of the types of thingsthat should be considered in the business continuity plan.One of the most important features of a business continuity plan is access to vitalrecords and resources, including information systems and data management systemsthat are necessary to support the critical operations and processes of the business. 22This, of course, requires that records, files, and applications are backed up off site andtested periodically. 23Some businesses utilize “cloud” storage as a solution to thispotential problem.Perhaps the most important part of the business continuity plan is communication, bothinternal and external.A business should consider establishing a disastercommunications tree that operates via telephone and email. After Hurricane Katrina,many businesses and employees were without access to landline or cellular telephoneservices. 24As a result, any business continuity plan must also consider alternativeinternal communication methods. Additionally, the plan must include a way for thebusiness to communicate with its outside customers and vendors, including maintainingupdated telephone lists and assigning personnel to contact those parties. 2522 BDA GLOBAL LLC, supra note 11, at 16.23 Id.24 Lessons Learned From Hurricane Katrina, supra note 20.25 BDA GLOBAL LLC, supra note 11, at 16.March 5, 2015 9 @ 3-5-2015 ALFA International6427256.3/SP/00009/0099/011215

Finally, once a business continuity plan is in place, a responsible employee or team ofemployees should be designated to continually monitor and update the plan asnecessary. In addition, after a catastrophic event, a business should retrospectivelyexamine its business continuity plan and determine what worked and what did not workunder the circumstances. During this self-assessment, it is important to obtain inputfrom management as well as employees involved in ground-level operations in order toproperly evaluate the effectiveness of your plan and make necessary changes.AT&T has prepared a business continuity planning checklist which is attached asExhibit A.C. InsuranceIn preparing for a catastrophic event, it is important for a business to analyze itsinsurance coverage thoroughly. The business should be concerned not only with theamount of insurance coverage, but also with whether catastrophic events, in particular,are covered. It is vital that you review your insurance portfolio with your insurancebroker or agent to ensure that you fully understand the coverage, deductibles, andexclusions in your policy. You should generate a list of potential catastrophic incidentsapplicable to your business and then review the incidents with the agent/broker to makesure they are covered. Often, additional riders are required to cover such naturaldisasters as floods and earthquakes. This may include an “Act of God” clause, whichcovers damages due to natural causes. It is important to insure against not onlyproperty damage, but also losses arising from business and work stoppages, lostMarch 5, 2015 10 @ 3-5-2015 ALFA International6427256.3/SP/00009/0099/011215

income, and terminated operations since such problems are common with catastrophicevents. As a result, business interruption insurance is essential.1. Business Interruption InsuranceBusiness interruption insurance, also known as business income insurance, covers thebusiness’ loss of income after a catastrophic event while the business facility is closedor in the process of being rebuilt. While property insurance only covers physicaldamage to the business, business interruption insurance covers profits the businesswould have earned during the down period.There are many aspects to business interruption insurance coverage that businessesshould be aware of in order to help mitigate the risk of having inadequate or nocoverage in the event of a catastrophic loss.• Business interruption losses are calculated either by the “net incomemethod,” which starts with net income without the loss plus actualcontinuing expenses minus any earnings recognized from continuedoperations, or the “gross earnings method,” which consists of net lostsales less non-continuing expenses.• Generally accepted accounting principles and insurance loss accountingare not always the same for business interruption values.• Even though replacement costs may exceed the cost to repair damagedequipment, replacing damaged equipment might be more cost effective.For example, replacing equipment in order to restart business operationsMarch 5, 2015 11 @ 3-5-2015 ALFA International6427256.3/SP/00009/0099/011215

as soon as reasonably possible may result in income and a significantlysmaller loss than the delay associated with the repair of equipment.• In the event of a catastrophe, “extra expense” coverage may be availableto cover “extra reasonable and necessary costs” to continue operationswhile the business facility and equipment are being restored and repaired.• Business interruption coverage usually begins the day damage is incurredand stops once the damage is or should have been replaced or repaired. 262. Contingent Business Interruption InsuranceIn today’s business market, many businesses rely on suppliers or customers in othercountries to produce and purchase products and services. 27With global supply chains,many businesses look to contingent business interruption insurance as a way to ensureadequate financial protection. 28Contingent business interruption insurance reimbursesa business for lost profits and other possible transferred risks, such as necessarycontinuing expenses, due to an insurable loss suffered by one or more of its suppliers orcustomers. 29Contingent business interruption insurance is also referred to as“dependent properties coverage” and is triggered if the following occurs:1. Direct physical loss or damage to a dependent property (supplier orcustomer),26 ZURICH AMERICAN INS. CO., 10 THINGS YOU PROBABLY DON’T KNOW ABOUT BUSINESS INTERRUPTION(Zurich HelpPoint. 2011).27 ZURICH AMERICAN INS. CO., CONTINGENT BUSINESS INTERRUPTION INSURANCE: DOES YOUR COMPANYNEED IT? 1 (Zurich HelpPoint 2011).28 Id.29 Id.March 5, 2015 12 @ 3-5-2015 ALFA International6427256.3/SP/00009/0099/011215

2. The loss or damage is caused by a covered cause of loss, and3. The loss results in a suspension of operations at a covered location. 30Contingent business interruption insurance is typically provided for the reasonableamount of time it takes the dependent property to repair their damage and resumenormal operations. 31As with an underlying property insurance policy, catastrophicevents such as earthquakes or flood losses typically are not covered under a contingentbusiness interruption policy. 32As a result, businesses need to specifically request andpurchase this type of coverage. 333. Alternative Risk TransfersIn the area of catastrophic losses, insurance can be problematic because catastrophesare low frequency but high severity events. Premium pricing incorporates a substantialrisk premium. Therefore, insurance can be expensive and not economically feasible forsome businesses. As a result, the insurance and financial markets have developedalternatives to traditional risk management techniques and insurance in order to makethe pricing of catastrophic risks more efficient. 34For example, contingent capitalstructures are contractual agreements that provide an infusion of capital in the event ofa catastrophic loss. 35These contingent capital contracts provide capital at a30 Id.31 Id.32 Id. at 2.33 Id.34 ROBERT J. RHEE, INSURANCE ALTERNATIVE RISK TRANSFER 4.35 Id.March 5, 2015 13 @ 3-5-2015 ALFA International6427256.3/SP/00009/0099/011215

prearranged, pre-loss event cost of capital. 36They may consist of debt or equityinfusion. 37Insurance derivatives are also instruments that are directly linked to a catastrophicevent. 38A derivative is a financial contract with value derived from something else,typically the value of an asset like a stock or an index or market reference. 39Basically,a derivative is a bet on the occurrence or nonoccurrence of a future event. 40Derivatives can be tailored to a specific risk transfer and can be structured aroundthings such as temperature, precipitation, stream flow, and wind. 41Another alternative risk transfer mechanism is insurance securitization. Insurancesecuritization converts an asset that is on an issuer’s balance sheet into a bondobligation. 42In response to catastrophes in the 1990s, this securitization technique wasused to create catastrophe bonds that securitized a catastrophic risk. An insurancesecuritization is basically a secured structured note providing for a collateralizedreinsurance obligation. 43The insurer typically cedes all or a portion of the premium to aspecial purpose reinsurance vehicle, which is usually established offshore in the36 Id. at 5.37 Id.38 Id.39 Id.40 Id.41 Id.42 Id.43 Id.March 5, 2015 14 @ 3-5-2015 ALFA International6427256.3/SP/00009/0099/011215

Cayman Islands or Bermuda due to regulatory and tax restrictions in the UnitedStates. 44D. Supply Chain InterruptionsAs referenced in earlier portions of this paper, today’s global economy results incomplex links between suppliers, manufacturers, distributors, and retailers.Acatastrophic event suffered by a supplier on the other side of the world can result in ashutdown of a business’s operations just as if the catastrophic event occurred at thebusiness’s facility. 45Because of this, supply chain risks require extra attention by abusiness. For example, earthquake damage to a Japanese factory supplying pistonrings to eight of twelve Japanese car manufacturers disrupted production for threeweeks. 46 An international electronics company maintained a single source of supply fora critical component and after a fire at the supplier’s plant, the company lost $400million in sales and subsequently shut down an entire business line. 47 Similarly, a fire ata plant in South Korea contributed to a shortage of notebook computer batteries andslowed market growth for ultra low cost notebook computers and ultra-mobilecomputers. 48 Many domestic companies were also negatively affected because of thedestruction to shippers and suppliers of goods caused by the devastation to the GulfCoast area after Hurricane Katrina.44 Id.45 Linda Conrad, Protecting Profitability if Your Supply Chain Breaks, RISK INSIGHT SUPPLY CHAIN ISSUE,2009, at 8, 9 (discussing the effect of a global economy on supply chains).46 Id. at 12.47 Id.48 Id.March 5, 2015 15 @ 3-5-2015 ALFA International6427256.3/SP/00009/0099/011215

As a result, businesses must know their suppliers and how their suppliers deal withdisruption from catastrophic events. This involves knowing where your suppliers’supplies—and possibly even raw materials—come from. 49 It is also important to knowwhere your business stands among your suppliers’ priorities. 50Does your supplierconsider your business a critical customer that will get appropriate attention if thesupplier is affected by a catastrophic event? 51Part of business risk management isknowing how prepared your suppliers are for disruption from catastrophic events. Forexample, do your suppliers have a business continuity plan? Many insurancecompanies will provide their insureds with a supply chain risk assessment and will helpbusinesses develop benchmarks to gauge external suppliers. For example, Zurichprovides the following supply chain checklist:1. Do you know who your critical suppliers are and how much their failurewould impact your company’s profits?2. Have you fully mapped your critical supply chains downstream to the rawmaterial level and upstream to the customer level?3. Have you integrated risk management processes into your supply chainmanagement approaches?4. Do you have routine timely systems for measuring the financial stability ofcritical suppliers?5. Do you understand your tier 1 production facilities and logistic hubexposures to natural catastrophes?49 Avoiding the Pitfalls of Supply Chain Disruption, RISK INSIGHT SUPPLY CHAIN ISSUE, 2011, AT 4, 6(discussing the importance of mapping a business’ supply chain).50 Id.51 Id.March 5, 2015 16 @ 3-5-2015 ALFA International6427256.3/SP/00009/0099/011215

6. Is supply chain risk management integrated into your enterprise riskmanagement approach?7. Do you record the details of supply chain incidents and the actions youhave put in place to avoid future incidents?8. Do your tier 1 suppliers have business continuity plans that have beentested in terms of their viability?9. Have you provided risk training to your supply chain management team?10. Is risk on the agenda of performance meetings with your strategicsuppliers? 52Similarly, some businesses have developed protocols that must be met by suppliers.One example of this type of protocol is the Customs-Trade Partnership AgainstTerrorism or C-TPAT, created by a consortium of the U.S. Government and businessesafter the September 11, 2001 terrorist attacks. 53E. Contractual ProtectionIn light of the continued threat of catastrophic events, it is imperative that businessesanalyze their contractual relationships to allocate the risk of non-performance as a resultof these events. Although contractual provisions can include indemnity, additionalinsured, notice, liquidated damages, suspension, and other provisions, the mostimportant provision is a properly-drafted force majeure clause. The purpose of a forcemajeure clause is to (1) allocate risk and (2) place the parties on notice of events that52 Zurich HelpPoint Supply Chain Health Check, RISK INSIGHT SUPPLY CHAIN ISSUE, 2009, at 26, 27(discussing standards by which a business can measure its supply chain health).53 Taking Measures to Cope with Delivery Disruption, RISK INSIGHT SUPPLY CHAIN ISSUE, 2011, at 14, 15(discussing planning for a critical supply shortage).March 5, 2015 17 @ 3-5-2015 ALFA International6427256.3/SP/00009/0099/011215

might temporarily or permanently excuse service. 54The primary requirement of anyforce majeure clause is that the invoking party’s performance of a contractual obligationis prevented by an event that is unforeseen and not within the control of either party. 55A force majeure clause allows a company to protect itself in the event of an Act of God,such as a hurricane, earthquake, or tornado.In drafting a force majeure clause, parties typically utilize either a general clause or aspecific clause which enumerates the events that will constitute force majeure. 56Anexample of a general force majeure is as follows:It shall not constitute a material breach, and neither party shall lose anyrights hereunder or be liable to the other party for damages or losses, onaccount of failure of performance by the defaulting party, if the failure isthe result of a natural disaster, national emergency, the act or omission ofa third party or similar event outside of a party’s control. 57An example of a specific force majeure clause that enumerates the events that willprevent or suspend performance is as follows:Neither party shall lose any rights hereunder or be liable to the other partyfor damages or losses except for payment obligations, on account offailure of performance by the defaulting party if the failure is the result of54 Richard Ruzzat, Force Majuere, COVERING BUS. CREDIT,http://www.coveringcredit.com/business_credit_articles/Laws_and_Regulations/art338.shtml (lastvisited Dec. 9, 2014).55 Id.56 Id.57 Id.March 5, 2015 18 @ 3-5-2015 ALFA International6427256.3/SP/00009/0099/011215

an act of God (e.g., earthquake, tornado, flood, inclement weather) or anact of terrorism, including chemical or biological warfare; labor dispute,lockout, strike, embargo; governmental acts, orders or restrictions; failureof suppliers or third persons; or any other reason where failure to performis beyond the reasonable control, and is not caused by the negligence,intentional conduct or misconduct of the defaulting party, and thedefaulting party has exercised all reasonable efforts to avoid or remedysuch force majeure. The defaulting party must provide written notice ofthe force majeure event to the remaining parties within three (3) days ofsuch event. 58From a legal standpoint, a well-drafted force majeure clause can act as a defense to abreach of contract claim against a business. However, once a force majeure clause isinvoked, the burden is on the party invoking the clause to prove that the event wasbeyond its control and without its fault or negligence .59 Additionally, the party invokingthe force majeure clause must provide notice to the other party so that the other partycan mitigate against the effects of the force majeure event. 6058 Id.59 Id.; see also Gulf Oil Corp. v. F.E.R.C., 706 F.2d 444 (3d Cir. 1983).60 Ruzzat, supra note 53.March 5, 2015 19 @ 3-5-2015 ALFA International6427256.3/SP/00009/0099/011215

III.Responding to the Catastrophic EventA. Immediate ResponseThe first priority for a business faced with a catastrophic event is to make sure all of itsemployees are safe during and after the event. Depending on the nature of thecatastrophic event, businesses must ensure that their employees are following a welldesignedemergency evacuation plan to get employees out of harm’s way. Once abusiness ensures that its employees are safe, it should immediately put in place itsbusiness continuity plan, including assembling the proper pre-determined team tolaunch and implement the plan. Businesses that can resume normal operations quicklyhave a much better chance of minimizing loss and surviving.Businesses should get their in-house or outside counsel involved early after acatastrophic event for both disaster-related advice and to protect sensitivecommunications. If a business continues to operate in a limited capacity after acatastrophic event, there may be governmental, regulatory, and various legal issuesthat need to be assessed. For example, there may be OSHA, workers’ compensation,wage/hour, and health code implications if you continue to operate in a limited capacity.B. Provide Timely NoticeAs soon as practical after the catastrophic event, businesses should notify each of theirapplicable insurance carriers of the event and any known losses. Similarly, given thenotice requirement in most force majeure provisions, businesses should provide noticeof the catastrophic event and the invoking of the force majeure clause to all of theircontracting vendors, suppliers, and customers.March 5, 2015 20 @ 3-5-2015 ALFA International6427256.3/SP/00009/0099/011215

C. Pursuing Insurance ClaimsAfter all applicable insurance companies are put on notice, businesses shouldimmediately assemble a team of professionals and experts to assist in the claimprocess. The team should normally consist of an attorney, independent appraisers,forensic accountants with insurance experience, and possibly a public adjuster. Theproper team will allow the business to pursue creative but legitimate recoveries underthe policy language and maximize coverage opportunities and potential recoveries.Retaining a team of experts early in the claim process will also allow the business toprovide the insurance adjuster with the business’s preliminary loss estimate before areserve is set.Many legal issues can arise with business interruption insurance claims after acatastrophic event. The following issues are particularly relevant and interesting. 611. Measurement of lossAs indicated in an earlier section in this paper, business interruption loss is typicallymeasured in one of two ways: the net income method or the gross earnings method.The focus is typically on an insured’s historical profits, but in some cases an insured candemonstrate that profits during the recovery period would have exceeded historicalprofits. In General Insurance Co. of America v. Pathfinder Petroleum Co., the insuredwas in business only eight months when its gasoline manufacturing plant was destroyed61 Russell Kranzler, Averting Disaster: Techniques for Analyzing Business Interruption Claims, N.Y. ST.B.J. (Oct. 2008) (discussing insurance issues arising from business interruption claims aftercatastrophic events). The entire discussion of the issues below was derived from this article.March 5, 2015 21 @ 3-5-2015 ALFA International6427256.3/SP/00009/0099/011215

y fire. 62The insured sought recovery of lost profits under the policy and an issuearose as to whether the lost profits should include those that would have been earnedduring the recovery period by a polymerization plant that the insured had contracted tobuild on its destroyed premises. 63The insurer argued against the recovery of suchprofits as the plant did not exist at the time of the loss. 64The court found that theinsurance policy covered net profits from the “business of manufacturing gasoline,” andthe polymerization plant was part of that business, thus the loss of the insured’s facilityprevented it from building the plant and earning the profits it would have generated. 652. Can a business profit from a catastrophic event?One issue often litigated after a catastrophic event is whether the insured can calculateits lost profits based on an increased demand for its products or services actuallyresulting from the catastrophic event itself. In Prudential-LMI Commercial InsuranceCo. v. Colleton Enterprises, Inc., the insured operated a hotel that had operated at aloss for several years prior to Hurricane Hugo. 66The insured sought to recover lostprofits claiming that if its property had not been destroyed, it would have realized profitsfrom the construction workers and temporary residents who came to the area as a resultof the hurricane. 67 The insurance company argued against such a recovery as it was62 General Insurance Co. of America v. Pathfinder Petroleum Co., 145 F.2d 368 (9th Cir. 1944).63 Id.64 Id.65 Id.66 Prudential-LMI Commercial Insurance co. v. Colleton Enterprises, Inc., 976 F.2d 727 (4th Cir. 1992).67 Id.March 5, 2015 22 @ 3-5-2015 ALFA International6427256.3/SP/00009/0099/011215

caused by the hurricane itself. 68The insurance policy allowed consideration of“probable earnings. . . had no loss occurred.” 69 The court interpreted the term “loss” tomean the hurricane, so the insured could only recover profits it would have earned if thehurricane had not occurred. 70In contrast, in Stamen v. Cigna Property and Casualty Co., the insured’s grocery storeswere damaged by Hurricane Andrew and the insured claimed business interruptionlosses based on the profits it would have earned if the stores had been open after thehurricane. 71The insurance company claimed that this would result in a windfall for theinsured. 72The court distinguished between “loss” and “occurrence” in finding that the“occurrence” was the hurricane but the “loss” was damage to the insured’s grocerystores. 73 In finding for the insured, the court concluded that if the insurance companyintended to calculate the insured’s lost profits based only on what it would have earnedif the hurricane had not occurred, then the insurance policy could have used thatlanguage. 74As a result of such rulings, the Insurance Services Office, known as “ISO”, a supplier ofpolicy forms to the insurance industry, has amended its forms to exclude any netincome that would have been earned because of an increase in the volume of businessdue to the favorable business conditions created by the loss on customers or on other68 Id.69 Id.70 Id.71 Stamen v. Cigna Property and Casualty Co., No. 93-1005, Slip Op. (S.D. Fla. June 13, 1994).72 Id.73 Id.74 Id.March 5, 2015 23 @ 3-5-2015 ALFA International6427256.3/SP/00009/0099/011215

usinesses. 75 The specific policy language and interpretation of the language by courtsin the relevant state will, of course, determine how that issue is resolved on a case-bycasebasis.3. Period of RestorationA business’s potential recovery on a business interruption claim will be significantlyimpacted by the period of restoration. The attorneys and experts for a business mustwork together to make sure that the appropriate period of restoration is utilized incalculating any loss. Most insurance policies provide for the recovery of lost incomeduring the period it would take, with due diligence, to repair or replace the damagedproperty and to resume business operations under the same or similar conditions thatexisted before the catastrophic event. In some situations, the business needs to extendthe period of restoration, and courts have allowed such extensions. For example, inCompagnie Des and Bauxites de Guinea v. Insurance Company of North America, thecourt allowed an extension of the period of restoration so that the insured could improveits facility to prevent the same damage from occurring again. 76After the September 11 terrorist attacks destroyed the World Trade Center, someinteresting litigation ensued regarding an insured’s location. In Duane Reade, Inc. v. St.Paul Fire & Marine Insurance Co., the appellate court defined the period of restorationas the time required to “build a reasonably equivalent store in a reasonably equivalentlocation,” disagreeing with the district court that found the period of restoration was the75 Russell Krauzler, Supra Note 61.76 Compagnie Des and Bauxites de Guinea v. Insurance Company of North America, 794 F.2d 871 (3 rdCir. 1986).March 5, 2015 24 @ 3-5-2015 ALFA International6427256.3/SP/00009/0099/011215

time needed for the insured drug store chain to resume “functionally equivalentoperations” at the location where its World Trade Center store was located. 77In ZurichAmerican Insurance v. ABM Industries, the insured maintained facilities at the WorldTrade Center providing janitorial and engineering services to the tenants and commonareas. 78After remand from the Circuit Court of Appeals, the district court distinguishedthe case from those like Duane Reade, Inc., finding that the insured could not simplyrelocate to another building and carry on its business. Instead, the court concluded thatthe appropriate period of restoration was the “hypothetical length of time required torebuild the World Trade Center.” 79D. Disease/PandemicAlthough uncommon, the recent Ebola scare in Dallas, Texas underscores theimportance of businesses being prepared for disease and pandemic in the workplace.The U.S. Centers for Disease Control and Prevention (“CDC”) require the existence ofthree conditions to declare that a global outbreak of disease has occurred: (1) theemergence of a new type of virus for which humans have little or no immunity, (2) theculpability of the new virus to infect and cause illness in humans, and (3) the capabilityof the virus to spread easily and without interruption among humans. 80Because manyAmerican companies’ sales, logistics, operations and financial employees regularly77 Duane Reade, Inc. v. St. Paul Fire & Marine Insurance Co., 411 F.3d 384 (2d Cir. 2005).78 Zurich American Insurance v. ABM Industries, 265 F. Supp. 2d 302 (S.D. N.Y. 2003), aff’d in part,vacated in part, rev’d in part by 397 F.3d 158 (2d Cir. 2005), on remand to No. 01 Civ 11200, 2006 WL1293360 (S.D. N.Y. May 11, 2006).79 Id.80 Questions and Answers About Avian Influenza (Bird Flu) and Avian Influenza A (H5N1) Virus,DEPARTMENT OF HEALTH AND HUMAN SERVICES CENTERS FOR DISEASE CONTROL AND PREVENTION,http://www.cdc.gov/flu/avian/gen-info/qa.htm (last visited Dec. 10, 2014).March 5, 2015 25 @ 3-5-2015 ALFA International6427256.3/SP/00009/0099/011215

travel overseas, and personnel from overseas vendors and buyers often travel to theUnited States, the World Health Organization estimates that a highly contagiousairborne disease like Avian Influenza could reach pandemic distribution in as little asthree months. 81When faced with a disease in the workplace, it is imperative that businesses do notpanic or contribute to already-existing panic. This requires early education on the partof the business regarding the applicable disease. In addition to being educated on thedisease at issue, businesses should also be aware of the various state and federal lawsgoverning the workplace and should be careful not to violate such laws by hastilyreacting. Understanding the legal consequences associated with a potential pandemicin the workplace could, at times, be crucial to the business’s continued operation.For example, if a business is an employer covered by the Americans with DisabilitiesAct (“ADA”), it must abide by the confidentiality provisions of the ADA. 82Thus, if anemployee suffers permanent health problems from contracting a disease and thisaffects a major life activity of the employee, the employer may not release medicalinformation related to its employees or information that could reasonably identify theemployee.Similarly, medical information received in connection with a request for leave under theFamily and Medical Leave Act (“FMLA”) should also be kept confidential. 83FMLA leave81 Ten Things You Need to Know About Pandemic Influenza, WORLD HEALTH ORGANIZATION, (OCT. 14,2005) http://apps.who.int/csr/disease/influenza/pandemic10things/en/.82 See 42 U.S.C. § 12181 et seq.83 See 29 U.S.C. § 2601 et seq.; 29 C.F.R. 825.100 to .800.March 5, 2015 26 @ 3-5-2015 ALFA International6427256.3/SP/00009/0099/011215

can be made available for those employees who have been exposed to otherindividuals diagnosed with a disease or who are under close observation andmonitoring. If a business has a suspected case of Ebola or other disease at work, thebusiness should not immediately rush to send out a notification letter. Instead, thebusiness should gather facts (not rumors) and immediately consult with an infectiousdisease expert and an attorney about the careful wording of a notification letter and thebest course of action. If the Health Insurance Portability and Accountability Act(“HIPAA”) applies to a business, then the business must also be careful of HIPAAviolations when handling certain information related to the health of an infectedemployee, or when there is a need to inform other employees of possible exposure. 84A pandemic may lead to employee absence in the workplace, and many employeesmay work from home. If employees are quarantined by the CDC due to possibleinfection or are asked by local health authorities to stay home, businesses can granttime off for FMLA leave. If asked to send employees home, businesses may berequired to pay the employees who are exempt under the Fair Labor Standards Act(“FLSA”), but not their non-exempt employees. 85Of course, prevention is still the best medicine, and businesses should adopt commonsense policies or protocols. For example, after the H1N1 flu scare years ago,employers put in reasonable low cost measures to help stop the spread of that disease,such as extra hand sanitizing stations and posters reminding employees to frequentlywash their hands. Businesses can adopt such measures at work and also remind84 See 42 U.S.C. § 1320(d) et seq.85 See 29 U.S.C. § 201 et seq.March 5, 2015 27 @ 3-5-2015 ALFA International6427256.3/SP/00009/0099/011215

employees of basic policies, such as not coming to work if you have a fever. With therecent Ebola scare, businesses can request that employees notify them if they plan toconduct travel in Ebola infected areas or if they have been in contact with someonediagnosed with or suspected of having the Ebola virus.IV.ConclusionCould a hurricane, earthquake, tornado, act of terrorism, disease outbreak, or othercatastrophic event possibly affect your business? A catastrophe is a low probability but,unfortunately, a very high severity event. Business leaders cannot assume it will neverhappen to their business. Instead, businesses must prepare for the consequences of acatastrophic event by implementing procedures that put them in a position to reactquickly and appropriately. Businesses must devote the appropriate resources todevelop a business continuity plan in preparation for a catastrophic event. When suchan event occurs, businesses must rapidly respond so they can return to normaloperations as soon as possible. Statistically, the odds are stacked against the longtermsurvival of a business hit by a catastrophic event. Only those businesses thatdevote the time, effort, and resources necessary to prepare and plan for a catastrophicevent will survive. It is no longer if, but when, your business will be affected by acatastrophic event. When it does, will your business survive or will it be anotherbusiness statistic?March 5, 2015 28 @ 3-5-2015 ALFA International6427256.3/SP/00009/0099/011215

2015InternationalClientSeminarALFAINTERNATIONAL2015INTERNATIONALCLIENTSEMINARFIRSTWORLDCHALLENGES:FINDINGPRACTICALSOLUTIONSIN ASHRINKINGGLOBALECONOMY5FORTHEROAD

5 for the RoadThe Politics of LitigationKevin G. OwensJOHNSON & BELL, LTD., Chicago, Illinoisowensk@jbltd.comCharles StewartBRADLEY ARANT BOULT CUMMINGS LLP, Montgomery, Alabamacstewart@babc.com1. For in-house counsel, be sure to identify just who is your client.2. Preserve all privileges – the attorney-client privilege and the attorney workproduct doctrine, especially as associated with any internal investigation orwitness interviews. Abide by ethical duties of confidentiality as appropriate.3. Assure competency! Potential catastrophic litigation is no place for the “jack ofall trades, master of none!”4. Properly supervise all non-attorneys participating in the investigation andlitigation.5. Maintain control of the litigation in the case of insurer involvement, particularlywhere coverage is challenged and the carrier reserves rights.March 6, 2015© 3-6-2015 ALFA International

5 for the RoadYearning for a Yin to Your Yang:Finding Balance in an Unbalanced WorldChristopher A. PageYOUNG MOORE AND HENDERSON, P.A., Raleigh, North Carolinachris.page@youngmoorelaw.comMelanie R. CheairsLORANCE & THOMPSON, P.C., Houston, Texasmrc@lorancethompson.com1. Attorneys are known for their competitiveness, perfectionism, and analytical nature,but there is a darker side to those qualities– attorneys are significantly more likely toabuse alcohol or drugs, suffer depression, and commit suicide, than members ofother professions.2. State Bars, medical professionals, and self-help courses offer attorneys manyresources to fight these demons, avoid disciplinary actions, and be successful.3. To be successful, not just in law, but in life, attorneys must find BALANCE.Specifically, work-life balance, as embodied in the meaning and form of the Yin-Yang symbol.4. Begin the process of considering how to balance your work and the rest of your lifeby asking yourself the question of who you are in terms of talents and passions.5. Once you decide who you are in terms of talents and passions make the choices onhow you choose to spend your time and commit to a balanced life. You and yourfamily won’t regret it.March 5, 2015© 3-5-2015 ALFA International

2015InternationalClientSeminarALFAINTERNATIONAL2015INTERNATIONALCLIENTSEMINARFIRSTWORLDCHALLENGES:FINDINGPRACTICALSOLUTIONSIN ASHRINKINGGLOBALECONOMYTRACK1:COMPLEXLITIGATION

5 for the RoadRoot Cause Analysis:Looking for Black and White in a World of GrayPeter A. DubrawskiHAIGHT, BROWN & BONESTEEL, LLP, Los Angeles, Californiapdubrawski@hbblaw.comJ.K. LeonardNAMAN HOWELL SMITH & LEE, PLLC, San Antonio, Texasjkleonard@namanhowell.com1. Root cause analysis (RCA) is commendable, yet must be approached carefully.2. When used properly, RCA can be an invaluable tool for assessing and mitigatingbusiness risk.3. When used improperly, RCA can be an invaluable tool for opponents andclaimants to establish liability against you.4. Study and consider several available RCA tools/formats before selecting one thatis appropriate for your business.5. Involvement of counsel may (or may not) preserve confidentiality and/or privilegeof RCAMarch 6, 2015© 3-6-2015 ALFA International

5 for the RoadStrategies for Avoiding Qui Tam Relator (Whistleblower)Controversies and ActionPatrick S. CoffeyWHYTE HIRSCHBOECK DUDEK S.C., Milwaukee, WIpcoffey@whdlaw.comChristopher E. KnightFOWLER WHITE BURNETT P.A., Miami, Floridacknight@fowler-white.com1. The government will continue to emphasize external reporting of alleged orsuspected fraud by companies and their responsible executives.2. The failure to understand and address the dynamics driving individuals toreport problems is the greatest risk.3. Potential whistleblower claims require reassessment of compliance and bettercommunicate to encourage internal reporting without fear of retaliation.4. Hotlines and other reporting mechanisms must be supplemented withmanagement efforts, including more reporting channels, tracking reporting,and responding to reported concerns.5. Evaluate and monitor risk and identify problems before they become claims.March 5, 2015© 3-5-2015 ALFA International

5 for the RoadTribalism in the Courtroom:What Neuroscience Has to Say about Bias, Loyalty, andGroup BehaviorT. Thomas SingerAXILON LAW GROUP, PLLC, Billings, Montanatsinger@axilonlaw.comStanley E. SiegelNILAN JOHNSON LEWIS PA, Minneapolis, Minnesotasiegel@nilanjohnson.comDina M. CoxLEWIS WAGNER, LLP, Indianapolis, Indianadcox@lewiswagner.com1. All people (including judges, juries, attorneys and their clients) are hard-wired to betribal.2. As members of tribes we are predisposed to take care of our own and turn onoutsiders.3. It is our job as advocates to invite the trier of facts, as much as possible, into ourtribe (or that of our client).4. Confidence in advocacy cannot be overstated. Science tells us that confidence(whether real or simply summoned from within by dint of will) is perceived by othersas competence. It is important for the advocate and his/her client to projectconfidence, but nor arrogance, through their mode of dress, posture, eye contact,calmness, and speech patterns.5. And we need to do it in a way that tells a story and makes a connection with ouraudience.March 5, 2015© 3-5-2015 ALFA International

5 for the RoadCatastrophic Litigation:Lessons from Defending Headline CasesBenton J. BartonHALL & EVANS, LLC, Denver, Coloradobartonb@hallevans.comP. Clark AspyNAMAN, HOWELL, SMITH & LEE, PLLC, Austin, Texasaspy@namanhowell.com1. Before a catastrophe strikes, make sure you are adequately insured (both incoverage areas and limits) for potential exposure that may arise from your work.2. Before a catastrophe strikes, update your preferred contract provisions toenforceably shift risk and limit exposure.3. After a catastrophe strikes, assemble your company team with subject matterexperts and counsel for preserving in-house privileges.4. After a catastrophe strikes, vet and retain the best litigation expert witnessesimmediately to avoid conflicts and unavailability in future litigation.5. When catastrophic litigation is filed, quickly retain the best mutually agreeablemediator and schedule early mediation sessions.March 6, 2015© 3-6-2015 ALFA International

2015InternationalClientSeminarALFAINTERNATIONAL2015INTERNATIONALCLIENTSEMINARFIRSTWORLDCHALLENGES:FINDINGPRACTICALSOLUTIONSIN ASHRINKINGGLOBALECONOMYTRACK2:VIRTUALREALITY

5 for the RoadHackers Anonymous—Risk Mitigation Strategies forHandling Ever-Changing Threats to Data SecurityChristopher C. GenoveseNelson Mullins Riley & Scarborough, LLP, Columbia, South Carolinachris.genovese@nelsonmullins.comDavid G. HymerBradley Arant Boult Cummings, Birmingham, Alabamadhymer@babc.com1. Fully assess what paper and electronic data the company has a duty to protectand inventory what the company is currently doing to protect it.2. Implement relatively easy and inexpensive security measures. This includesencrypting all company hardware as a standard practice, redacting sensitiveinformation where possible, blocking off company systems from only those whoneed access, and using a 90 day password change cycle.3. Educate and update company employees. This includes developing and trainingemployees on meaningful company policies and procedures related to datamanagement and information security.4. Conduct meaningful audits of third party vendors (this includes outside counsel)as well as internal company systems.5. Prepare to respond to the inevitable data breach by developing a data breachresponse plan, confirming the company has adequate insurance coverage, andpreselecting an attorney experienced in data breach issues.March 6, 2015© 3-6-2015 ALFA International

5 for the RoadClient Confidentiality in the CloudPatrick MichaelDINSMORE & SHOHL LLP, Louisville, Kentuckypatrick.michael@dinsmore.comWilliam G. IrelandHAIGHT, BROWN AND BONESTEEL, LLP, Los Angeles, Californiawireland@hbblaw.com1. Advantages: Easily Accessible and Secure.2. Client Consent in Engagement Letter.3. Select a Reliable Provider.4. Up to Date Security and Encryption.5. Ability to remove data from service.March 6, 2015© 3-6-2015 ALFA International

Five for the RoadIt is Bound to Happen:Managing Losses for the Inevitable Data BreachElaine MossBROWN & JAMES PC, St. Louis, Missouriemoss@bjpc.comLisa MickleyHALL & EVANS, LLC, Denver, Coloradomickleyl@hallevans.com1. Your company will suffer a data breach, if it has not already happened.2. Notification requirements are expansive and expensive.3. Protecting the attorney client privilege during your investigation of the breach iscritical.4. Know your potential risks before going to market for cyber insurance.5. Cyber insurance and the claims services provided by those carriers could saveyour business in the event of a breach.March 6, 2015© 3-6-2015 ALFA International

5 for the RoadStrategies for Battling Patent TrollsEugenia G. CarterWhyte Hirschboeck Dudek, S.C., Madison, Wisconsinecarter@whdlaw.comRonald KatzManatt, Phelps & Phillips, LLC, San Francisco, Californiarkatz@manatt.cmom1. Proactively respond to the NPE’s initial demand, affirming your respect for the IP ofothers, but requesting more information to properly evaluate the matter.2. Know your adversary: not all NPE’s are equal. Check out who is behind them, whorepresents them, who are the inventors and their litigation history.3. Legislating against “patent trolls” is difficult because there is general no recognizeddefinition of a “troll” and legislation presents the risks of undermining the value ofimportant patents owned by non-trolls.4. If you are sued by a NPE, consider forming/joining a joint defense group to divide upthe work and spread the cost burden among group members.5. Consider pursuing challenges to NPE’s patents that can be brought in the PatentOffice (Post-Grant Review and Reexaminations).March 6, 2015© 3-6-2015 ALFA International

2015InternationalClientSeminarALFAINTERNATIONAL2015INTERNATIONALCLIENTSEMINARFIRSTWORLDCHALLENGES:FINDINGPRACTICALSOLUTIONSIN ASHRINKINGGLOBALECONOMYTRACK3:HUMAN RESOURCES

5 for the RoadLions, Tigers, and Bears - When Compliance Officers orIn-House Counsel Become WhistleblowersSchaun D. HenryMCNEES WALLACE & NURICK, LLC, Harrisburg, PASHenry@mwn.comColleen P. LewisDINSMORE & SHOHL LLP, Cincinnati, OHCLewis@dinsmore.com1. Employee whistleblowers who report improper conduct or who participate inrelated proceedings are protected from retaliatory action including discharge,suspension, or being harassed for engaging in such protected activity.2. Trusted professionals such as in-house counsel and compliance officers arepursuing whistleblower claims.3. The best defense is a good offense. Your company should invest in complianceby creating a culture of integrity. Implement and enforce an anti-retaliation policyand train employees on the prevention and reporting of suspected wrongdoing.4. Draft and disseminate policies which protect your company records and whichclearly spell out ethical responsibilities of your employees.5. If you find yourself embroiled in a whistleblower action brought by in-housecounsel, you should examine the typical defenses and consider, as a part of yourdefense, counterclaims against the accusing whistleblower. Begin by asking ifthe disclosure of information is protected by the attorney-client privilege.March 6, 2015© 3-6-2015 ALFA International

5 for the RoadWorkplace Trends – What is Hot and What is NotJoel R. HlavatyFRANTZ WARD, LLP, Cleveland, Ohiojhlavaty@frantzward.comLisa A. KrupickaBURCH, PORTER & JOHNSON, PLLC, Memphis, Tennesseelkrupicka@bpjlaw.com1. Employers need to be careful in using an individual’s criminal history whenmaking employment decisions, as any information used must be job related andconsistent with business necessity. The recommended approach is to use anindependent assessment that considers several factors relating to the position atissue and an individual’s criminal background.2. Franchisors and franchisees need to be aware that they may be found by theNational Labor Relations Board to be joint employers where the totality of thecircumstances demonstrate the franchisor wields day-to-day influence over theworking conditions of the franchisee’s employees.3. In light of the increased protections being afforded to members of the lesbian,gay, bisexual and transgender (“LGBT”) community, employers should reviewtheir employment policies and provide training to all employees and managersregarding the fair and non-discriminatory treatment of LGBT employees.4. Employers should review their policies and practices relating to an employee’suse of social media during non-working hours so as not to violate an individual’srights under the National Labor Relations Act.5. The EEOC’s Pregnancy Discrimination Guidelines caution employers that whilepregnancy is not a disability, pregnancy-related complications may be adisability, and that pregnant employees must be accommodated to the extentthat non-pregnant employees are accommodated.March 5, 2015© 3-5-2015 ALFA International

5 for the RoadBuilding a Better Mousetrap – Protecting Company AssetsJames M. PetersonHIGGS, FLETCHER & MACK, LLP, San Diego, Californiapeterson@higgslaw.comEva KnipschildKENNEDY VAN DER LAAN, Amsterdam, Netherlandseva.knipschild@kvdl.nl1. Start with the fundamental question: What information qualifies as a “protectabletrade secret” under state and/or federal law? Decide at the outset whether this“trade secret” or other information requires protection.2. Different states have different laws regarding trade secret protection and it isimportant to know the rules of your state.3. Understand what you can and cannot do if utilizing a restrictive covenant(specific to the locations where they operate). When parties are decidingwhether to sue, state law variations will make choice of law a powerful factor inanalyzing the risks and benefits of pursuing trade secret litigation, and the choiceof forum may prove critical in the success or failure of the action.4. Determine whether a breach of your confidentiality agreement or restrictivecovenant entitles you to injunctive relief, monetary damages, attorneys’ fees, orany other type of damages or relief. (Just as state laws differ on the validity ofrestrictive covenants, so too do they differ on the extent of remedies available forbreach of those covenants.)5. Be cautious that your efforts to protect confidential information did not go “toofar.” (For example, there has been a significant rise in litigation regarding thevalidity and enforceability of anti-poaching agreements; these are agreementsbetween two different employers to refrain from hiring each other’s employees;they are very risky and could violate antitrust laws.)March 5, 2015© 3-5-2015 ALFA International

5 for the RoadSex, Drugs, Rock and Roll -Is this VH1 behind the Music or my Office?Deborah P. KellyDICKSTEIN SHAPIRO LLP, Washington, District of Columbiakellyd@dicksteinshapiro.comJane E. BrownPAINE HAMBLEN, Spokane, Washingtonjane.brown@painehamblen.com1. Most problems can be untangled if you focus on the conduct, not the cause of theconduct.2. Top rainmakers and banner clients have to go if their conduct would get a “regular”employee fired.3. The Americans with Disabilities Act puts a yellow light on firing an employee justbecause she smokes pot.4. Marijuana is legal in about half the United States; as that is likely to increase, figuringout how to handle your employee’s lawful activity is an important area to navigate.5. Corrective action is relatively easy, but after the corrective action, the work environmentitself has to be addressed – a challenge that is complicated but necessary.March 5, 2015© 3-5-2015 ALFA International

2015InternationalClientSeminarALFAINTERNATIONAL2015INTERNATIONALCLIENTSEMINARFIRSTWORLDCHALLENGES:FINDINGPRACTICALSOLUTIONSIN ASHRINKINGGLOBALECONOMYTRACK4:EMERGINGCHALLENGES

5 for the roadNavigating Insolvency and Bankruptcy Issues in the EU:German, French, UK and American PerspectivesFrédéric CohenCOURTOIS LEBEL, Paris, Francefcohen@courtois-lebel.comJohn SykesCHARLES RUSSELL, LLP,London, EnglandJohn.Sykes@crsblaw.comMarcello Di StefanoTIEFENBACHER, Heidelberg, GermanyDiStefano@tiefenbacher.deJohn A. RobertsSEMMES, BOWEN & SEMMES, P.C.,Baltimore, Marylandjaroberts@semmes.com1. The 28 members of the European Union (EU) all have their own insolvency laws,and they are all different than the U.S. Bankruptcy Code.2. The proper forum for cross-border insolvency cases is governed by the EURegulation on Insolvency, which applies only to companies whose “centre ofmain interests” (COMI) is within the EU.3. Although the German insolvency law is not as debtor-friendly as U.S. bankruptcylaw, recent reforms to the German law promote corporate restructuring, and arestrongly inspired by the U.S. Bankruptcy Code.4. French insolvency law is more debtor-friendly, and has also recently developedvarious procedures that promote the restructuring of companies before theyactually become insolvent and, thus, avoid the opening of insolvencyproceedings.5. English insolvency law is often seen as being so much more debtor-friendly thattroubled companies in recent years have attempted to move their COMI toEngland in order to take advantage of the re-vamped Administration rescueprocess, the ability to effect a “pre-packaged” disposal of an insolvent business,and less onerous employment laws.March 5, 2015© 3-5-2015 ALFA International

5 for the RoadThe Law Department of the 21 st CenturyDarryl M. BloodworthDEAN, MEAD, EGERTON, BLOODWORTH, CAPOUANO& BOZARTH, P.A.,Orlando, Floridadbloodworth@deanmead.com1. Change is coming rapidly to the legal field, and that is especially true of the inhouselegal department.2. All in-house legal departments must become more efficient - consider the LeanSix Sigma methodology.3. Bring outside counsel in-house by a combination of technology andcommunications shared through a managed legal provider program.4. Companies and their legal departments must develop a more global perspective.5. Insurance issues are becoming more prevalent and every company must have agood understanding of the law of the applicable country re coverage issues.March 6, 2015© 3-6-2015 ALFA InternationalO1166462.1

5 for the RoadWhere in the World?ALFA Goes Global To Collect JudgmentsEddy HayesLEAKE & ANDERSON, LLP,New Orleans, Mississippiehayes@leakeandersson.comAndrew BassakMANATT, PHELPS & PHILLIPS, LLP,San Francisco, Californiaabassak@manatt.comBrett CowellCOWELL CLARKE, Adelaide, Australiabcowell@cowellclarke.com.auGero SchneiderTIEFENBACHER, Heidelberg, Germanyschneider@tiefenbacher.de1. Arbitration awards are enforced in accordance with the New York Conventionon the Recognition and Enforcement of Foreign Arbitral Awards.2. The Foreign Judgment (Reciprocal Enforcement) Act 1933 applies betweenthe UK and Australia or Canada and the Administration of Justice Act 1920between Nigeria and the UK.3. There are EU Council Regulations in place which facilitate enforcement ofjudgments of EU member states in other member states.4. For uncontested claims a European Enforcement Order can be applied forwhich makes enforcements easier.5. If there are no treaties or other Regulations or Conventions about theenforcement of foreign judgments a new litigation process will have to initiated.March 5, 2015© 3-5-2015 ALFA International

5 for the RoadEarth, Wind and Fire – When it is not a Concert InvitationPlanning for a Catastrophic EventMark S. ScudderStrasburger & Price, LLP, Dallas, Texasmark.scudder@strasburger.comBrian P. McCarthyMcDowell, Knight, Roedder & Sledge, LLC, Mobile Alabamabmccarthy@mcdowellknight.com1. Identify and assess the risks to your business of catastrophic events through adedicated and proactive approach to risk management.2. Develop a written business continuity plan for responding to a catastrophic eventthat at a minimum identifies a plan for recovery, an alternative business location,a method for assessing vital records and resources, and the key people assignedto the recovery effort.3. Procure adequate insurance coverage for catastrophic events, includingbusiness interruption insurance and contingent business interruption insurance.4. Audit your suppliers and their suppliers to ensure they are prepared for acatastrophic event.5. Include a properly drafted force majeure clause in your contracts with vendorssuppliers, and customers to allocate risk of non-performance as a result of acatastrophic event.March 6, 2015© 3-6-2015 ALFA International

2015InternationalClientSeminarAUSTRALIAAUSTRIABRAZILCANADACHILECOLOMBIACOSTARICAALFAINTERNATIONAL2015INTERNATIONALCLIENTSEMINARAGUIDETO DOINGBUSINESSAROUNDTHEWORLDGHANAGUATEMALAIRELANDISRAELLUXEMBOURGMEXICONETHERLANDSNIGERIAPARAGUAYPOLANDROMANIASPAINTURKEYUNITEDKINGDOMGERMANYNEW ZEALAND

Aus t r a l i aDoi n g Business In Au s t r a l i aFrequently Asked Questions

TABLE OF CONTENTSINTRODUCTION ................................................................................................................... 1BUSINESS STRUCTURES ................................................................................................... 2Competition law ............................................................................................................ 3The Australian Prudential Regulatory Authority......................................................... 4EMPLOYMENT RELATIONS ................................................................................................ 5Overview of the Australian industrial relations system ............................................. 5Minimum conditions of employment ........................................................................... 5Contracts of employment ............................................................................................. 6Anti-discrimination........................................................................................................ 6Occupational health and safety legislation ................................................................. 6Workers’ compensation................................................................................................ 7Superannuation............................................................................................................. 7Taxation ......................................................................................................................... 7Termination of employment ......................................................................................... 7Summary........................................................................................................................ 7TAXATION ............................................................................................................................ 8Income tax, which includes capital gains tax.............................................................. 8Capital gains tax (“CGT”) for non-residents ............................................................. 10Other taxes .................................................................................................................. 10IMMIGRATION .................................................................................................................... 12General business visa options for non-Australian employees ................................ 12Business Visitor Visa Options ................................................................................... 12Temporary Business (Long Stay) Visa (Subclass 457) ............................................ 13Employer Nomination Scheme (sub-classes 856 and 121) ...................................... 14© COWELL CLARKE 2013. No part of this document may in any form or by any means be reproduced, stored ina retrieval system or transmitted without prior written consent.P950592_191.doc

- 2 -FOREIGN INVESTMENT REVIEW BOARD AND GENERAL FOREIGN INVESTMENTISSUES................................................................................................................................ 16Background to FIRB.................................................................................................... 16FIRB is advisory .......................................................................................................... 16Foreign acquisitions and investment in Australia .................................................... 16Approvals of acquisitions or transactions required under the Act ......................... 16Application of the Act to sensitive industry sectors ................................................ 17Free trade agreements (FTAs).................................................................................... 17DEALING WITH THE AUSTRALIAN GOVERNMENT ........................................................ 18Introduction ................................................................................................................. 18AUSFTA ....................................................................................................................... 18Opportunities............................................................................................................... 18Rules and Processes .................................................................................................. 19Challenging decisions ................................................................................................ 20More information......................................................................................................... 21DISPUTE RESOLUTION/COURT SYSTEMS...................................................................... 22Federal system............................................................................................................ 22Procedures and costs................................................................................................. 22Alternative dispute resolution.................................................................................... 23FOREIGN CORRUPT PRACTICES..................................................................................... 24Australia’s international obligations.......................................................................... 24Bribery of foreign public officials .............................................................................. 24Defences...................................................................................................................... 24Contravention of the Division .................................................................................... 25International reach of the Division............................................................................. 25Enforcement of legislation ......................................................................................... 25Conclusion .................................................................................................................. 26P950592_191.doc

CONTRIBUTORSCornwall Stodart, Melbourne, AustraliaJohn HutchingsTelephone: + 613 9608 2259Email: j.hutchings@cornwalls.com.au)Cowell Clarke, Adelaide, AustraliaBrett CowellTelephone: + 618 8228 1111Email: bcowell@cowellclarke.com.au)Meyer Vanderberg, Canberra, AustraliaArchie TsirimokosTelephone: +612 6279 4444Email: archie.tsirimokos@meyervandenberg.com.auTressCox, Sydney, AustraliaAlistair LittleTelephone: +612 9228 9217Email: Alistair_Little@tresscox.com.au)TressCox, Brisbane, AustraliaLeo HopsickTelephone: +617 3004 3535Email: leo_hopsick@tresscox.com.auP950592_191.doc

- 1 -INTRODUCTIONAustralia welcomes foreign investment. By international standards, most foreign citizenswishing to establish or invest in businesses in Australia can do so in a relatively straightforward manner. This document aims to provide a brief overview of some of the key legalconsiderations to be taken into account if you are considering investing in or establishinga business venture in Australia.This document has been prepared jointly by the Australian member firms of ALFAInternational, the Global Legal Network. The firms’ contact details are on the front of thisdocument. Please contact any of them if you require further information or assistancewith doing business in Australia.This document is current at September 2011.Please note that many of the laws referred to below are complex and the followingsummaries are very general in nature. This document is not legal advice. Please do notact in reliance upon it but always seek specific legal and other appropriate professionaladvice before taking action.P950592_191.doc

- 2 -BUSINESS STRUCTURESCowell ClarkeForeign citizens doing business in Australia can establish, own and carry on businessusing a variety of business structures. Those structures include:• Sole trader – an individual typically conducting a small business with a smallamount of capital investment.• Partnership – 2 or more individuals or entities carrying on business together witha view to sharing profits. Each partner is jointly and separately liable for theliabilities of the partnership business. Establishment of a limited partnership insome circumstances is possible but is not prevalent in Australia.• Joint venture – similar to a partnership but usually established for a particularproject. Joint ventures may be unincorporated or incorporated. The rights andliabilities of each joint venturer will depend upon the terms of the joint ventureagreement.• Trust – trading trusts are widely used in Australia and are commonly a form ofunit trust where the equity interests are units, which are similar to but distinctfrom shares in a company. Most trading trusts will have a corporate trustee.• Foreign company – a foreign company may apply to the Australian Securities &Investments Commission (“ASIC”), the body that regulates Australiancorporations, to be registered in Australia as a foreign company.Foreign companies may apply for listing as publicly traded entities. Almostinvariably such a listing would occur on the Australian Securities Exchange(“ASX”), which is the primary securities exchange in Australia. To be listed onASX, a company must comply with the ASX Listing Rules and with otherlegislative requirements, particularly those under the Corporations Act 2001,which is the principal (but certainly not the only) piece of legislation governingAustralian companies.A foreign company registered in Australia must have a registered office inAustralia and must appoint a local agent who will be responsible for ensuring thecompany complies with its legal obligations in Australia. As with almost all publiccompanies in Australia, the company will be required each year to lodge withASIC a copy of its financial accounts and to notify ASIC from time to timeregarding details of its structure including the provisions in its constitution and itsoffice holders.• Public company limited by shares – these companies have issued shares. Apublic company does not have a limit on its number of shareholders. It must havea registered office in Australia and at least 3 directors and at least 1 companysecretary. Two of the directors and the secretary must ordinarily reside inAustralia.P950592_191.doc

- 3 -Public companies are permitted to raise funds from the public, subject to certaindisclosure and compliance requirements being met. A public company may belisted on ASX.A public company is typically identified by the suffix “Limited” or the abbreviation“Ltd”.• A proprietary company limited by shares – this is the most common type ofcompany in Australia. A proprietary limited company may if it chooses, have justone corporate or individual shareholder holding 1 issued share. At the other endof the spectrum it can have no more than 50 non-employee shareholders plusadditional employee shareholders. Proprietary limited companies are not able toengage in public fundraising activities.It must have a registered office in Australia and at least 1 director who ordinarilyresides in Australia. The company need not have a company secretary but if itdoes, the secretary must ordinarily reside in Australia.A proprietary limited company is typically identified by the suffix “Pty Limited” or“Pty Ltd”.Where a trading trust structure is utilised, that trust will often have a proprietary limitedcompany as its trustee.Subject to some foreign investment regulation (see the section below on foreigninvestment), there is little regulation in Australia preventing ownership of Australianbusiness interests by foreign citizens, either directly or through interposed Australiancompanies or trading trusts.Most foreign citizens will establish an Australian business presence by acquiring theequity interests in an Australian company or by acquiring the business assets which theywill hold either directly or through an Australian company which they establish and own.Competition lawAustralian competition law is found predominantly in the Competition and Consumer Act2010 and a number of pieces of State legislation. The regulatory body is the AustralianCompetition & Consumer Commission. The Competition and Consumer Act seeks toprotect consumers and to promote fair trading and competition in trade and commerce inAustralia. Amongst other things, it prohibits:• most forms of restrictive pricing agreements;• the use of substantial market power by a party to deliberately damage acompetitor or exclude other businesses from the market;• mergers and acquisitions that have the effect or likely effect of substantiallylessening competition in the market;• misleading or deceptive conduct, frequently in the area of advertising orpromotion or misrepresentation about where products are made or their price,quality and performance;P950592_191.doc

- 4 -• unconscionable conduct in both consumer transactions and commercial dealings;• contraventions by a corporation of an applicable prescribed industry code ofconduct. The Franchising Code of Conduct is a typical example.The Australian Prudential Regulatory AuthorityThe Australian Prudential Regulatory Authority (“APRA”) sets standards and overseesregulation for the prudent management of banks and other deposit taking institutions,insurance companies and friendly societies to maximise the likelihood that they willremain financially sound and able to meet their obligations to depositors and policyholders.P950592_191.doc

- 5 -EMPLOYMENT RELATIONSCornwall StodartIn Australia, the terms and conditions of an individual’s employment are not limited totheir employment contract. Common law principles, legislation, industrial instruments(such as industrial awards and registered workplace agreements) and decisions ofindustrial tribunals all regulate the employment relationship.This paper covers some key employment issues faced by Australian employers in thedaily operation of their business (due to space constraints this summary is necessarilylimited to the major areas of concern to employers. There are additional areas ofemployment regulation that have not been covered in this section).Overview of the Australian industrial relations systemEmployment matters are governed by both state and federal legislation. Industrialtribunals are set up in each state (as well as federally) to regulate this legislation. Since 1January 2010, the predominant industrial relations system has been the federal one,with a system of Awards and 10 National Employment Standards (NES) that regulate theminimum terms and conditions of virtually all private sector employees.Minimum conditions of employmentThe key features of the federal system are the NES and Awards.In the federal system, statutory terms and conditions are prescribed by:• The NES – These comprise 10 employment standards that must be compliedwith in all circumstances. They apply to all national system employers and arenot negotiable. The standards cover hours of work, flexible workingarrangements, paid and unpaid leave (including parental leave, long serviceleave, annual leave, personal/carer’s leave, compassionate leave and communityservice leave), public holidays, notice of termination (generally and onredundancy) and information to be provided to an employee at thecommencement of their employment.• Awards cover a broad spectrum of industries, but only apply to employees whoseduties are covered by the work classifications in a particular Award. Determiningwhich Award applies and the appropriate classification can be a complexprocess. Awards set minimum terms and conditions in excess of the NES andprescribe the minimum wages for each work classification. Like the NES, Awardterms must be complied with. However, it is possible to vary the terms of anAward either through an Individual Flexibility Agreement or an EnterpriseAgreement (which would apply to all employees or a particular group ofemployees), provided that the employees are ‘Better Off Overall’. Depending onthe type of agreement used, it may need to be approved by Fair Work Australia(FWA) and have to comply with strict procedural requirements. Once approved,these agreements will override the Award. Making these agreements can be acomplex process and legal advice should be obtained.P950592_191.doc

- 6 -Employers are required to maintain time and wages records that are subject toinspection by unions (in limited circumstances) and the Fair Work Ombudsman.Employers must also provide employees with payslips that give certain statutoryinformation prior to the money being paid.The legislation contains a series of enforcement measures (including prosecutions forbreach of the legislation, Awards or enterprise agreements, fines and claims forunderpayment of wages), which can be taken by the Fair Work Ombudsman, individualsand unions. While prosecutions are generally undertaken and fines imposed on theemployer, in some circumstances they may be brought personally against its directorsand managers, if they have aided and abetted a breach.Contracts of employmentIn addition to the statutory regime, all employees are also covered by a contract ofemployment. While a contract of employment cannot override the statutory conditions,additional provisions may be included in a contract of employment to protect theemployer. These include a contractual notice period, the ability to suspend an employee,and provisions protecting confidential information, trade secrets, intellectual property andconduct post termination (including solicitation of business). Every employee shouldhave a written contractual provision for notice in order to avoid ‘reasonable notice’claims, which can result in pay in lieu of notice of between 1 month and 12 months beingpayable. For employees who are not covered by an Award (normally senior/managerialemployees), it is particularly important to have a written contract of employment,because apart from the NES, this will be the only document regulating the employee’sterms of employment.Anti-discriminationState and federal legislation prohibits a wide variety of discrimination and sexual andracial harassment in employment. The legislation also covers a range of othercontractual relationships including sub-contractors, the provision of goods and servicesand education.This is a complex and highly litigated area of law.Occupational health and safety legislationState and federal occupational health and safety legislation imposes a general (nondelegable) duty upon employers to provide a safe work environment and ensure thehealth and safety of employees, contractors, members of the public and volunteers. Abreach of the duty can result in, among other things, criminal prosecutions andsubstantial penalties. In some circumstances, not only can the employer be prosecuted,but a director and/or senior manager can also be personally liable.Recently a number of workplace bullying cases have received considerable publicity.Some states have made certain types of intentional bullying a criminal offence. Allemployers should have an anti-bullying policy and complaints procedure (incorporating atraining regime) in order to minimise the potential of this type of claim and the adverseimpact that bullying has in the workplace.P950592_191.doc

- 7 -Workers’ compensationAustralia has enacted protective legislation with respect to persons injured at work. Stateand federal legislation requires employers to maintain workers’ compensation insurancefor employees and other workers (including some contractors) who are deemedemployees for the purposes of the legislation. The insurance is intended to cover thecost of compensating an employee who is injured at work. While the general principles ofworkers’ compensation are the same, the actual legislative regime varies from state tostate and specific advice should be obtained relative to the state in which the injuredworker is located.SuperannuationEmployers must make compulsory superannuation (which is similar to a pension fund)contributions on behalf of their employees, or alternatively, pay a superannuationguarantee charge. The standard minimum superannuation rate is 9% but a number ofemployers have negotiated higher rates with their employees or unions.TaxationEmployers are required to deduct tax from employees’ wages and pay it to the AustralianTax Office. A similar requirement is also imposed on employers with respect to certaintypes of contractors who may be deemed employees for the purposes of the income taxlegislation.Termination of employmentTermination of employment is regulated by legislation, workplace agreements, commonlaw principles and employment contracts. These sources specify circumstances when anemployee can be terminated and how termination should be carried out. A variety ofclaims can result from a termination of employment, depending on whether the basis ofthe claim is statutory or contractual. This is a highly regulated and litigated area andspecific legal advice should always be obtained prior to terminating employment.SummaryEmployment relationships and workplace relations generally, are highly regulated inAustralia. In some industries, employees are very quick to litigate matters (particularly ifthe workforce is unionised). It is important that foreign investors taking on employmentobligations ascertain their rights and obligations as employers.. To minimise risk (notonly to a business but also to the directors and managers of a business), employersmust ensure they are aware of, and meet, their obligations to employees.P950592_191.doc

- 8 -TAXATIONCowell ClarkeIncome tax, which includes capital gains taxAustralia currently imposes income tax on the net income (i.e. gross income lessallowable deductions for expenses) plus realised capital gains of all business entitiesand individuals.A capital gain or capital loss is the difference between what it costs to acquire an assetand what is received on disposal of the asset. The taxable amount of a capital gain foran asset held for more than 12 months is calculated on 50% of the gain, except if anasset is owned by a company in which case no 50% discount is available. Capital gainsin respect of assets acquired prior to 20 September 1985 are generally not subject tocapital gains tax.Taxation of non-Australian residentsNon-resident companies, trusts and individuals are subject to Australian income tax onAustralian sourced income. Non-residents will generally be subject to Australian incometax on the same basis as residents and will be exempt from Australian tax on foreignsourced income. Different taxation implications may arise in relation to dividend, interestand certain royalty income and where a double tax agreement (DTA) (if one exists)between Australia and the relevant foreign jurisdiction provides otherwise. Australia hastax treaties with many countries in order to avoid double taxation and evasion and wherethe provisions of those treaties conflict with the Australian Income Tax Assessment Act,the provisions of the treaties generally prevail.A company will be considered an Australian resident for taxation purposes if it is:• incorporated in Australia, or• if not incorporated in Australia, carries on business in Australia and has either itscentral management and control in Australia, or it is controlled by Australianresident shareholders.Financing operationsCertain rules operate when the ratio of debt versus equity used to finance the Australianoperations exceeds specified limits (Thin Capitalisation rules). The Thin CapitalisationRules restrict the deductibility of finance expenses (e.g. interest) attributable to theAustralian operations of foreign multinational investors. These rules may apply to:• Australian entities that are foreign controlled and foreign entities that either investdirectly into Australia or operate a business through an Australian permanentestablishment; and• Australian entities that control foreign entities or operate a business throughoverseas permanent establishments and associate entitiesP950592_191.doc

- 9 -where interest of more than $250,000 in a financial year is claimed against Australianassessable income and the debt exceeds a permitted ratio of debt to foreign equity. Thepermissible ratio of debt to equity is generally 3:1. A ''foreign controller'' is one that has(either alone or with an associate) a 10% or more interest in the shares, voting rights ordividend entitlements of the Australian company, partnership or trust.Taxation of Financial ArrangementsNew legislation has been introduced reforming the taxation of financial arrangements.Simply put, it applies to:• business taxpayers with aggregated turnover of at least $100 million; and• arrangements to which a taxpayer has a right to receive, or an obligation toprovide, a financial benefit of a monetary nature.In effect, gains and losses from financial arrangements will be recognised over the life ofthe financial arrangements for tax purposes, irrespective of the traditional capital orrevenue considerations (generally, gains and losses from financial arrangements are onrevenue account).Sales between a foreign entity and an Australian entityThe transfer pricing provisions provide a legislative framework for dealing witharrangements under which profits are shifted out of Australia, primarily through themechanism of inter-company and intra-company transfer pricing. Examples of “internalprofit-shifting” include profit-shifting within the same enterprise, such as between a headoffice in one country and a permanent establishment (“PE”), or branch in anothercountry, or between PEs of the enterprise in different countries. The effect of transferpricing provisions is to ensure there is no manipulation of profits to be taxed in Australiaby depressing Australian assessable income or increasing allowable deductions inAustralia.Withholding taxesWithholding tax is imposed on certain payments from Australia to a foreign entity and islevied on the full amount of dividends, interest and certain royalties payable to nonresidentsat the following rates:• Dividends: 15% for most treaty countries and 30% for non-treaty countries,except for dividends that are fully franked (i.e. generally have borne tax) inAustralia which are not subject to withholding tax.• Interest: 10% on the gross amount of interest paid (ie without deductingexpenses incurred in deriving that interest, etc). With some exceptions, this rateis unaffected by Australia’s DTAs.• Royalties: 10% for most treaty countries and 30% for non-treaty countries.Financial year end and tax ratesAustralia’s financial year runs from 1 July to 30 June. Individuals and most businessentities operate on this financial year for accounting and taxation purposes.P950592_191.doc

- 10 -The rates of income tax for the year ending 30 June 2011 are:• Companies: Resident and Non-Resident are subject to a 30% flat rate.• Resident Individuals: From 1 July 2011 rates range from 15% to 45% dependingon the level of taxable income. The 45% rate presently applies to taxableincomes above AUD$180,000.• Non-Residents: Higher rates are applied in the case of non-residents althoughthe same top marginal rate of 45% is applied to taxable incomes aboveAUD$180,000.• Investment income, such as trust distributions and interest received by childrenunder 18 years of age, is effectively taxed at the top marginal rate of 45%.• Medicare levy: in addition to income tax, a Medicare levy of 1.5% is assessed onthe taxable income of residents that exceeds AUD$18,488. Medicare refers toAustralia’s national health system.• Flood Levy: In addition to income tax and Medicare levy, a temporary flood andcyclone reconstruction levy will apply to payments made from 1 July 2011 to 30June 2012 assessed at a rate of 0.5% on tax amounts between $50,000-$100,000 and 1% on tax amounts in excess of $100,000.• Fringe Benefits Tax (FBT): employers are also subject to a fringe benefits tax atthe rate of 46.5% on non-cash benefits provided to employees such as privateuse of motor vehicles and interest free housing loans.Capital gains tax (“CGT”) for non-residentsForeign residents are subject to CGT in Australia, generally where a capital gain is madeon certain specified assets. The specified assets are referred to as “taxable Australianproperty.” Broadly this means direct or indirect interests in land in Australia, andbusiness assets of an Australian permanent establishment. For land acquisitions inAustralia by non-residents, prior specific tax advice should be obtained about theappropriate structure.Other taxesGoods & Services Tax (“GST”) is a broad consumption tax imposed at the rate of 10%on most goods and services transactions in Australia. It is similar to a value added tax,rather than a sales tax, in that it is generally refunded to all parties in the chain ofproduction other than the final consumer.Payroll Tax: is imposed by the States and Territories on business payrolls at ratesvarying from 4.75% to 6.85% with concessions and exemptions for businesses withsmall payrolls.Stamp Duty: is payable to State and Territory Governments on a variety of documentsand transactions including transfers of real estate interests, mortgages and a range ofpersonal property. The rate may be up to 5.5% of the value of an asset.P950592_191.doc

- 11 -Land Tax: is charged annually by State and Territory Governments on the value of landowned, with exemptions in relation to land owned and used as one’s principal residence.Death, Estate & Gift Duties: currently there are no such taxes in Australia. However,some caution needs to be exercised as capital gains tax can apply to certain gifts.P950592_191.doc

- 12 -IMMIGRATIONTressCoxGeneral business visa options for non-Australian employeesThere are various visa options available for business travel to Australia. The appropriatetype of visa will depend on the intended purpose and length of stay:• Short term business visas for visits to Australia for up to three months without theright to work in Australia;• Temporary long stay visas for up to four years which allow the visa holder to workin Australia (sub-class 457);• Employer Nomination Scheme visas for migration to Australia on a permanentbasis (sub-classes 856 and 121).The following is a summary of the main requirements of each of these types of visas.Please note that these requirements frequently change and are current as at July 2011.Professional advice from a registered migration agent should be sought before applyingfor a visa in individual cases.Business Visitor Visa OptionsBusiness visitor visas allow the visa holder to remain in Australia for a period notexceeding three months for business purposes, such as attending a conference, trainingsession or conducting business negotiations. The holder of a business visitor visa mustnot engage in studies or training for more than three months, undertake work that can bedone by an Australian citizen or permanent resident; or work in Australia.There are four different types of Business visitor visas.1. Electronic Travel Authority (ETA) (Subclass 956 and 977) and eVisitor (Subclass651)The ETA and eVisitor visas are electronic visas which are applied for via theinternet by the visa applicant, travel agent or airline. To be eligible for an ETA oreVisitor visa, the visa applicant must be outside Australia at the time the visa isapplied for and hold a passport of an ETA or eVisitor eligible country.2. Business Short Stay (Subclass 456) visaAll passport holders who want to visit Australia for business purposes may applyfor this visa option. Application is made by lodging a paper form with the relevantAustralian mission.Generally this type of visa does not give a right to work except in limitedcircumstances. For example, work may be allowed if it is highly specialised andnon-ongoing; for a period of less than six weeks.P950592_191.doc

- 13 -3. APEC Business Travel CardThe APEC Business Travel Card allows business people to make multiple shortterm visits to other APEC economies over a three year period. This scheme hasmany significant benefits including:3.1 only requiring a single application form,3.2 business people do not have to apply for individual visas or entry permitseach time they wish to travel for business; and3.3 cardholders are able to access fast track immigration processing lanes atmajor airports in participating economies.All APEC countries (except for Canada, the Russian Federation and the UnitedStates of America) fully participate in the APEC Business Travel Card scheme.Temporary Business (Long Stay) Visa (Subclass 457)The sub-class 457 visa is designed to assist Australian employers in addressing labourshortages, where an appropriately skilled Australian is not available, by employinggenuinely skilled workers from overseas. Also, overseas employers not carrying onbusiness in Australia can deploy their employees to work in Australia for the purposes ofestablishing business or fulfilling contractual obligations. Once granted, the visa allowsthe employee (and any dependant of the employee included in the application) to remainand work in Australia for up to 4 years.The following requirements must be met when sponsoring an employee under a subclass457 visa:1. SponsorshipThe employer must:1.1 be lawfully operating a business either inside or outside of Australia,1.2 meet the prescribed training benchmark, if operating a business inAustralia,1.3 attest that the employer has a strong commitment to employing locallabour and non-discriminatory work practices if operating a business inAustralia; and1.4 give certain undertakings to the Australian government.Once approved as a standard business sponsor, the employer is able tonominate an unlimited number of sub-class 457 visa applicants for a period of 3years.P950592_191.doc

- 14 -2. NominationThe employer must nominate the position to be filled. This requires the proposedposition to be on a gazetted list of occupations permitted for sub-class 457 visasat the time of application.The position must provide no less favourable terms and conditions ofemployment to the nominee than an equivalent Australian employee would havein the same location. This includes the requirement that the salary of theposition be at market rate based on sources such as salaries of Australianemployees in the same business, industrial instruments/awards and salarysurveys.3. Visa applicationThe employee who is to fill the nominated position must demonstrate that s/hehas the relevant qualifications and employment experience to meet therequirements of the position. Further, the employee (and any dependant familymembers of the employee) must meet certain character requirements andundergo a health check. Visa applicants must also make adequatearrangements for health insurance during the period of their intended stay.If granted, a sub-class 457 visa allows the employee to remain and work in Australia forup to 4 years subject to certain conditions, including condition 8107 which requires theholder of a sub-class 457 visa to:• work in the occupation for which they were nominated;• work for the sponsor, or an associated entity of the sponsor, who nominated theposition they are working in; and• not cease employment for a period of more than 28 consecutive days.In the event that the employment of the employee with the sponsor is terminated, thesponsor must inform the Department of Immigration within 10 days of the date oftermination. Unless the employee can apply for a new visa or find a new sponsor, theemployees’ sub-class 457 will be cancelled.Employer Nomination Scheme (sub-classes 856 and 121)The Employer Nomination Scheme (ENS) enables an Australian employer to recruit, ona permanent basis, highly skilled staff from overseas or temporary residents currently inAustralia, when they are unable to fill a vacancy from within the Australian labour market.The ENS process consists of two stages; nomination by the employer and the nominee’sapplication for a visa.The criteria to be met by the employer are generally similar to those for a sponsor undera sub-class 457 visa, with some differences with respect to training and salaryrequirements. The employer must offer the nominated employee a position for at least 3years, which does not exclude the possibility of renewal.The visa applicant must fulfil one of the following three sets of criteria:P950592_191.doc

- 15 -1. 1.1 the visa applicant’s skills have been assessed as suitable by the relevantassessment authority for the occupation to which the appointment relatesand1.2 unless exceptional circumstances apply, the applicant has beenemployed in the occupation to which the appointment relates, for at least3 years before making the application, or2. the visa applicant must be nominated to fill a position that attracts a base salaryin excess of $250,000.00 per annum (excluding superannuation or allowances);or3. the visa applicant:3.1 holds a visa of a specified sub-class (including but not limited to a subclass457 visa) and3.2 has worked full-time in the occupation to which the appointment relates inAustralia, while holding an appropriate visa, for at least a period of 2years immediately before making the application and3.3 has worked full-time for the nominating employer in the occupation towhich the appointment relates while holding an appropriate visa for atleast 12 months immediately before making the application.Further, an applicant must be under 45 years of age, have vocational English and meetthe mandatory health and character requirements. There are exceptions to theserequirements.Once the ENS visa is approved, the employee has the right to live and work in Australiaon a permanent basis. The visa remains valid even if employment of the employee withthe sponsor is later terminated.P950592_191.doc

- 16 -FOREIGN INVESTMENT REVIEW BOARDAND GENERAL FOREIGN INVESTMENT ISSUESCornwall StodartBackground to FIRBThe Foreign Investment Review Board (FIRB) is a non-statutory body established toadvise the federal government on foreign investment policy and its administration. Thepurpose of FIRB is to examine any proposal by foreign persons and governments toundertake direct investment in Australia (Proposal). FIRB then makes recommendationsto the government on whether such Proposals are suitable for approval under thegovernment’s policy.FIRB is advisoryFIRB provides only an advisory service to the federal government. It is the responsibilityof the federal Treasurer to decide on Proposals and the Treasurer is not obliged toaccept FIRB’s advice in making that decision.Foreign acquisitions and investment in AustraliaThe legal framework for foreign investment matters considered by FIRB is outlined in theForeign Acquisitions and Takeovers Act 1975 (FATA or Act). FATA regulates foreignpersons buying certain land interests, acquiring control of certain business enterprises,or acquiring mineral rights in Australia.Foreign governments and foreign persons proposing to invest in Australia may need toobtain prior approval before making a direct investment in Australia. Different monetarythresholds apply to US and New Zealand investors.Approvals of acquisitions or transactions required under the ActThe following Proposals require the prior approval of the Treasurer:• acquisitions of substantial interests in Australian businesses with total assets of$248 million or more ($1078 million for US and NZ investors) or if the Proposalvalues the business at $248 million or more ($1078 million for US and NZinvestors);• takeovers of offshore companies whose Australian subsidiaries or assets arevalued at $248 million or more ($1078 million for US and NZ investors), oraccount for more than 50 per cent of the Target’s global assets;• direct investments of any nature by foreign governments or their agenciesirrespective of size;• acquisitions of interests in Australian urban land (including interests that arise vialeases, financing and profit sharing arrangements and the acquisition of interestsin urban land corporations and trusts) that involve:P950592_191.doc

- 17 -oooooothe acquisition of developed commercial real estate (eg hotels or motels),where the property is subject to heritage listing, valued at $5 million ormore;the acquisition of developed commercial real estate, where the property isnot subject to heritage listing, valued at $54 million or more ($1078 millionfor US and NZ investors);the acquisition of accommodation facilities irrespective of value;the acquisition of vacant urban land irrespective of value;the acquisition of residential land irrespective of value; orproposals where any doubt exists as to whether they are notifiable (forexample, funding arrangements that include debt instruments havingquasi-equity characteristics will be treated as direct foreign investment).• acquisitions of interests in Australian rural land (land wholly and exclusively usedfor primary production) valued at $248 million or more ($1078 million for US andNZ investors).Application of the Act to sensitive industry sectorsSensitive industry sectors have different regulatory and approval requirements forProposals. Those sectors include media, telecommunications, transport, military trainingmanufacture or supply, and security technologies. Any Proposal in a particular industrysector should be examined on a case by case basis and compared against FIRBguidelines and the Treasurer’s current policy. For US and NZ investors, acquisitions ofinterests in Australian businesses in defined sensitive sectors do not require notificationunless the value of the interest to be acquired exceeds $248 million.Free trade agreements (FTAs)The Australia-United States Free Trade Agreement came into effect on 1 January 2005and modified Australia’s foreign investment policy as it applies to United Statesinvestors, making it easier for investors to invest in Australia and generally easingrestrictions on trade in those countries. Australia also has FTAs with Singapore(operational from 28 July 2003) and Thailand (operational from 1 January 2005) and hasscoping studies underway for FTAs with ASEAN and New Zealand, Malaysia and China.More recently, New Zealand investors can now benefit from the increased FIRBacquisition threshold values which previously only applied to United Stated investors.This policy was foreshadowed by the investment protocol to the Australia-New ZealandCloser Economic Relations Trade Agreement which was signed by both counties on 16February 2011. The changes are incorporated in FIRB’s updated foreign investmentpolicy which was released on 1 March 2013.More recently, an investment protocol to the Australia-New Zealand Closer EconomicRelations Trade Agreement was signed on 16 February 2011, but has yet to come intoforce at the date of this publication. Once implemented, the investment protocol will allowNew Zealand investors to benefit from the increased e FIRB acquisition and transactionthreshold values which currently apply to United States investors.P950592_191.doc

- 18 -DEALING WITH THE AUSTRALIAN GOVERNMENTMeyer VandenbergIntroductionThe Australian Federal Government is one of Australia’s largest purchasers, contractingto procure goods and services in the sum of over $42 billion annually.The core principle of the Australian Government Procurement Framework is to ensurethat the Australian Government achieves “value for money”. There are more than 120Australian Government departments, agencies, authorities and companies subject to thisframework. For most products and services there is no single ‘government market’, asmany agencies operate individually.Value for money is considered by the Australian Government as best achieved byadopting appropriately competitive and non-discriminatory procurement processes.Australian Government officials are required to buy goods and services in an ethical,accountable and transparent manner. They must not seek gifts or other favours frompotential suppliers, and are required to follow procedures and protocols designed toensure a fair and consistent approach to procurement activities.When selling to the Australian Government it is important that suppliers understand thecustomer, the associated rules and processes, and how to watch for opportunities. Anoverview of these matters is set out below.AUSFTAThe Australia-United States Free Trade Agreement (AUSFTA) resulted in Australian andUS businesses being granted non-discriminatory rights to bid on contracts to supplyAustralian Government entities, including all major procuring entities and administrativeand public bodies. Australia’s procurement policies largely emanated from thisagreement and benefit suppliers throughout the world.Chapter Fifteen of the AUSFTA provides comprehensive obligations requiring eachcountry to apply fair and transparent procurement procedures and rules and prohibitingeach from discriminating against suppliers from the other country. It establishes a basicrule of “national treatment”, meaning that each country’s procurement rules must treatthe other country’s suppliers in a manner that is “no less favourable” than their domesticcounterparts. The Chapter also bars discrimination against locally established supplierson the basis of foreign affiliation or ownership and provides rules aimed at ensuring a fairand transparent procurement process.OpportunitiesOverseas suppliers can access information about opportunities to supply to theAustralian Government on “AusTender”. See www.tenders.gov.auAusTender provides centralised publication of Australian Government businessopportunities, annual procurement plans, multi-use lists and contracts awarded.P950592_191.doc

- 19 -AusTender’s subscription service allows anyone to register the area of their businessinterest and receive free automatic email notifications of the latest opportunities as theyare advertised. It also allows suppliers to lodge tender responses online.Another avenue to government which may be of particular interest to internationalsuppliers is the Defence Unsolicited Proposals Gateway. The Department of Defencereceives many ‘unsolicited proposals’ from industry due to its unique businessrequirements. These proposals may range from small, off-the-shelf supply items to morecomplex capability solutions. Defence has therefore established this gateway to providea single entry point for businesses and individuals to submit their proposals to Defence.See http://www.defence.gov.au/dmo/id/ic/dupg.cfm.Rules and ProcessesThe major Australian Government agencies (but not all) are governed by the FinancialManagement and Accountability Act 1997 (Cth) (FMA Act). The FMA Act sets out theframework for the proper management of public money and public property by theExecutive arm of the Australian Government. The regulations under the FMA Act requiregovernment officials to comply with the the Australian Government’s “CommonwealthProcurement Guidelines” (CPGs). There are also a number of Australian Governmentbodies governed by the Commonwealth Authorities and Companies Act 1997 (Cth).These bodies are also subject to the CPGs but to a lesser degree as they do not tend toengage in substantial purchases. These requirements can be accessed on theDepartment of Finance and Deregulation’s website www.finance.gov.au.The CPGs articulate the Australian Government’s procurement policy in detail with thecore principle underpinning all activities being “value for money”. The CPGs explain howvalue for money is to be achieved through encouraging competition (nationally andinternationally) promoting the efficient, effective and ethical use of resources andensuring that Australian Government bodies act in an accountable and transparent way.The CPGs include a set of mandatory procurement procedures which must be followedwhen the value of the property or services being purchased exceeds the thresholds setby the Australian Government. These mandatory procurement procedures essentiallyrequire agencies to advertise the opportunity to the world (i.e. conduct an “open tender”process) unless specific circumstances apply. The threshold for all non-constructionprocurements is $80,000 for FMA Act agencies and $400,000 for CAC Act agencies.The threshold for procurements of construction services is $9 million for all agencies.Where the value of goods or services sought is below the threshold, agencies have moreflexibility to decide on a procurement process appropriate to the scale, scope andrelative risk of the proposed procurement. This may be an over-the-counter purchase, alimited invitation to one or more suppliers for oral or written quotes, an approach to themarket through limited invitations to tender, or a public approach to the market throughan open tender process.As a consequence of the CPGs, many Australian Government agencies have set uptheir own “panel arrangements”. A panel is an arrangement established through an opentender process, under which multiple suppliers are selected to supply agreed goods andservices and enter into a “deed of standing offer” with the agency. Panels are anattractive option for many agencies because the open tender process only needs to becarried out once every few years to test the market and to establish the panel. Theagency may then purchase directly from suppliers on the panel, as required. TypicalP950592_191.doc

- 20 -services provided through panels include legal, accountancy, human resources, buildingand maintenance and design services.Most Australian Government Agencies conduct purchasing decisions on an individualbasis. However, for some goods and services, the Australian Government has managedto enter into “cooperative” arrangements where agencies group together in a singleapproach to the market (often described as “clustering”). This aims to enable theAustralian Government to achieve better terms commensurate with the aggregated valueof its participation in a particular market sector. It also aims to create efficiencies foragencies and for potential suppliers including through a reduced number of approachesto the market. In Australia these arrangements have been used for the purchase ofinformation and communications technology services with various degrees of success.The other form of cooperative procurement is where one agency approaches the marketbut signals its intention to allow other agencies to join the contractual arrangement at alater date (described as “piggybacking”), for the property or services specified in theapproach to the market.Until recently, Australian law firms have needed to tender for each AustralianGovernment agency panel. This onerous and costly process has led to theestablishment of a multi-use list for legal services which can be utilised by all AustralianGovernment Agencies.In addition to the CPGs, each agency has a set of Chief Executive Instructions (CEIs),which outline, in broad terms, the duties and responsibilities of all officials involved infinancial management in a department including procurement activities.CEIs provide additional mechanisms for Chief Executives of FMA Act agencies to applythe key principles and requirements of the financial management framework to theiroperations.The Department of Defence has an extensive manual detailing its procurement policiescalled the Defence Procurement Policy Manual. Seewww.defence.gov.au/dmo/gc/dppm.cfm.Challenging decisionsA supplier who is unhappy with a tender process or decision, should first ask for adebrief. The CPGs require agencies to offer debriefing sessions to unsuccessfultenderers as a matter of course. If not, agencies will provide debriefings on request. Theprimary purpose of a debriefing is to enable potential suppliers to submit morecompetitive bids in the future and can be a valuable source of information on thestrengths and weaknesses of the suppliers tender. Comparative aspects of the winningoffer, or any other offer, cannot be discussed. The purpose of a debriefing session is notto justify the selection of the successful tenderer, rather it is to give feedback on thesuppliers response.Unsuccessful tenderers also have other avenues of complaint other than courts, such asthe Commonwealth Ombudsman and the Australian National Audit Office.Chapter 15 of the AUSFTA requires both Australia and the United States to havemechanisms in place whereby unsuccessful tenderers who complain about the conductof a tender process can obtain timely and impartial consideration of their complaint,P950592_191.doc

- 21 -including that each party must have at least one impartial administrative or judicialauthority that is independent from its procuring entities to receive and review challengesthat suppliers submit in accordance with domestic law (Article 15.11). Despite what wasagreed, Australia does not have an efficient and effective system of challenging tenderprocesses judicially. Whilst breaches of the financial management framework, includingin relation to procurement, may attract a range of criminal, civil or administrativeremedies, the process of challenging tender processes in court is quite difficult.More informationFor more information concerning Australia’s procurement processes, see theDepartment of Finance and Deregulation website. www.finance.gov.au.P950592_191.doc

- 22 -DISPUTE RESOLUTION/COURT SYSTEMSCowell ClarkeFederal systemAustralia has a sophisticated court system which reflects Australia’s constitutionalstructure as a federation. Each of Australia’s 6 States and 2 Territories has its own Stateor Territory Supreme Court and inferior courts. The Commonwealth of Australia also hascourts including the High Court of Australia, the Federal Court of Australia and theFamily Court of Australia. The High Court of Australia is the ultimate court of appeal forAustralian cases and is the court of first instance for determination of disputesconcerning the Commonwealth constitution.Australia’s legal system is a common law system, operating on principles derivedoriginally from English law. Most areas of business, however, are also regulated byCommonwealth, State and/or Territory statutes.State and Territory courts are able to exercise Commonwealth jurisdiction in someareas. For example, corporations and securities law is governed by Commonwealthlegislation, but litigation concerning corporations and securities disputes can becommenced in either the Federal Court of Australia or in State or Territory Supremecourts.Other areas of importance to business, such as employment and occupational healthand safety are dealt with under a combination of Commonwealth and State/Territorylaws. Since some State/Territory courts can exercise Commonwealth and State/Territoryjurisdiction, the choice of the most suitable court in which to initiate litigation can be animportant tactical decision.The States and Territories also has civil administrative tribunals which exercise a rangeof jurisdictions covering matters such as administrative law, planning, building, consumerdisputes, some employment related disputes and some debt claims. The jurisdictionsvary from state to state and in many instances, legislation dictates that disputes of acertain nature must be brought in a tribunal.Procedures and costsThe great majority of litigated business related disputes in Australia are heard by a judgealone without a jury. It is only criminal and (in some states) defamation matters which arenow typically tried before a jury and even then, parties can opt for trial by judge alone inthose types of matters.Representative class actions are permissible in Australia and are increasingly popular,especially, broadly speaking, in medical negligence cases and in shareholder claimsagainst corporations and their directors. However, to date, the track record forsuccessful class action claims is relatively limited.P950592_191.doc

- 23 -Exemplary or punitive damages are not frequently awarded by Australian courts. It isgenerally only in cases of particularly egregious or contumacious breaches or acts ofnegligence that courts will award exemplary damages.While a number of plaintiff law firms offer “no win/no fee” costs arrangements, litigationon a contingency basis, in which the plaintiff’s lawyer is remunerated by reference to apercentage of the damages awarded in favour of the plaintiff, is not permitted inAustralia.In most jurisdictions, the “loser pays” principle applies in relation to recovery of legalcosts. There are some exceptions where costs are not awarded in favour of thesuccessful party. The tribunals referred to above typically do not make costs awards sothat parties are left to bear their own costs.Alternative dispute resolutionAlternative dispute resolution methods have been well utilised in Australia and manycommercial contracts will include ADR clauses.For many years mediation has been a frequently used method of ADR in business andprivate matters and many Australian courts build in a compulsory, or court supervised,mediation process before a proceeding can be set down for trial.Australia also has a well developed arbitration system and promotes itself as a regionalcentre for international arbitration. Australia is a signatory to the New York Convention.Resolution of a dispute by arbitration may be nominated in an ADR clause where adispute is likely to involve parties from different jurisdictions, due to the cross borderenforcement procedures for arbitral awards which are available in countries which aresignatories to the New York Convention.P950592_191.doc

- 24 -FOREIGN CORRUPT PRACTICESCowell ClarkeAustralia’s international obligationsAustralia is a signatory to the OECD Convention on Combating Bribery of Foreign PublicOfficials in International Business Transactions (the Convention). The essence of theConvention is to encourage each signatory state to enact legislation necessary tocriminalise the bribing of foreign public officials.Australia adopted the Convention in 1999. The relevant legislative provisions are in theCriminal Code Amendment (Bribery of Foreign Public Officials) Act 1999 (Cth) (theCode), often referred to as the Bribery Act.Bribery of foreign public officialsDivision 70.2 (the Division) of the Code provides that a person (which includes a bodycorporate) is guilty of an offence if that person:• promises, provides or causes to provide or offer a benefit;• which is not legitimately due;• with the intention of influencing another person, which may be a foreign publicofficial (foreign official);• in order to obtain or retain business or a business advantage that is notlegitimately due.The person will be guilty of an offence even if the other person is not a foreign official. Allthat is needed to trigger the provision is an intention to influence a foreign official.A foreign official is defined in the Code and includes an employee or official of a foreigngovernment body; a member of the executive, legislature or judiciary of a foreigncountry; or an employee of a public international organisation in which 2 or morecountries are members – such as a United Nations body or the Red Cross.DefencesA person will not be guilty of an offence if the benefit conferred on or offered to theforeign official is required or permitted by the written law of the foreign official’s country.A person seeking to rely upon this defence has the onus of proving that written law.Further, a person will not be guilty of an offence if the benefit conferred on or offered tothe foreign official is appropriately characterised as a facilitation payment. Pursuant tothe Code, a benefit will be classified as ‘facilitation’ if the benefit offered or given to theofficial is of a minor nature and is given with the intention of expediting or securing theperformance of a minor routine government action. Practically speaking, the actionshould be one which would have to be done in any case and the facilitation paymentexpedites its doing. If there is an official published government list of fees for theparticular matter that specifically includes a fee for expediting a matter, that will help.P950592_191.doc

- 25 -Routine government action is defined in the Code and expressly excludes encouraging adecision: about whether to award or continue business with a particular person; or theterms of new or existing business arrangements. Thus any payment conferred with theintention of obtaining or retaining business will not qualify for the defence.Once the payment is made (assuming it falls within the ambit of ‘routine governmentaction’), the person who has offered or given the benefit must appropriately record allrelevant details as prescribed by the Code. The record must be retained by the person:unless and until 7 years have passed since the alleged conduct; or through no fault ofthe person, the record has been lost or destroyed.Contravention of the DivisionA person who breaches the Division and cannot make out a statutory defence will beguilty of an offence. The extent of penalties imposed will depend on whether anindividual or corporation has contravened the Division.Contravention by an individual is punishable by imprisonment for not more than 10years; a fine not more than 10,000 penalty units (AUD1,100,000 at the date of thisarticle); or both.A contravention by a corporation is punishable by not more than the greatest of thefollowing:• 100,000 penalty units (AUD11,000,000 at the date of this article);• If the Court can determine the value of the benefit that the body corporate, andany related body, have obtained directly or indirectly and that is reasonablyattributable to the conduct constituting the offence – 3 times the value of thatbenefit;• If the Court cannot determine the value of the benefit – 10% of the annualturnover of the body corporate during the period of 12 months ending at the endof the month in which the conduct constituting the offence occurred.International reach of the DivisionThe Division applies to any person where the conduct constituting the alleged offenceoccurs wholly or partly in Australia. The Division will also apply to conduct occurringwholly outside Australia where at the time of the alleged conduct: the person was anAustralian citizen or resident or in the case of a body corporate; was incorporated by orunder a law of the Commonwealth or of an Australian State or Territory. Foreigndirectors of an Australian company who condone or permit the company to contravenethe Code will be at risk of prosecution.Enforcement of legislationThe Australian Federal Police is the enforcement authority of the Code. Since beingenacted, there have been no convictions for a breach of the Code. Thus, the precisejudicial bite and scope of the Division is yet to be determined. Although no convictionshave yet been recorded, the recent bribery convictions of Rio Tinto executives in Chinaand the AWB scandal have however increased awareness of foreign bribery. Theenormous penalties imposed on companies and individuals under the United StatesP950592_191.doc

- 26 -Foreign Corrupt Practices Act in recent years have been well noted in Australian boardrooms.ConclusionIndividuals and corporations must ensure they comply with the Division when transactingbusiness or proposing to deal with foreign officials. Companies will be liable for theactions of their overseas employees and also potentially their agents. Those breachingthe Code risk incurring significant imprisonment, monetary penalties and reputationaldamage. The Australian government and many international organisations, such as theWorld Bank and the major international funding agencies have strict anti-corruptionpolicies. Breaches of those policies may lead to sanctions including black listing forfuture tenders or contracts.Companies doing business in Australia should implement anti-corruption policies andimplement on-going training for their personnel.P950592_191.doc

www.alfainternational.com

LAW OFFICESDR. F. SCHWANKVIENNAYOUR PARTNER IN THE HEART OFEUROPEESSENTIALBUSINESS GUIDE FORFOREIGN INVESTORSIN AUSTRIAWWW..SCHWANK..COMANFIRM

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AUTHORS:Friedrich Schwank, Dr. iur.(Univ. Innsbruck, 1972)Austrian AdvocateMerran Loewenthal, LL.B.(Univ. Syd. 1973)SolicitorThis guide represents the law of Austria as at 1st April 2013However it is a guide only and does not replace professional legaland tax advice- 3 -

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TABLE OF CONTENTS ::IntroductionEssentials For Foreign Investors ____________________________________ 91. Foreign Environment ____________________________________________________ 92. Unusual Corporate Structure _____________________________________________ 93. More than Taxes ______________________________________________________ 104. Cover Your Back ______________________________________________________ 105. Lost in Labour ________________________________________________________ 106. For better or worse ____________________________________________________ 117. Information is Value ___________________________________________________ 11Chapter OneDo’s and Don’ts For Foreign Investors ______________________________ 13I Introduction __________________________________________________________ 13II Representative Office __________________________________________________ 13III Branch of a foreign company ____________________________________________ 14IV Commercial Agents ____________________________________________________ 14V Distributorship ________________________________________________________ 15VI Joint Venture _________________________________________________________ 15Chapter TwoCorporate Structures ____________________________________________ 17I Corporate Vehicles for Foreign Investors ___________________________________ 17II Basic principles of Austrian companies ____________________________________ 17III The Limited Liability Company (GmbH) ____________________________________ 18IV Joint Stock Corporation (AG) ____________________________________________ 20Chapter ThreeTax Planning __________________________________________________ 23I Attitude of Fiscal Authorities - In General __________________________________ 23II Subsidiaries in Foreign Jurisdictions _______________________________________ 23i Zero Tax Jurisdictions _________________________________________________ 23- 5 -

ii Low-Tax Jurisdictions _________________________________________________ 23iii Jurisdictions That Exempt Foreign-Source Income __________________________ 23ivvviJurisdictions That Grant Tax Incentives to Offshore and Qualified Holding Companies___________________________________________________________________ 24Jurisdictions That Provide Tax Exemptions for Manufacturing and Processing Exports___________________________________________________________________ 24Jurisdictions That Provide Tax Reductions for International Companies with PrivilegedOffshore Financial Status ______________________________________________ 24III Tax Treaty Regime ____________________________________________________ 24In General ______________________________________________________________ 24i Characteristic Provisions and Treatment __________________________________ 24ii Taxes covered _______________________________________________________ 25iii Exchange of Information _______________________________________________ 25iv Assistance in Collections _______________________________________________ 25IV Treaty Shopping ______________________________________________________ 26i Treaty Shopping Defined ______________________________________________ 26ii Impact of Treaty Shopping on Tax Relief __________________________________ 26iii Administrative and Judicial Response to Treaty Shopping _____________________ 26iv Treaty Limitations on Treaty Shopping ____________________________________ 26v Treatment of Inbound Treaty Shopping ___________________________________ 26vi Treatment of Outbound Treaty Shopping _________________________________ 26V Treatment of Offshore Transactions ______________________________________ 26i Tax-Haven Legislation _________________________________________________ 26VI Strategic Corporate Tax Planning _________________________________________ 27i Holding Structures ____________________________________________________ 27ii Commissionaire Structures _____________________________________________ 28iii International Holdings _________________________________________________ 28iv Rulings in Advance ___________________________________________________ 28v EU Parent Subsidiary Directive __________________________________________ 28VII Group Taxation _______________________________________________________ 28Austria’s Double Taxation Treaties ___________________________________________ 31Chapter FourProtect your Know-How and IP____________________________________ 35I Introduction __________________________________________________________ 35II Competition Law ______________________________________________________ 35III Trademark Act ________________________________________________________ 35IV Registered Design Protection ____________________________________________ 36V Patent Law __________________________________________________________ 37VI Industrial Designs Protection ____________________________________________ 39- 6 -

VII Semiconductor Chip Design Protection ____________________________________ 40VIII Copyright Law ________________________________________________________ 40IX Domain Names _______________________________________________________ 41Chapter FiveLabour and Employment _________________________________________ 43I Introduction __________________________________________________________ 43II Contract of Employment ________________________________________________ 43i Form ______________________________________________________________ 43ii Hiring ______________________________________________________________ 43iii Contents ___________________________________________________________ 44iv Foreign Employees ___________________________________________________ 48III Termination of Employment _____________________________________________ 48i General ____________________________________________________________ 48ii Termination Without Notice ____________________________________________ 50iii Termination With Notice _______________________________________________ 53iv Legal Consequences for Employer and Employee on Termination ______________ 54v Special Provisions relating to Plant Closures, Cutbacks etc ____________________ 56vi Provisions upon Takeover of a Business ___________________________________ 57vii Foreign Employees ___________________________________________________ 57IV Equal Pay ____________________________________________________________ 57V Discrimination ________________________________________________________ 57VI The Right to Strike ____________________________________________________ 58VII Trade Unions _________________________________________________________ 58i The Role of Trade Unions ______________________________________________ 58ii Special Treatment of Trade Unions ______________________________________ 59VIII Arbitration/Conciliation _________________________________________________ 59IX Workers’ Participation in Management _____________________________________ 59Chapter SixPensions and Superannuation _____________________________________ 61I State Pension ________________________________________________________ 61i Pension Authorities ___________________________________________________ 61ii Contributions ________________________________________________________ 61iii Amount of Pension ___________________________________________________ 61iv Right to Pension _____________________________________________________ 61v Treaties ____________________________________________________________ 62II Private Pension Arrangements/Superannuation _____________________________ 62- 7 -

i Restrictions on who may set up a Non-state Pension ________________________ 62ii Forms of Pension Arrangements _________________________________________ 63iii Legal Structure ______________________________________________________ 63iv Registration Requirements _____________________________________________ 63v Types of Investments _________________________________________________ 63vi Minimum or Maximum Funding Requirements ______________________________ 64vii Favourable Tax Treatment _____________________________________________ 64viii Insurance Requirements _______________________________________________ 64ix Surplus of Assets _____________________________________________________ 65x Pension Aspects of purchasing or selling Businesses _________________________ 65xi Additional Advisers ___________________________________________________ 65- 8 -

- INTRODUCT IION -ESSENTIALS FOR FOREIGN INVESTORSAny enterprise or investor making an investment or setting up business abroad is a target formany suitors. Foreign governmental agencies, chambers of commerce, non-governmentalorganisations, banks, accountancy and law firms try to persuade the foreign investor tochoose their jurisdiction, provide long lists of persuasive incentives, advantages of corporatelocations, market opportunities and sometimes even perks such as tax holidays, sunsetclauses, government grants and so forth.The first rule to remember is that success depends on a careful and informed choice. Thereis no such thing as a free lunch, but there can be a difference in the quality of the lunch. Bymaking a careful and informed choice the lunch might be quite agreeable or even better andin some instances, excellent. As stated, it all depends on a careful and informed choice. Tomake such a choice the foreign investor has to take into account the following essentialinformation:1. Foreign EnvironmentIn the host country there are some basic do’s and don’ts to be taken on board by theforeign investor and these are not easy to identify, as the foreign investor is used to theenvironment, rules and practices of their own country and marketplace.Therefore they might be misled by assuming that the business environment, rules andpractices of another jurisdiction are similar to their own. This not only leads to seriousmistakes but is a recipe for disaster and often ends in disputes and litigation. At thispoint the foreign investor and the local partner discover too late that their supposed firmagreement was an agreement on shaky grounds. Although it was based on good mutualpersonal understanding, there was a basic misunderstanding about the material terms.The first step for a foreign investor is therefore to find out the specific do’s and don’ts ofthe other jurisdiction. In respect to Austria, these are set out in the first chapter of thisEssential Business Guide and are more or less applicable throughout the countries of theEuropean Union and the European Economic Area.2. Unusual Corporate StructureThe second essential point for the foreign investor is to understand the basic corporatestructures in the target or host jurisdiction. At a first glance any company appears to bejust a company as it is a legal entity different from its shareholders and directors.However, a closer look at the details reveals huge differences. Such details relate to thecapitalisation, the accounting and reporting, directors’ and shareholders’ liabilities, rightsof representation, etc. A lack of understanding of these issues causes not only distress tothe foreign investor who may be locked into a situation too difficult to exit from, but alsofinancial losses.For instance, in a dispute before the Austrian courts about the right to vote in ashareholders’ meeting, a publicly listed US-based multinational as a 50% shareholder inan Austrian limited liability company was faced with the difficulty of proving to theAustrian court that its Vice President, International, had the legal right to represent theUS corporation in that shareholders’ meeting. The Austrian judge expected the VicePresident’s authority to be documented in an official certification from the AustrianCompany Registry, a public record in Austria, and was completely puzzled that there is nosuch Company Registry in the United States. Various legal experts on US corporate lawhad to give evidence to establish the rights of representation of the Vice President,International, as a company officer.A proper understanding of the basic corporate rules of the host jurisdiction is thereforeessential for a foreign investor prior to finally committing to equity investments in a- 9 -

partner’s business. In respect to Austria, the basic corporate structures and rules are setout in chapter two of this Guide.3. More than TaxesTax planning is the next essential step to be understood by a foreign investor and theiradvisors. Tax planning is complex, as not only the rules of the host jurisdiction have to betaken into account but also the rules of international taxation to be applied between thejurisdiction of the investor and the host jurisdiction. While these international rules arefrequently reduced to writing in bilateral tax treaties on the avoidance of double taxationit is important to understand the actual application and practice of these rules.Frequently, tax planning is understood only as how to minimize a tax burden for aproposed business activity. While this is certainly an aspect to be borne in mind, thereare more important issues which may be overlooked in the enthusiasm for profits withlower tax expected by the foreign investor or from the foreign investment.More important are those issues which are not expressed in terms of tax rates andbrackets but other problems which might arise in a trans-border situation such as taxablepermanent establishments, transfer pricing, cost plus taxation, deductibility of interest,rentals, licence fees and royalties, deductibility of commissions payable to third parties,etc. Above all, the exit strategy which is the tax burden in case of relocation of theenterprise out of the host jurisdiction, the sale of the business interest in the hostjurisdiction, trans-border mergers and liquidation must be examined.Foreign investments also have an upside aspect of taxation, in particular the availabilityof reducing tax exposure within a group, tax exemption of foreign dividends, in particularthe participation exemption and the Parent-Subsidiary Directive of the European Union.These aspects are covered in chapter three - Tax Planning.4. Cover Your BackThe main purpose of foreign investment is frequently the expectation of making profits ina foreign and promising market. The investor has interesting know-how or a profitablebusiness model and expects to boost the success by taking their products, know-how andbusiness models international, in particular to markets such as the European Union,Eastern Europe, Central Asia or Russia.This can be done by going solo or cooperating with a local partner. The choice isfrequently to do it with a local partner as the partner in the host jurisdiction has the localmarket knowledge, customer base or networks to turn the venture into a success. Beforefinalizing and making commitments, a foreign investor is strongly advised to protect theirknow-how, trademark, business name, patents and all industrial property.Failure to obtain proper protection prior to making commitments may not only result inlengthy disputes and court procedures but actually in a loss of such rights. For instancethe trademark “Land Rover” was lost in Brazil to a local company which registered “LandRover” for itself. In Austria an electronics shop registered “Apple” as a trademark and forseven years Apple Macintosh had to fight in the courts before recapturing its owntrademark.The full and enforceable protection of know-how and industrial property rights istherefore absolutely essential for a foreign investor. This is therefore covered in chapterfour of this Guide.5. Lost in LabourIn the host jurisdiction, the foreign investor usually requires workers to carry out thebusiness. Local labour is usually used for this purpose. Additionally, some people mayalso be seconded directly by the foreign investor to the host jurisdiction. Both groupscome under the local labour law; the main aim of that law is very often to protect theemployee and not the employer.- 10 -

If this is so in the jurisdiction of the foreign investor as well, they will certainly be awarethat this is an essential aspect of a foreign investment and will usually pay great attentionto this point.In respect to Austria, the protection of employees and the risks of an employer are setout in chapter five of this Guide. In contrast to all other European countries, Austria doesnot provide for any obligation on the part of the employer to pay hefty terminationcompensation to employees. This is certainly one of the advantages of using Austria as abase for operating throughout the internal market of the European Union.6. For better or worseA further point essential to foreign investors may be pensions and superannuationschemes. When seconding managerial staff from the investor’s home jurisdiction to thehost jurisdiction, or hiring and retaining managers in the host jurisdiction, the issue of acompany pension and superannuation may arise. To avoid any surprises, and inparticular to provide the foreign investor with sufficient information about the Austriansystem, pension and superannuation are covered in chapter six of this Guide.This chapter should in particular help the foreign investor to avoid making promises andcommitments which may be common in the home jurisdiction of the investor but may betoo generous in the host jurisdiction. Once an over generous promise has been made, itis virtually impossible to withdraw it without disappointing and demotivating the localmanager to be hired or the manager to be seconded.7. Information is ValueNo doubt there are other aspects of great importance for a foreign investor beforemaking final decisions and final commitments. Such final points like business licences,regulatory permits, banking rules, payroll procedures etc, require advice by theappropriate professional advisors to be engaged in the host jurisdiction. However, theseare finer points which are important but are not essential knowledge for a foreigninvestor when making contacts overseas and investigating possibilities.- 11 -

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- CHAPTER ONE -DO’’S AND DON’’TS FOR FOREIGN INVESTORSIIntroductionForeign investors from countries outside the European Union and the European EconomicArea often face pitfalls or miss opportunities when committing themselves to investments andbusiness activities in Europe. The foreign investor is well advised to learn from mistakesmade by others, keep away from danger zones and leverage the success of their investmentby using opportunities not available in their own jurisdiction.The following contains recommendations to foreign investors for securing success; what to doand what to avoid. The recommendations focus on foreign investments in business and donot discuss the immigration of the foreign investor to Austria. In such instances, differentconsiderations may apply and additional problems have to be dealt with.II Representative OfficeA representative office of a foreign business can be established in Austria without anyformalities; in particular, there is no requirement of registration with the Company Registry,any business name registry or the tax office. A representative office also does not requireany business licence or regulatory permit. However, in the area of financial services andinsurance, notification of the establishment of the representative office may have to be filedwith the supervising authority.For purposes of establishing a representative office, the foreign enterprise rents officepremises or commercial space and hires the required employees. Any employees have to beregistered with the local tax office and the local social security office for payroll withholdingpurposes.The activities of a representative office however have to be strictly limited to the purposes setout in the relevant tax treaty between Austria and the jurisdiction of the company setting upthe representative office in Austria.If a foreign company sets up a representative office in Austria, its activities have to be limitedto:Storage, display or delivery of goods or merchandise belonging to the enterprise, forinstance, consignment stock or goods for the purpose of processing by anotherenterprise.Purchasing office, i.e. the representative office buys goods and merchandise for theforeign company.Collecting information for the enterprise, e.g. market intelligence.Activities which have a preparatory or auxiliary character for the enterprise, e.g.advertising or scientific research.Any activities in excess of those listed may result in the foreign enterprise being consideredas having a permanent establishment and not just a representative office in Austria. Theresult will be that the foreign company becomes taxable in Austria to the extent that theactivities of the Austrian establishment contribute to the profit of the Foreign company. Asthis is often difficult to determine, drawn out and costly procedures will follow involving anexchange of information and negotiations between the tax administrations of both Austriaand the foreign jurisdiction.- 13 -

It is important to note that each tax treaty may have a slightly different description of thepermitted activities of a representative office. The relevant tax treaty has to be revieweddepending on the jurisdiction of the foreign enterprise. In a non-treaty situation, i.e. theforeign enterprise is situated in a jurisdiction which does not have a tax treaty with Austria,the representative office itself may already trigger a taxable permanent establishment inAustria. Prior to opening such a representative office it is recommended that an agreementor binding ruling is sought from the Austrian tax office.III Branch of a foreign companyOnce the activities of a foreign enterprise in Austria exceed the limits of the activities of arepresentative office, the presence in Austria will be considered as a taxable permanentestablishment. The foreign enterprise will therefore be required to register a branch inAustria.While it is possible to register the branch of a foreign company with the Austrian CompanyRegistry, a foreign investor is strongly advised to use this route only in exceptionalcircumstances after having thoroughly discussed this option with their professional advisors.The drawbacks of a branch of a foreign company in Austria are the cumbersome andexpensive registration and house-holding requirements. The registration in Austria has toreflect the full status of the foreign company which requires certified and apostilledtranslations of all foreign and non-German documents. Whatever the foreign company isrequired to file under its own corporate regulations has to be filed with the Austrian CompanyRegistry as well.The registration of the branch of a foreign company also requires all directors - including thenon-executive directors - to sign the application for registration of the branch whereby thesignatures have to be notarised and apostilled. In the case of companies with directorsresident in various jurisdictions, this can be a cumbersome task.As an alternative to registering the branch of a foreign company, it is easier, faster and lessexpensive to form and register a subsidiary in the form of an Austrian limited liabilitycompany (GmbH) or a joint stock corporation (AG).IV Commercial AgentsThe commercial agent in Europe enjoys a high degree of protection vis-à-vis the principal onthe basis of a Directive of the European Commission signed into law throughout the membercountries of the European Union. The courts are also highly protective of commercial agentsand in some instances where the commercial agent has been fully dependent upon andsubject to close supervision and control by the principal, the agency contract has sometimesbeen interpreted as an employment contract with all resulting tax and social securityconsequences including full labour law protection.The commercial agent is entitled to statutory commission, interest on commissions due,override commissions for direct business of the principal, termination compensation of up toone year’s gross commission, commissions for business after termination and has no liabilityfor damages if the agent terminates.There is no need for a signed agency agreement as the exchange of correspondence or anoral understanding may already establish a principal-agent relationship whereby the statutoryprovisions for the protection of the agent apply automatically.Even a written agency agreement cannot exclude the major protections of the commercialagent, e.g. the termination compensation. Clauses in agency agreements excluding orlimiting the agent’s protection are ineffective and the statutory provisions apply. Thestatutory provisions can also not be avoided by agreeing to submit the agency agreement toa foreign law which does not provide such protection. The choice of law clause will be- 14 -

considered ineffective to the extent that it negates the protection the agent would haveotherwise enjoyed under statutory provisions.Before appointing a commercial agent in Austria or in any other country of the EuropeanUnion, it is vital to seek legal advice and to have the agreement drafted to avoid pitfalls. Theadditional protection afforded by law and in particular the mandatory terminationcompensation may serve the principal as leverage in negotiations with an agent for insistingon a lower commission percentage than the principal is otherwise paying to agents in theforeign or other overseas jurisdictions.Depending on the circumstances, it might be possible to create a broker or factor contractrather than a commercial agency agreement to avoid the pitfalls set out above. However, thedrafting of such agreements requires great care and legal advice.VDistributorshipAs an alternative to using a commercial agent, a foreign enterprise might consider theappointment of distributors. A distributor might require some exclusivity or at least someselective distribution systems. Again, there are a number of legal pitfalls.An exclusive or selective distribution system may violate national or European competitionlaw. The distributorship contract therefore requires scrutiny as to its legal compliance. Forinstance, there are clear rules as to the limits of any geographic area for exclusivedistribution, parallel imports and retail price maintenance.However, there is another danger when appointing distributors in Europe. A distributor whois economically dependent on the manufacturer to a high degree may, at the time of thedissolution of the distribution, claim contract protection similar to a commercial agent (seeabove). While there are no statutory provisions for the protection of distributors, courts inAustria and in other EU countries have extended the protection of the commercial agent tothe distributor in a considerable number of instances. Also, although the beginning of adistributor relationship might be harmonious and not exposed to such dangers, anyremarkable success achieved by the distributor might make the distributor economicallydependent upon the manufacturer. If the manufacturer then wants to go directly into thatmarket, e.g. by setting up a subsidiary, the distributor may object and require considerablepayments in return for giving up any action to determine their rights in the courts andthereby create an unclear situation in this particular market for a number of years.VI Joint VentureJoint ventures are an attractive business model for foreign investors using a local partner toimplement a project. In Austria, such projects are typically building and construction projects,plant contracting, IT projects, pharmaceutical developments and life science projects.However the foreign or overseas joint venture partner would rely completely on the localknowledge of the local partner and frequently does not have the proper controlling andmanagement information systems in place. These joint ventures therefore sometimes proveto be high risk ventures and often end in drawn out litigation or arbitration.Apart from any particular risk of the local joint venture partner itself, there is a high risk vis-àviscreditors of the joint venture as, according to Austrian law, each partner of a joint ventureis jointly and severally liable to the creditors of the joint venture. In the absence of specificcontractual stipulation in the agreement each joint venture partner can bind the joint ventureitself to third parties. The foreign partner might then find themselves at the mercy of thecreditors, in particular in case of insolvency of the local partner. This risk can be managed byway of an incorporated joint venture in which the joint venture partners create a newcompany and, as a result, the liability of each joint venture partner is limited to their equitycontribution.- 15 -

Before entering into a joint venture agreement with an Austrian or other European partner, aforeign or overseas enterprise is advised to review other options such as sub-contracting witha profit share agreement in the project, alternatively taking the role of general contractor or,as suggested, creating a new company with the other joint venture partner, combined with asophisticated corporate governance and control mechanism.- 16 -

- CHAPTER TWO -CORPORATE STRUCTURESICorporate Vehicles for Foreign InvestorsForeign investors favour theLimited Liability Company (GmbH: Gesellschaft mit beschränkter Haftung); and/orJoint Stock Corporation (AG: Aktiengesellschaft)as vehicles for investment in Austria or as a platform for business in the European Union,Eastern Europe, Russia and Central Asia. In addition to operational and business activities,these corporate vehicles can be used for holding purposes and for acting as regionalheadquarters.Other structures are available but are used by foreign investors only in unusual circumstanceswhich require special solutions. Amongst the other structures are branches of foreigncompanies, private foundations, cooperatives, limited and unlimited partnerships, Europeanstock corporations, European private companies and various other forms of businessorganisations and associations. Amongst those listed, the private foundation is sometimesused by foreign investors as an ultimate holding structure, in particular as an Austrianfoundation can be set up for either profit purposes or for non-profit purposes.II Basic principles of Austrian companiesThe attractions of Austria as a corporate location for setting up companies by foreigninvestors are as follows:No discrimination against foreign shareholders. Neither the nationality or residenceof foreign individuals, nor the place of incorporation or main place of management ofcorporate shareholders has any impact on their standing and rights as shareholders.They are treated equally with any Austrian shareholders. Restrictions are onlyapplied in line with any UN Security Council resolutions.No corporate law restrictions on foreign directors or office bearers of Austriancompanies. Their nationality and place of residence does not matter, and there areno restrictions on a foreign investor appointing himself director of an Austriancompany. However, care must be taken that the appointment of a foreign directordoes not result in the Austrian company having its main place of management inanother jurisdiction, thereby becoming tax resident in that jurisdiction in line withexisting tax treaties. In the absence of a bilateral tax treaty, an Austrian companywill always be considered tax resident in Austria, as internal Austrian tax law uses thestatutory seat of a company as its place of residence. Where a tax treaty applies thetest of the main place of management, a foreign investor acting as a director of anAustrian company is well-advised to have a second Austrian resident directordocumenting that the company is actually managed from Austria and not fromabroad. In such a setting it is possible for the foreign shareholder/director to havethe right of sole representation of the company while the Austrian resident directoronly represents the company together with another director.No official permission or accreditation required for setting up an Austrian company bya foreign investor, except for some specific businesses such as banks, financialservices, insurance, pension funds.No foreign investment control. Irrespective of the size of the investment, the foreigninvestor does not have to obtain any administrative consent or government approval.- 17 -

Exceptions apply for the acquisition of land, agricultural land particularly, as theAustrian provinces have each passed legislation which provides certain control andadministrative approval prior to a foreign controlled company or foreign individualsacquiring real property. There may be other restrictions such as anti-trustclearances, securities laws and regulations etc. which may affect an investment butthey affect both foreign and domestic investors.No restrictions on using nominee shareholders. They are registered in the CompanyRegistry as shareholders, they are treated as shareholders and neither discriminatedagainst nor denoted as nominee shareholders. There is also no requirement todisclose the beneficial shareholders to the Company Registrar. The trust agreementcan be disclosed to the tax office at the time of distribution of dividends or realizationof capital gains in order to shift the tax burden from nominee to beneficial owner, butthe tax office must keep the trust agreement confidential.No Foreign Exchange Control in Austria other than certain reporting requirements tothe Austrian National Bank for statistical purposes only. This also applies when anAustrian company establishes foreign subsidiaries.The advantages set out above provide a foreign investor with a safe and reliableenvironment. Austrian rules and legislation are not as frequently changed as may be thecase in other countries, in particular in the area of corporate and commercial law. The Act onthe Limited Liability Company (GmbH) is still the 1906 Act and the Act on Joint StockCorporations (AG) is from 1965. Over the years both Acts have been slightly amended tocope with the changing business environment and practices. A foreign investor can thereforeexpect a secure and reliable structure and legal environment which allows long termplanning.III The Limited Liability Company (GmbH)A GmbH is created by one or more shareholders drawing up Articles of Association in theform of an Austrian notarial deed and the registration of that deed with the Company Registrykept at the Commercial Court or the High Court of the relevant district. Once entered intothe Register, the GmbH becomes a legal entity of its own.In order to get there, a number of steps are required as follows:The GmbH needs a name, followed by the designation “Gesellschaft mit beschränkterHaftung” or “GmbH”. The name can be the name of a shareholder, a description ofthe business to be carried out by the company, a fantasy name or any combinationthereof. The name must not conflict with the name of an existing company, must notinterfere with existing IP rights and, above all, the name has to be true. This mightcause problems in connection with geographic descriptions e.g. “Austria” or “Europe”as a geographic area as the description would only be permitted if the company isactually intending to carry out business throughout that region. The name must alsonot contain a description of a business for which a special licence is required, such as“bank”.The company has to have a description of its business objectives. As businessesoften require a business licence it is advisable to limit the business objectives to theactual business to be carried out by the company and not to use an all inclusiveclause as commonly found in Anglo-American articles of association. In addition tothe main business objectives, it is advisable to mention ancillary business activitiessuch as holding activities, management of other companies doing the same businessetc.The company requires a statutory seat stated in the Articles of Association, whichmust be a geographic location in Austria e.g. “Vienna”. An actual business address orregistered office does not have to be stated. The statutory seat determines thejurisdiction of the Commercial Court or High Court keeping the Company Registry.- 18 -

Other clauses of the Articles of Association can be stipulated to suit the requirementsof the investor. In particular the financial year, rights of shareholders, procedures inAGMs, transfer of shareholdings etc. Austrian corporate law does not use model orstandard articles of association, and most are drafted individually to suit theshareholders.A GmbH has to state its statutory capital to be subscribed by the shareholders.There is no concept of capital being authorised but not subscribed. At the time offormation, at least a quarter of the subscribed capital has to be contributed by theshareholders in cash or in kind. At present, the minimum amount of statutory capitalis EUR 35,000 of which half, i.e. EUR 17,500 has to be contributed at the time of theformation. The shareholders remain personally liable for any unpaid part of thestatutory capital. This personal liability even survives the transfer of the shareholdingto a new shareholder.A GmbH does not and must not issue share certificates. The shareholding is abusiness and ownership interest evidenced in the corporate documentation and theentries in the public Company Registry.Foreign investors are always advised to contribute the initial capital contribution incash and not in kind. In case contributions are made in kind, an application has tobe made to the court for the appointment of an expert to evaluate the actual value ofthe contribution in kind with a view to protect creditors.The capital contribution is subject to a one per cent Capital Transfer Tax. It will onlybe levied at the time of the formation or capital increase of the company. Thetransfer of a shareholding to another shareholder does not trigger any tax.The initial cash contributions by the shareholders have to be paid into an Austrianbank account opened in the name of the company to be formed. The bank will blockthe funds until the actual registration of the company in the Company Registry. Thebank will issue to that effect a certificate to be submitted to the Company Registrartogether with the application for registration.No particular debt-equity ratios are required with the exception of companies carryingout special business such as banking, insurance and the like. The thin-capitalisationrules are reduced to the simple requirement of having to call a shareholders’ meetingif a company has lost half or more of its equity. Also a company director may incurpersonal liability for debts of the company if she/he keeps on trading while thecompany has become insolvent.The GmbH requires at least one director. He/she is appointed by resolution of theshareholders signed in the presence of an Austrian notary public. The GmbH doesnot require any other company officers, though it is possible to appoint additionaldirectors and procurists. The latter are appointed by the director.To avoid the necessity of actually coming to Austria to appear before a notary,foreign investors are advised to empower Austrian representatives with anauthorization to sign the Articles of Association and any shareholder resolutions. Thisprocedure avoids any language problems. If the notary is faced with a person who isnot able to communicate in German, a court licenced interpreter is required to attendthe signing to interpret, which adds to the time, cost and expense.The director of the company has to sign the application to the Company Registrar forthe registration of the company in the presence of the notary public. Together withthe application, the Company Registrar needs to have the Articles of Association, thebank certificate on the paid in capital, the director’s specimen signature, the taxclearance of having paid the one per cent tax on the capital and, in the case of anyunusual company name, such as geographic description, an opinion by the localChamber of Commerce.- 19 -

The company may commence business operations prior to its registration, althoughanyone acting for the company incurs personal liability for any commitments made onbehalf of the company. Once the company has been registered, it takes over allliabilities from the persons having acted for the company and they in turn are freedfrom their personal liability.The company must comply with the annual reporting requirements to the CompanyRegistrar, in particular by way of filing a form with basic data on the financialstatements. Only larger companies are required to file full financial statements withthe Company Registrar.The Company Registry is a public register open to inspection by the general public. It is keptelectronically and can be accessed over the internet by registered users for a nominal fee.A GmbH is a suitable vehicle for a foreign investor who either uses a nominee shareholder orhas no problem with publication of name, date of birth and address. In view of the limitedreporting requirements, a GmbH can keep its business activities to a great extent confidentialand away from public attention. This might be of particular relevance where the Austriancompany is to act as a international holding company, regional headquarter or group head.IV Joint Stock Corporation (AG)The Stock Corporation (AG) lends itself to both private investors and raising capital from thepublic. Foreign investors are able to use the Austrian AG for similar purposes as a GmbH.The use of an AG might in particular be suitable for more than one private investor as Austriadoes not restrict or control joint investment schemes as long as they do not qualify asinvestment funds.The establishment of an AG is similar to the establishment of a GmbH in a number of ways.It starts with the drawing up of the Articles of Association and is completed with theregistration of the AG in the Company Registry. The following matters have to be attendedto: The determination and choice of a name followed by the description “AG”. Anyname, description or fantasy name may be used. The name must not be confusingor misleading.Business objectives and the seat of the corporation follow the same rules as theGmbH.The minimum issued, subscribed and paid in capital is EUR 70,000. The capital hasto be paid into an account of the AG with an Austrian bank which in turn will issue acertificate for the Company Registrar.Instead of contributing the capital in cash, the founding shareholders may prefer tocontribute in kind. This is however under the same restrictions as with a GmbH, asan expert valuation is required as to the actual value, and this will be carried out byone of the experts appointed to the Commercial Court.The founding shareholder or shareholders are furnished with a global share certificaterepresenting the capital paid in to the AG. This global certificate can later beexchanged against shares according the Articles of Association.The founding shareholder or shareholders appoint the first Supervisory Board of theAG consisting of at least three members, who must be individuals. Corporatemembership on a Supervisory Board is not possible.The Supervisory Board in turn appoints the first director or directors of the AG. Theterm of their appointment must not exceed five years. They can be removed at anytime by the Supervisory Board.Austrian corporate law follows the two-tier board system of governance, whereby theSupervisory Board has the power to appoint and dismiss the directors but no power- 20 -

to represent the AG.represent the AG.In turn, the director or directors have the sole power toThe capital is subject to one per cent tax the first time the AG is capitalised. In caseof a capital increase, the tax has to be paid on the amount by which the capital isincreased. Subsequent transfers of shares are not subject to transfer tax.The Supervisory Board and director have to draw up formal reports about theformation of the company and sign them in the presence of a notary public.Once all documents have been signed the director has to sign an application to theCompany Registrar for the registration of the company and has to submit along withit the Articles of Association, the bank certificate, the clearance certificate of the taxoffice, the report of the Supervisory Board and the director on the formation of thecompany, specimen signatures of the directors and specimen signatures of theSupervisory Board members.Once the AG is registered in the Company Registry it becomes a full legal entity andcan start operation through its director. Any person acting for the AG prior to itsincorporation incurs personal liability. This personal liability is automatically takenover by the AG upon registration in the Company Registry while at the same time thepersonal liability of the persons acting prior to incorporation ends.An AG has the duty to obtain an annual audit by a certified public accountant. Theauditor’s report, together with the financial statements, has to be filed with theCompany Registry, which is open to inspection by the general public. At the sametime a notice has to be published that the documents have been filed and areavailable for inspection.In contrast to the GmbH, the financials of an AG are fully accessible by the public. However,the benefit is that the foreign investor or other shareholders can be kept confidential. Onlywhere the AG is controlled by one single shareholder, holding 100% of all bearer shares, isthere a duty to register the name of this sole shareholder with the Company Registry.A transfer of shares can be done by physically handing over the endorsed share certificatestogether with the change of registration of the name of the shareholder in the share registerkept by the company. Bearer shares are only available with listed companies.In the case the AG is publicly listed, disclosure requirements have to be complied with byshareholders directly or indirectly acquiring, exceeding, or falling below shareholdings of 5%,10%, 50%, 75% or 90% of the shares of an AG listed at the Vienna Stock Exchange.- 21 -

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- CHAPTER THREE -TAX PLANNINGIAttitude of Fiscal Authorities - In GeneralAs a general rule, Austria’s tax laws do not discriminate against low-tax or no-taxjurisdictions. The rationale for this attitude is to allow Austrian business organisations to haveaccess to low-tax and no-tax jurisdictions for purposes of international strategic businessplanning. Even the Austrian government, on some occasions, has used tax havens for issuingtreasury bonds for the international markets.Any transaction taking place abroad will result in a higher duty of co-operation by theAustrian tax payer with the Austrian tax authorities, in particular, when low-tax or no-taxjurisdictions are involved.Dividends and capital gains received by an Austrian company from its offshore subsidiariesare tax exempt, provided the anti-avoidance test is not met. This test provides that this typeof income to an Austrian company may lose its exempt status and become subject to Austriancorporate tax if:1. the overall local direct and indirect tax burden of the offshore subsidiary does notexceed 15 per cent in respect of its profits, and2. the subsidiary’s main resources are dedicated to passive business.Careful corporate and operational planning should ensure that the anti-avoidance test is met,so that there is complete legal enjoyment of offshore benefits.Even if the test is not met, a credit for taxes paid abroad is still available.Austria has not enacted any CFC legislation and is unlikely to enact it in the future.II Subsidiaries in Foreign JurisdictionsiZero Tax JurisdictionsIn transactions involving jurisdictions which have exemption from taxation, the participationexemption for dividends and capital gains may be lost if the anti-avoidance test is met. Inaddition, the tax payer will be under a higher duty of cooperation whenever the Austrian taxauthorities investigate transactions taking place in the tax-exempt jurisdiction.iiLow-Tax JurisdictionsIn transactions involving low-tax jurisdictions, foreign dividends or capital gains may becometaxable if the overall local tax burden does not exceed 15 per cent of the profits and the mainresources of the subsidiary are dedicated to passive business, in particular, earning incomefrom interest, leasing and capital gains (anti-avoidance test above). Foreign tax credits arestill available. Furthermore, there is a higher duty of co-operation with the Austrian taxauthorities.iiiJurisdictions That Exempt Foreign-Source IncomeIn regard to jurisdictions that exempt foreign-sourced income from taxation, the Austrian taxauthorities would require a higher duty of cooperation and disclosure when scrutinising thetransactions. Otherwise there are no repercussions.- 23 -

ivJurisdictions That Grant Tax Incentives to Offshore andQualified Holding CompaniesIn respect to jurisdictions that grant tax incentives to offshore and qualified holdingcompanies, dividends and capital gains from these jurisdictions may not be tax exempt underthe participation exemption if the anti-avoidance test is met, i.e., the overall tax burden doesnot exceed 15 per cent of the profits and the main resources of the subsidiary are dedicatedto passive business (see above). There is a higher duty of co-operation with the Austrian taxauthorities.vJurisdictions That Provide Tax Exemptions for Manufacturingand Processing ExportsIn regard to jurisdictions that provide tax exemptions for manufacturing and processingexports, if these exemptions result in an overall tax burden not exceeding 15 per cent of theprofits, the participation exemption for dividends and capital gains may be lost. There is ahigher duty of cooperation with the Austrian tax authorities who will examine the activities ofthe foreign subsidiary, in particular whether the subsidiary’s main resources are actuallyapplied to manufacturing. If so, the anti-avoidance test will be met and the participationexemption will apply.viJurisdictions That Provide Tax Reductions for InternationalCompanies with Privileged Offshore Financial StatusIn respect to jurisdictions that provide tax reductions for international companies withprivileged offshore financial status, if these exemptions result in an overall tax burden notexceeding 15 per cent of the profits and the main resources of the subsidiary are dedicated topassive business, the anti-avoidance test will not be met and the participation exemption fordividends and capital gains may be lost. There is a higher duty of co-operation with theAustrian tax authorities.III Tax Treaty RegimeIn GeneralAustria has income tax treaties with 90 countries, additional tax information exchange treatieswith four offshore centres and treaties on interest with 15 offshore centres. Most of thesefollow the Organisation for Economic Co-operation and Development (OECD) Model Treaty.iCharacteristic Provisions and Treatmenta. Persons coveredBoth individuals and companies are covered by double-taxation treaties, as a standardfeature of the Austrian tax treaty regime.b. CitizenshipAs a general rule, citizenship or “domicile” has no relevance. However, in a residencytest under a double-taxation treaty, citizenship may be eventually decisive in case ofdual-residency.c. Dual-Resident IndividualsIn respect to dual-resident individuals, citizenship may provide the final test ofresidency, as provided for in various tax treaties.Under a regulation issued by the Austrian Federal Ministry of Finance, individuals do notestablish a tax residence in Austria for the purpose of income tax, irrespective of a homebeing available in Austria, if the following conditions are met:- 24 -

iithe home is used for not more than 70 days per year;proper records on the use of the home are kept; andno ordinary tax residence is established in Austria within five years.d. Dual-Resident CompaniesThe place of management will determine where the company is resident for taxpurposes, while, in Austrian domestic tax law, the place of incorporation is decisive. Inthe case of European Union (EU) Companies, the Parent Subsidiary Directive mayoverride treaty provisions between Austria and other European Union Member States.e. Resident ForeignersResidency for Tax Purposes: If a foreigner meets the residency test under the applicabledouble-taxation treaty, he/she will be considered resident in Austria for tax purposes,irrespective of nationality or any valid residency permit.Third-Country Persons Seeking Eligibility for Treaty Purposes: If a third-country personactually establishes a residency for tax purposes in Austria, he/she will be treated astax-resident in Austria and will be subject to taxation in Austria of all income worldwide.Permanent travellers will be treated as resident in Austria if they meet the lowest formof residency under the Federal Tax Code (availability of a place to stay in Austria),unless they are able to prove that they are taxed on their worldwide income by anothercountry.Taxes coveredTypically, all income and corporate profit taxes are covered under Austria’s double-taxationtreaties and, where relevant, wealth taxes. Austria does not levy wealth, gift or inheritancetaxes.iiiExchange of InformationMost double-taxation treaties contain the exchange-of-information clause of the OECD ModelTreaty.As a result of Austria’s bank secrecy, in the past the actual exchange of information wasfrequently not possible because Austrian banks refused to disclose details of bank accounts offoreign customers unless criminal proceedings had already been commenced by a court.Austria has now fully implemented the OECD standards and relaxed its bank secrecy rules inrespect to foreign account holders, allowing Austrian banks to reveal account informationwhere there is a specified request for information as a bank customer.In addition, other bilateral and multilateral treaties of mutual assistance in both administrativeand criminal matters and EU Directives require an exchange of information.Group requests for information are currently not possible in Austria.ivAssistance in CollectionsAs a general rule, foreign revenue debts are not enforceable in Austria, either againstresident individuals or corporations with assets in Austria. A foreign revenue debt is onlyenforceable if so provided in a bilateral agreement. At present, the following double-taxationtreaties provide for assistance in collections:France;Germany;Norway; andUSA.- 25 -

Assistance in collections is also provided to other EU member states in compliance with theEuropean Community (EC) Directive 2001/44/EC amending Directive 76/308/EEC. TheseDirectives have been implemented in Austria and are applicable in addition to any existingbilateral agreements fully subject to taxation.IV Treaty ShoppingiTreaty Shopping DefinedAustrian tax legislation does not provide any definition of treaty shopping. The anti-avoidancerules (see text, below) are designed to prevent treaty shopping. The tests applied by the taxauthorities indicate the approach taken by the Austrian administrative practice. In addition,the tax authorities are able to apply the substance-over-form rule. If the treaty shopping hasno commercial background at all, the tax authorities could challenge the economic value ofthe transaction and deny the relief sought by means of treaty shopping.iiImpact of Treaty Shopping on Tax ReliefIf the tax authorities establish that the transaction carried out in the course of the treatyshopping has no substance, but only form, the tax authorities may disregard the formalaspects and treat the transaction as a domestic transaction.iiiAdministrative and Judicial Response to Treaty ShoppingThe administration attempts to avoid Austria being used for establishing holding companiesfor mere treaty-shopping purposes. However, the Tax Office has failed in the AdministrativeCourt when challenging alleged treaty-shopping structures. In any case, it is advisable todocument the business reasons underlying the establishment of holding companies in Austria.In respect to outbound treaty shopping, the administrative response is to challenge thetransaction whenever it violates the substance-over-form rule.ivTreaty Limitations on Treaty ShoppingSome double-taxation treaties contain specific limitations on treaty shopping, such as thetreaties with Ireland, Liechtenstein, the Netherlands and the United States. One must also beaware of specific domestic tax provisions limiting benefits in particular circumstances.vTreatment of Inbound Treaty ShoppingIn a case of inbound treaty shopping, the Tax Office, depending on the circumstances, mightrefuse the privileges sought by treaty shopping, such as tax exemption of foreign dividendsand capital gains, as well as refusal of VAT credits.viTreatment of Outbound Treaty ShoppingIn respect to outbound treaty shopping, the Tax Office might apply the substance-over-formrule and treat the transaction as a domestic transaction fully subject to taxation.VTreatment of Offshore TransactionsiTax-Haven LegislationIn GeneralAustrian tax law and/or fiscal administrative practice does not either classify or list zero-taxand low-tax jurisdictions. Only in the context of the exemption of foreign dividends andcapital gains on the basis of participation may an overall threshold of 15 per cent of taxationwith respect to profits be relevant, provided the subsidiary’s main resources are dedicated topassive business.- 26 -

a. Offshore Investment FundsUnder Austrian tax law, there is no discriminatory treatment of offshore investmentfunds simply because they have been established offshore.b. Foreign TrustsTrusts established by Austrian residents or with Austrian-resident beneficiaries aretreated as separate legal entities under Austrian tax law, provided they are truly opaquediscretionary trusts. As a result, foreign discretionary trusts will not be subject toAustrian taxation.If foreign trusts are non-discretionary (bare trusts or interest-in-possession trusts), theywill be considered to be part of the assets of the Austrian resident settlor and/or incomeof the Austrian resident beneficiaries and taxed accordingly.c. Foreign Personal Holding CompaniesUnder Austrian tax law, foreign personal holding companies will be considered to be partof the assets of the Austrian resident, unless he or she can demonstrate a valid businesspurpose for the foreign personal holding company.d. Foreign CorporationsForeign corporations established as subsidiaries in offshore or low-tax jurisdictions willbe considered to be independent taxable entities of that jurisdiction, provided they areeither comparable to an Austrian company or are a recognized EU company. The receiptby the Austrian parent company of dividends and capital gains will be tax exempt,provided the following conditions are met:equity participation of 10 per cent or more;holding of that equity participation for more than one financial year; andthe foreign corporation is not caught by the anti-avoidance test, as follows:- the overall direct and indirect tax burden suffered by the foreign subsidiary doesnot exceed 15 per cent of its profits; and- the main resources of the foreign corporation are dedicated to passive businesssuch as earning income from interest, capital gains, licence fees or leasing rates.In case both elements of the anti-avoidance test are met, the participationexemption will be denied and, as a result, the dividends and/or capital gains will befully taxed in Austria at the corporate tax rate of 25 per cent. However, any taxesimposed abroad will be credited.An example of where both elements are met is a foreign subsidiary with an overalltax burden of less than 15 per cent on its profits, and in the business of convertinginterest into dividends. In this situation the Austrian holding company would not beable to claim the tax exemption.e. Other Vehicles Facilitating Offshore TransactionsOther vehicles facilitating offshore transactions may be scrutinized to determine whetherthey meet the substance-over-form rule. If a transaction fails to meet this test, it will betaxed as a domestic transaction.VI Strategic Corporate Tax PlanningiHolding StructuresAustrian companies can establish their subsidiaries offshore, either in no-tax or in low-taxjurisdictions. This is an accepted practice for corporate tax planning and is particularlyattractive for structures owned by ultimate non-Austrian resident beneficiaries. Austrian- 27 -

holding companies will enjoy tax exemption both for foreign dividends and capital gainsderived from the disposal of shareholdings in foreign subsidiaries.iiCommissionaire StructuresCommissionaire structures are accepted as such by Austrian law and administrative practice.They enjoy the same tax status as any other commercial activity. For value-added taxpurposes, commissionaires are treated as distributors. To manage high-risk investments, inparticular investments in Russia, emerging economies and other high-risk jurisdictions, a basecompany in a tax haven or a low tax jurisdiction will facilitate the managing of risks.This may be achieved by an Austrian company acting as a commissionaire for a foreigncompany, which takes the full commercial risk on its books.iiiInternational HoldingsCompanies in no-tax or low-tax jurisdictions can be legitimately established for ultimateholding companies of international groups.This will be considered by the Austrian tax authorities as a legitimate use and not as treatyshopping.To have the legitimate use accepted, the purpose of the offshore holding must be fullydisclosed to the tax inspector.ivRulings in AdvanceThe tax-planning effects of an international holding structure can be submitted to theInternational Tax Department of the Austrian Federal Ministry of Finance on a no-name basisfor a preliminary ruling. Such rulings can be obtained in two to four weeks. In addition, abinding ruling can be obtained from the local Corporate Tax Office, prior to implementation ofthe structure. Binding rulings are subject to an administrative fee.vEU Parent Subsidiary DirectiveDividends paid by an Austrian company to its corporate shareholders resident in othermember countries of the European Union remain untaxed both at the sending and receivingends by virtue of the EU Parent Subsidiary Directive guaranteeing freedom of movement ofcapital inside the Internal Market. By carefully choosing the parent shareholding company ofthe Austrian company, the overall tax burden on both business profits and on the dividendsof the ultimate shareholders may be reduced.VII Group TaxationIf a profitable Austrian company is holding Austrian or foreign subsidiaries their losses can beconsolidated with the profits of the holding company. The following conditions have to bemet:Application for forming a tax group to be filed with the Tax Office and signed by allmembers of the group.The holding company as the head of the group has to have a controlling participationin the subsidiaries of 50% or more of the equity.The group has to be established for a minimum of three years and in the case thatthe group is terminated earlier, all tax advantages are reversed.The losses of the subsidiaries to be utilised by the group head have to be thesubsidiary’s own losses.- 28 -

The group taxation regulation is aimed at encouraging and supporting the internationalisationof Austria’s industry and business. There is no residence, nationality or other qualifying testfor shareholders of the Austrian holding company or the group head. The Austrian holdingcompany might well be held by non-resident shareholders. As a result, group taxation is anattractive feature for foreign investors.- 29 -

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AUSTRIA’’S DOUBLE TAXATION TREATIESAA SS OO FF 11 SS STTTAA PP RR II LL 22 00 11 33Treaty Limits on Withholding TaxesCOUNTRYDividendsLimits in % ofRoyaltiesInterest%Albania 5/15 10 10Algeria 5/15 10 10Argentina 15/0 15 12.5Armenia 5/15 5 10Australia 15 10 10Azerbaijan 1/15 10 10Bahrain 0 0 0Barbados 5/15 0 0Belarus 5/15 5 5Belgium 15 10/0 15Belize 5/15 0 0Bosnia-Herzegovina 10/5 5 5Brazil 15 10/15 15Bulgaria 0 0 0Canada 5/15 0/10 10China 7/10 10 10Croatia 15 0 5Cuba 5/15 5 10Cyprus 10 0 0Czech Republic 10 15 0Denmark 10 0/10 0Egypt 10/15 0 15Estonia 5/15 10 10Finland 10 5 0France 0/15 0 0Georgia 0 0 0Germany 5/15 0 0Great Britain 5/15 0/10 0Greece 0/No limit 0/10 0/10Hong Kong 10/0 3 0- 31 -

Treaty Limits on Withholding TaxesCOUNTRYDividendsLimits in % ofRoyaltiesInterest%Hungary 10 0 0India 10 10 10Indonesia 10/15 10 10Iran 5/10 5 0/5Ireland 0/15 0/10 0Israel 25 10 15Italy 15 0/10 10Japan 10/20 10 10Katar 0 5 0Kazakhstan Republic 5/15 10 10Kuwait 0 0/10 0Kyrgyz Republic 5/15 10 10Latvia 5/10 5/10 10Liechtenstein 15 10 10Lithuania 5/15 5/10 10Luxemburg 5/15 10/0 0Macedonia (FYROM) 0/15 0 0Malaysia 0/5/10 10/15 15Malta 15/32.5 10 5Morocco 10/5 10 10Mexico 5/10 10 0/10Moldavia 5/15 5 5Mongolia 5/10 5/10 0/10Morocco 5/10 10 10Nepal 5/10/15 15 10/15Netherlands 5/15 0/10 0New Zealand 15 10 10Norway 5/15 0 0Pakistan 0/10/20 20/25 0Philippines 10/25 15 15Poland 5/15 5 5Portugal 15 5/10 10Romania 15 10 10- 32 -

Treaty Limits on Withholding TaxesCOUNTRYDividendsLimits in % ofRoyaltiesInterest%Russian Federation 5/15 0 0San Marino 0/15 0 0Saudi Arabia 5 10 5Serbia 15/5 5/10 10Singapore 10 5 5Slovakia 10 15 0Slovenia 5/15 0/10 5South Africa 5/15 0 0South Korea 10/15 2/10 10Spain 10/15 5 5Sweden 5/10 0/10 0Switzerland 5 5 5Tajikistan 0 0 0Thailand 10/20 15 0Tunisia 10/20 10/15 10Turkey 5/15 10 5/10/15Turkmenistan 0 0 0Ukraine 5/10 0/5 5United Arab Emirates 0 0 0USA 5/15 0/10 0Uzbekistan 5/15 5 10Venezuela 5/15 5 4.95/10Vietnam 15/10/5 10/7.5 10Austria has treaties with the following offshore centres as a result of which tax on interest accrued innon-resident accounts is withheld at source:AndorraAnguillaArubaBritish Virgin IslandsCayman IslandsGuernseyIsle of ManJerseyLiechtensteinMonacoMontserratNetherlands AntillesSan MarinoSwitzerlandTurks and Caicos Islands- 33 -

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- CHAPTER FOUR -PROTECT YOUR KNOW-HOW AND IPIIntroductionIndustrial property protection in Austria deals with subjective rights to intellectual property.The proprietor of an intellectual property right is entitled to exclude third parties from theregulated use of this right, or claim an appropriate equitable remuneration.In Austria, the principle of territoriality, codified in article 34 of the Act on InternationalPrivate Law, is relevant to the protection of intellectual property rights. According toparagraph 1 of article 34, the coming into existence, content and expiry of immaterial goodsare to be determined by the jurisdiction in which their use and/or infringement takes place.Holders of intellectual property rights acquired in Austria are protected only within Austria.Intellectual property covers the fruits of commercially exploitable and entrepreneurialactivities, as well as the protection of marks. The rights exist in various forms and areregulated in a number of legal acts. These acts are the subject matter of the followingcommentary and will be discussed in turn.II Competition LawCompetition law is extensively regulated by the Unfair Competition Act. Competition lawensures that anyone who takes part in trade and commerce with the aim of promoting his orher own self-interest to the disadvantage of other competitors, does so without the use ofillegal, unethical or unfair means.A breach of intellectual property rights entitles the holder of these rights to claim damagesand such claims, as well as applications to cease use and injunctions can be brought in theAustrian Commercial Courts. Where no enterprise exists or the enterprise is not domiciled inAustria, an action must be started at the place of the defendant’s permanent residence.Failing this, local jurisdiction is passed onto the defendant’s temporary domicile and in anyother case, it is with the place of the original infringement.III Trademark ActThe aim of the Trademark Act is to distinguish the goods or services of one enterprise fromsimilar goods or services of another. A trademark makes known the origin of goods orservices, or may serve to individualise a particular product.It is a distinguishing mark that enjoys formal protection once registered in the TrademarkRegister. Contrary to other marks such as a company’s name, a trademark is transferable andit can be separated from its founder. It is the individualising function of the trademark,rather than its outer appearance, that is protected by this legal area.Trademarks fulfil the individualising function when they can be distinguished from othermarks. The ‘distinctiveness’ required for a trademark may be of itself or acquired throughcommercial acceptance. Distinctiveness is exhibited when the mark can demonstrate arelatively high level of individuality, such as that found with few names and ‘fantasy’ pictures.Some terms that lack this high level of individuality and have been accepted into everydaylanguage, may, nevertheless, be recognised as distinguishing marks. However, ciphers,numbers, unpronounceable combinations of letters as well as generic names and descriptivestatements lack distinctiveness.- 35 -

Distinctiveness gained as a result of commercial acceptance occurs when a trademark is seento represent a particular company, merchandise or certain service in the market place. Theterm ‘commercial acceptance’ may be locally or nationally defined. Where the registration of atrademark requires commercial acceptance, however, nationwide acceptance has to beproved.When various trademarks collide, with the effect that one falls within the protective sphere ofanother, assuming all other necessary requirements for the protection of marks have beenmet, the mark with the later priority must give way to the mark with the earlier priority. Theright of priority starts on the day an orderly application has been lodged. A danger ofconfusion arises when the use of a trademark allows it to be wrongly classified.Whether such a mistake has arisen is a question of law and is judged objectively. A danger ofconfusion in its narrowest form takes place when both trademarks are connected to oneenterprise. Such a situation means there is the danger that the trademarks may be confusedwith one another. This is termed ‘direct’ danger of confusion.A different situation arises where, although the trademarks remain distinct, they may beassigned to the same firm due to their close similarities. This is termed ‘indirect’ danger ofconfusion. A danger of confusion in its widest form occurs when the trademarks involved areowned by different enterprises. Due to their similarities, however, a strong connectionbetween the enterprises is assumed.Trademark protection is established by registration with the Trademark Register. Registrationis preceded by a written application to the Patent Office. The Patent Office undertakes adouble test of legality, checking first the legality and then proceeding to test for similarities.If the trademark is granted by the Patent Office, it is protected for a term of 10 years, whichcan be repeatedly renewed by re-registration. In accordance with article 29 of the TrademarkAct, a trademark may expire for a number of reasons, first and foremost on the request ofthe trademark owner.Expiration is also possible through lack of re-registration, as well as a decision of the PatentOffice Revocation Division in answer to a request for cancellation. Cancellation grounds existwhere:1. Certain trademarks collide;2. There are registration obstacles, such as the liquidation of the company involved; or3. There is a failure to use a trademark appropriately within 5 years of its first registration.IV Registered Design ProtectionThe Registered Design Act protects the external appearance (the aesthetically perceptiblecolour and form) of a product. The protection afforded by the presently applicable RegisteredDesign Act should be clearly distinguished from the Industrial Design Act discussed below.Only new designs are protected by the Registered Design Act. Article 2 provides a negativetest to determine what is a new design. A design is not to be regarded as new, when it looksexactly like, or confusingly similar to, the appearance of an object that existed prior to thedesign’s date of priority, and that was accessible by the public, and, obviously, when theobject’s appearance may be transferred to the object listed on the design’s commodityclassification.All sensually perceivable objects that are absolutely and objectively new to the public are perse not new. Note, however, that the term “public” is not statutorily defined. A broadconstruction of the term is preferred, as to do otherwise would be to expand the realm of theAct to incomprehensible limits. The date of priority is defined as the date an orderlyapplication has been lodged.The principle of novelty, regulated in article 2, is subject to various exceptions. A disclosurethat may injure the claim to novelty is inapplicable when it is not expressed 6 months prior to- 36 -

the date of priority, and is concerned with either an obvious misuse to the disadvantage ofthe applicant, or the displaying of the design by the applicant (or his rightful successors) atan official or officially recognised trade fair.Article 3 prohibits the possibility of dual protection. As a result of the principle of priority,older rights enjoy advantages in their protection over newer rights that are exactly the sameas, or confusingly similar to their older counterparts. The Patent Office does not undertake atest of novelty during the registration process. Theoretically therefore, a new patent cannotimpute protection until the first design has been declared void.The principle of creator is valid in the protection of registered designs. Only the creators of adesign, and their rightful successors, have a claim to the protection of the design. Thus,design protection is a transferable right under Austrian law. Note, however, that a designcreated by an employee for his employer during the term of employment belongs not to theemployee but the employer. The exclusive intellectual property rights granted to thepossessor of a design are codified in article 4.Design protection is achieved by application. According to articles 11 and 12, a writtenapplication that includes a reproduction or a copy of the design takes place either at thePatent Office or at a Commercial Chamber. Each registration process checks that a design, asdefined by the Registered Design Act, is present.What is not checked, however, is the novelty of the design, whether there has been aninfringement of the dual protection prohibition and whether the applicant has, in fact, a claimto the protection of the design. Once the copyright in the design has been awarded, thedesign is entered into the Design Register and the holder is awarded a certificate. Copyrightin the design begins with the publication of the design and ends 5 years to the end of themonth in which registration took place. Provided the renewal fees are paid on time, copyrightprotection can be twice renewed for further 5-year periods.Copyright of a design ends by expiry of the protection, or by a Patent Office revocation of thedesign on the grounds that it is either obviously not new, or that it falls foul of the dualprotection prohibition. It is also possible for an application of revocation to be made by anindividual who believes a design to be contrary to the Registered Design Act. Copyright of adesign may also be deprived of an individual when another alleges his entitlement to theprotection.VPatent LawProducts that demonstrate high levels of inventive thought come within the jurisdiction of thePatent Act, and are protected by letters of patent.Inventions with significant ethical relevance for society at large, such as unethical inventionsand inventions within the biological and medical realms are not patentable. However, Austriahas implemented the directive 98/44/EC of the European Parliament and of the Council of 6thJuly 1998 on the Protection of Biotechnological Inventions.As a result of the implementation, inventions involving biological material are capable ofbeing patented, however with the exception that the human body in all its phases offormation and development is not patentable.Inventions relating to plants and materials are only patentable provided they are notrestricted to a particular plant or animal variety. This scope of protection of a patent onbiological material also extends to the next generation derived from the protected materialeither by way of propagation or by way of multiplication.Only the inventor and his rightful successors can claim for the issuing of a patent. A claim isestablished through the registration of a patent. Until otherwise proved, the first applicant willbe deemed to be the inventor. A test as to whether or not the applicant is in fact entitled topatent the invention is not undertaken.- 37 -

Where two inventions have been simultaneously invented, only the first applicant’s inventionis patented. If it can be shown, however, that at the time of registration the individual of thesimultaneously achieved invention had bona fide use of his invention in Austria, or had madeserious preparations for the commercial exploitation of the product, he will qualify as a prioruser.The effects of the first applicant’s patent do not affect the prior user’s rights. The latter isempowered to continue using the invention in the method and to the same extent adoptedprior to the priority date. Usage of the product is firmly restricted to its prior operation. Theprior user’s opportunity to obtain a patent grant re-occurs when the first applicant’sregistration fails to patent the product.An employee invention occurs when an invention is attributed to an employee and is inventedwithin the working sphere. It must either be undertaken as an obligatory service at thesuggestion of the enterprise, or is one that has been made substantially easier by the supportor the experience of the enterprise.In principle, the employee may claim for a patent grant under article 6 clause 1 of the PatentAct. This entitlement is not subject to a contrary agreement by the parties. The employermay claim the inventions of employees, however, where the contract of service is of a publiclaw nature or where the parties of a private contract reach an agreement to this effect.The registration of an invention as a patent requires a written application to the Patent Officein Vienna. The applicant gains a right of priority as a result of successful application. ThePatent Office undertakes a preliminary investigation for formal and material defects.If no defects arise, the patent is published in the Austrian Patent Gazette and is left open forfour months from this date to general examination. Third parties are given the opportunity tomake claims against the granting of the patent. If no such third party claim is made, thepatent will be deemed as granted with the expiry for the four-month time limit. At this point,the patent is entered into the patent register and published for the attention of customers inthe Patent Gazette. A certificate is awarded to the holder and the printed patent specificationis published.The maximum term given to patents is 20 years from the date of registration. The owner of apatent is entitled to licence the invention to third parties at his own free will. Austrian patentlaw also provides for compulsory licences.An administrative authority may demand such licences, where the proprietor of anindependent invention of immense commercial significance requires the use of an olderpatent to fully exploit the new invention. The same is true for the owner of the older patent,who is entitled to demand a licence for the independent patent. A compulsory licence mayalso be appropriate where the patentee does not appropriately exploit the patented productand where exploitation is within the public interest.In the area of biological material, a compulsory license can be obtained if a breeder cannotachieve the development of a further plant variety without infringing a prior patent. Thebreeder is able to obtain a non-exclusive license for the patent provided the plant varietyconstitutes a significant technical progress of considerable economic value compared to thepatent and provided the license is necessary to exploit the plant variety.A patentee’s exclusive right to prohibit third parties from the use of the patented product iscodified in article 22 of the Patent Act and is, following the principle of territoriality, restrictedto Austria.Article 46 holds that a patent is extinguished by:- Expiration of the 20 year term; or- Failure to pay the annual fee, by surrendering the patent or, in accordance with article 33clause 1, as a result of the intestate death of a patent holder.According to article 47, a patent may be totally or partially reversed to ensure that theinvention is utilised to an appropriate extent within the country.- 38 -

It is also possible to declare a patent void. The requirements are that:- The object was in fact not patentable;- The patent does not fully and clearly disclose the invention thus allowing it to be executedby an expert; or- The micro-organisms deposited were not permanently accessible to the public.Moreover, an application to deprive a patentee of a patented product can be madesuccessfully where the patentee does not have a claim to the grant of the patent or is guiltyof taking a substantial part of the invention from the documents of another without thelatter’s approval.The cancellation of a patent takes place in an action for cancellation, and is regulated by thecorresponding civil law procedures.VI Industrial Designs ProtectionThe Industrial Design Act seeks to protect new industrially expedient technical designs thatdo not fulfil the level of novelty required under the aforementioned Patent Act. Protectionafforded by the Act is especially useful for economic goods that often enjoy only short livedand temporary legal protection.The Act’s jurisdiction corresponds to that of the Patent Act, but is extended to take intoaccount the programming logic that forms the basis of data processing programs. The Actdoes not apply to plants, animals and biological material or methods of their breeding. Asapplications for industrial design protection are not examined at all, their protection wouldseriously impair biotechnological innovations.Pursuant to article 18 of the Industrial Design Act, registration occurs at the Patent Office.The Office merely establishes the formal requirements in a test of legality. It does not,however, look into the novelty of the invention or the validity of the applicant’s claim to theprotection of the industrial design. The Patent Office checks the technical stand of theinvention, and compiles a report which is then conferred upon the applicant seekingregistration. The latter has the opportunity to speed up the process by requesting theimmediate drawing up of the report.Once the requirements for registration have been met, the invention is filed in the RegisteredDesign Register and published in the Registered Design Gazette.A registered design application may be transformed into a patent application, so long as thisoccurs within two months of the research report. This is advantageous to an applicant fromwhose research report it emerges that a registration of a patent is promising.A right of priority is awarded to the applicant on the day an orderly application has beenlodged. The term of protection is shorter than that obtainable under Patent law. Itcommences with the official publication of the industrial design, and ends, at the very latest,10 years to the end of the month in which the registration took place. Legal actions broughtunder the Registered Design Act are heard at the Commercial Court of Vienna, which hasexclusive jurisdiction in this area.According to article 28 of the Industrial Design Act, anyone can contend the nullity of aregistered design, basing their contention on either one of the following grounds:1. The design does not fall under the protection of the Industrial Design Act,2. The design cannot be executed without an expert; or3. The content of an earlier application to obtain design protection for an object is notconsistent with the application that is presented at registration.An individual claiming to be the rightful possessor of a registered design is entitled to petitionthat the right be deprived from the alleged possessor, and be transferred to him.- 39 -

VII Semiconductor Chip Design ProtectionDevelopers of microelectronic semiconductor chip products (topographies) are protectedunder the Semiconductor Chip Act from the reproduction and/or exploitation of thetopography by third parties.The registration process under this Act also takes place at the Patent Office. Once again, theregistration process is focused on the ascertaining of formal requirements. Materialrequirements for the protection of a semiconductor chip are not tested. Once all requirementsfor registration have been met, the semiconductor chip protection right is registered in theSemiconductor Chip Register without further examination and published in the PatentRegister.According to article 8 clause 1 of the Semiconductor Chip Act, protection does not simplybegin with the confidential commercial exploitation of the topography, (provided this isregistered within two years). Neither does it arise on the date of registration at the PatentOffice, given that the topography has not been previously exploited, or has only beenexploited within confidential commercial circles.Protection commences only once the semiconductor chip has been entered into theSemiconductor Chip Register. Article 8, clause 2 of the Semiconductor Chip Act makes it clearthat this protection expires at the close of 10 calendar years starting from the year in whichprotection was first awarded.In accordance with article 12 of the Semiconductor Chip Act, the protection afforded by theAct is transferable and inheritable.The Commercial Court of Vienna has exclusive jurisdiction for actions based on theSemiconductor Chip Act. According to article 13 of the Act, anyone can attack the validity ofthis protected privilege. Grounds of nullity arise where the topography was not capable ofbeing protected or when the claim to protection of a semiconductor chip has expired.According to article 4 of the Act, the latter occurs where the topography has not been usedoutside the confidential commercial sphere of activity for 15 years after the first recording, orwhere the topography was not registered at the Patent Office. It is also possible for nullity tobe declared where authorisation, as established by article 5 of the Act, was lacking or hadsubsequently been abolished. Authorisation is restricted exclusively to natural persons whoare citizens of, or residents in, the European Union (EU) or European Economic Area (EEA)countries, as well as those legal persons with actual establishments in these countries.Semiconductor chip protection may be declared void by application, when supportingdocuments to the report do not in fact correspond with the report. The person (or party)who is, in fact, the actual possessor of the topography, is also entitled to claim that the rightsbe deprived of the alleged owner and transferred to him.VIIICopyright LawThe Copyright Act protects intellectual property creations in the literary, musical, artistic, andcinematography fields. Moreover, the Act guarantees the protection of activities, such asartistic performances, photography, the carrying of sounds or images, broadcasting, and thenews.The term “author” is attributed to the creator of the work. There is a presumption that theindividual that is indicated as the author of a work is in fact the author of the work. Austriancopyright law is based on individual exclusive rights to exploit copyrighted work, so long asno legal restrictions exist.Pursuant to article 24 of the Act, an author can authorise third parties to exploit the creationin a regulated manner. The provision also makes it possible for the author to transferexclusive exploitation rights to a third party.- 40 -

In the latter case, the author maintains his right to legally contend any breaches to thecopyright, but he must refrain from using the work. The exclusive rights of exploitation areheritable, as well as alienable.Copyright durations awarded to works of literature, music, and fine art are determined bywhether the author of a work will be so characterised on the basis of the presumption ofauthorship, and whether or not the copyright was registered with the Copyright Registermaintained by the Federal Ministry of Justice.The Federal Ministry of Justice does not test the authority of the applicant seekingregistration or the correctness of the facts made. If the author’s rights are registered within70 years of the work’s creation, his copyright protection is given a 70-year time limit thatcommences on death, irrespective of whether or not the author can be classified in a mannerthat grounds his presumption of authorship. If, however, the author fails to register hiscopyright and the latter does not fall into one of the classified categories that establish apresumption of authorship, the copyright expires 70 years after the creation of the work.Copyright protection for cinematography works expires 70 years after the death of the lastliving director, screenplay author, dialogue author, or creator of musical works speciallyrequested for the film.The scope of protection of the Copyright Act encompasses authors of Austrian citizenship,irrespective of where their work is first produced. At the same time, all work that is producedwithin Austria is protected by the Act in accordance with article 95. In principle, foreignauthors whose works are not produced in Austria or based on Austrian-owned property maybenefit from the Act’s protection, so far as protection from their own countries, equivalent tothe Act’s protection, reaches them.IX Domain NamesThe protection of domain names, the alphanumerical chain of symbols formed to construct anInternet address, is a relatively new legal area still under development. Each domain can berepresented only once on the Internet and, thus, it is important to guarantee that only thechosen addressee is reached through the given address. This legal area has yet to be codifiedin Austria.At present, the intellectual property rights resulting from the use of domain names areprotected by the Austrian competition law regime. “Domain-grabbing” occurs when a personengaging in trade deliberately acquires a domain name, with the intention of sabotaging thecostly prior efforts of a competitor by using the name for his own business purposes or byexploiting his gained position at the expense of his competitor. This is considered unethicalunder article 1 of the Unfair Competition Act.A claim in deception can be made when another label is used as the domain name, therebymisrepresenting the origin and, thus, the qualities of the economic performance. A domainuser is acting in bad faith in the sense of article 9, clause 1, and is liable to pay damageswhen he uses the domain name in a manner that arouses confusion. An enterprise thatregisters a domain name as its website address uses this as an enterprise sign in the businessmarket. A danger of confusion occurs when the use of the domain name brings about thedanger that it may be wrongly associated with a particular enterprise.There is presently, however, no trademark or distinguishing mark protection for domainnames. Thus far, they have not been ascribed any distinguishing mark-like effects. It remainsto be seen whether domain names, which currently merely specify a machine rather than aperson, addressee, or sender of a message, may be treated as distinguishing marks in thefuture, thereby allowing users to freely choose the expressive force of distinguishing marksfor themselves. As a consequence of the present value attributed to domain names, noanalogy is drawn to marks that cannot prove distinctiveness and are thus prevented from- 41 -

trademark registration, in accordance with article 4, clause 1, sentence 3, of the TrademarkAct.The holder of a domain name is only entitled to the exclusive worldwide use of the domainname. There is no established right, however, to prevent third parties from using the domainnames for purposes other than the registered use of the domain name. Registration of adomain name occurs at the head office of the NIC.AT Internet Verwaltungs- undBetriebsgesellschaft mbH, based in Salzburg, Austria. Private law contracts are signed for thepurposes of registration. It is not possible to merely reserve a domain name. Note that theregistration of a domain name does not require any proof of Austrian citizenship; nor doesthe domain user have to be resident or headquartered in Austria.- 42 -

- CHAPTER F IIVE -LABOUR AND EMPLOYMENTIIntroductionAustria has comprehensive legislation covering all aspects of labour law. The main sourcesare:1. General Civil Code (ABGB). The Code, in particular Articles 1151 to 1164, sets out basicprovisions on the employment relationship.2. Labour Constitution Act (Arbeitsverfassungsgesetz). This Act provides basic provisions oncollective employment law. Of particular importance is the legislative authority containedin the Act to enter into collective agreements and enterprise agreements.3. Statutes on aspects of labour law. There are a considerable number of statutesregulating various aspects of labour law such as holidays, employment of foreigners andemployee liability.4. Statutes on types of employees. There are separate statutes regulating different types ofemployees e.g. manual workers, agricultural workers, salaried employees, domesticworkers, public servants and apprentices. Covering the most important and centralaspects of the employment law relationship for non-manual workers is the SalariedEmployees Act (Angestelltengesetz). Unless otherwise stated, the provisions of theSalaried Employees Act shall be referred to.II Contract of EmploymentiFormThere are no specific statutory requirements as to the form of a contract of employment. Itmay therefore be either in writing or oral. However, according to a 1993 Act(Arbeitsvertragsrechts-Anpassungsgesetz), where there is no written contract of employment,an employer is required to give the employee a written statement (called ‘Dienstzettel’) of themost important terms of the employment agreement, i.e. the starting date, the period ofemployment (if there is one), salary, holidays, termination terms etc.iiHiringaPreferential HiringAccording to the Employment of Invalids Act (Behinderteneinstellungsgesetz) a certainnumber of disabled persons must be employed, at present at least one disabled personfor each 25 employees. Failure to comply with this results in a payment obligation in lieuto the Federal Ministry for Labour, Health and Social Affairs.Other than that, there are no other requirements to give preference to any particularperson or group of persons when hiring.bForeign NationalsThe Employment of Foreigners Act (Ausländerbeschäftigungsgesetz) applies to thehiring of foreign nationals and contains restrictions on their employment. Except for astated number of exceptions, e.g. refugees who have been granted asylum, diplomaticand consular workers, guest lecturers at Austrian universities or art academies andschools, European Commission workers, citizens from the European Union or EEA- 43 -

countries, foreign nationals may not be employed in Austria without first obtaining awork permit.A work permit will only be granted to a foreign national if certain conditions apply. Inparticular, the labour office and authorities dealing with residency permits will check theterms of the proposed employment provisions, the accommodation proposed for theemployee, whether the current position and development of the employment marketwould permit the employment, to ensure that the employment does not conflict withany public or national economic interests.cDiscriminationThere is also an Equal Treatment Act (Gleichbehandlungsgesetz) which forbidsdiscrimination of the basis of sex, age, religion and otherwise with regard to all terms ofemployment, including hiring.iiiContentsaTerms Required or Imposed by LawMinimum Notice PeriodThe minimum notice periods fixed by the law depend on the provisions governing theemployment relationship and on the length of time the employee has been in thecurrent employment.For salaried employees, the periods which must be observed by the employer are asfollows:0–2 years 6 weeks’ notice to the end of the quarter of theyear2–5 years 2 months’ notice "up to 15 years 3 months’ notice "up to 25 years 4 months’ notice "more than 25 years 5 months’ notice "These notice periods may be varied, but not reduced, by collective bargainingagreements or by agreement between the employer and employee. For example, it canbe agreed that notice can be given to the 15th or to the end of every month instead ofonly to any quarter of a year.Salaried employees must observe a notice period of one month to the end of eachmonth. However this period can be shortened or extended up to a period of six monthsas long as the period to be observed by the employer is not shorter than the period tobe observed by the employee.According to the Business Licence Act and the General civil Code, employmentrelationships with manual labourers can be terminated under observance of a 14-daynotice period. However most collective bargaining agreements provide for longer noticeperiods which depend on the length of time the employee has been employed. In anycase, the notice periods for the employer and the manual labourer must be the same.Maximum Working HoursAccording to the Working Hours Act (Arbeitszeitgesetz), in general, an employee maynot work more than eight hours a day or 40 hours per week. Any hours worked inexcess of these hours will be deemed overtime and subject to additional compensationat a marked-up rate.The maximum working hours may be varied, but not increased, by way of collectiveagreements. The usual working hours fixed according to most collective agreements are- 44 -

at present 38.5 hours per week. As a result of the liberalization of the markets, theWorking Hours Act has been amended to include complex provisions on flexible workinghours which fix maximum average working hours over longer periods of time. Variouscollective bargaining agreements in specific industries allow longer working hours ifrequired by the nature of the business, as long as the average maximum hours over acertain fixed period are not exceeded.Minimum WagesThere is no fixed statutory minimum wage. Minimum wages are fixed in the collectiveagreements.If no minimum wage is fixed in the applicable collective agreement and no fixed salary iscontained in the employment contract, the salary paid to the employee must bereasonable (Art. 1152 ABGB).Minimum HolidaysAccording to the Vacation Act (Urlaubsgesetz) and National Holidays Act(Feiertagsruhegesetz), employees are entitled to the following minimum vacation andholidays per year:(i)(ii)(iii)25 working days for employees working Monday-Friday and who have workedcontinuously for the same employer for up to 25 years;30 working days for employees working Monday-Friday and who have workedmore than 25 years continuously for the same employer;All national holidays which are fixed by law. If such holidays fall on a Saturday, ifthat is not a working day for the employee, or a Sunday, then no day may betaken in lieu. Any person who is required to work on such a day will beremunerated additionally for that time. An increased payment will be made only ifagreed between employer and employee or if provided for in the applicablecollective agreement.Maternity/Paternity RightsThe Mothers Protection Act (Mutterschutzgesetz) and the Fathers Leave Act (Väter-Karenzgesetz) contain rights of both mother and father: The Mothers Protection Actprovides specific protection during pregnancy:(i)(ii)(iii)(iv)(v)(vi)(vii)Expectant mothers may not carry out any hard physical work, work that involvesparticular burdensome odours, physical burdens or work that implies a risk to thehealth of the mother or the child.Expectant mothers may not work with dangerous substances, dangerous rays orwork with the damaging effect of heat, cold or wet.Work in which the salary earned by a person is dependent on the level of herperformance is not permitted for pregnant women after the 20th week ofpregnancy.Expectant mothers may not carry out work which requires continuous sitting orstanding unless they can take short breaks.Expectant mothers may not work at places where there is smoking unless theemployee is a smoker herself, always provided this is possible at all in respect tothe type of business.Expectant or nursing mothers may not work overtime, total weekly hours mustnot exceed 40 hours and total daily hours must not exceed nine hours.Night work and work on Sundays and public holidays is permitted only in certaincircumstances set out in the Act.- 45 -

(viii) Pregnant employees may not work at all for the eight weeks prior to the expecteddate of birth and eight weeks after confinement, referred to as ‘the protectionperiod’ (Schutzfrist). If the protection period before the birth is reduced, theperiod after the birth can be increased to 16 weeks.Parental leave is permitted as follows:(i)(ii)(iii)(iv)One parent or both parents in turns lasting at least two months may take parentalleave up to the second birthday of the child. The total term of the leave may besplit between the parents twice.If a parent takes full time parental leave for a year after the birth, one parent orboth parents, in turns lasting at least two months, may take further part-timeleave for two years up to the child’s third birthday.If one parent takes full time parental leave for a year after the birth, both parentsmay work part-time for a further year.If no parental leave is taken, then both parents may work part-time in turns of atleast two months up to the seventh birthday of the child.An employer may not give notice of termination during the employee’s pregnancy anduntil four months after confinement. If an employee takes paternal leave, he isprotected from notice of termination until the end of four weeks following that leaveunless the prior consent of the Labour Court has been obtained.Night WorkAccording to the EU Night Work Adjustment Act (“EU-Nachtarbeits-Anpassungsgesetz”),persons who regularly or during 48 weeks per calendar year work at least 3 hoursbetween 10 p.m. and 5 a.m. are entitled to additional rest periods, free healthexaminations and, under certain conditions, transferral to a day job.Leave of Absence for Military or Other Public Service DutiesAccording to the Security of Job Positions Act (Arbeitsplatzsicherungsgesetz), anemployer must release an employee from his duties if the employee has received anorder that he attend military service.An employee who has been drafted to do military service may not in principle be givennotice from the time of the announcement or service of the drafting order until theexpiry of one month after the end of the military service. An employee must inform theemployer of the announcement or service of the drafting order without delay.Otherwise, military servicemen may only be given notice on limited grounds and withthe prior consent of the Labour Court (Article 12 (3) Security of Job Positions Act).Confidentiality of Employer’s SecretsThe duty of an employee to keep confidential his or her employer’s operational andbusiness secrets is contained in the following statutory provisions:(i)(ii)(iii)(iv)The Business Code (Gewerbeordnung) contains provisions on the duty ofconfidentiality imposed on manual labourers, factory workers and apprentices.Art. 115 (4), Labour Constitution Act contains the duty of confidentiality owed bymembers and representatives of members of the Workers’ Council.Art. 11, Unfair Competition Act (Unlauteres Wettbewerbsgesetz) provides that anyemployee who breaches his or her duty of confidentiality with regard to theemployer’s operational or business secrets may be convicted and sentenced to upto three months’ imprisonment or a fine of up to 180 days’ income.The breach of an obligation to secrecy by a salaried employee can constitutegrounds for immediate dismissal (Article 27 fig. 1, Salaried Employees Act).- 46 -

Non-compete ClausePost contractual non-compete clauses are permissible under Austrian law and can beentered into with both salaried employees and manual workers. The requirements areas follows:The employee must be at least 18 years of age.The restriction must be in the field of the employer and must not last longer thanone year. Non-compete clauses can include restrictions with regard to employed aswell as self-employed activities of the employee.The non-compete clause must be reasonable. Essentially, the employee may not berestricted to such an extent that he/she is forced to give up a trained profession andchange his/her field altogether. If the employee has the possibility of performinghis/her job in another field, or another geographic area, the non-compete clause willusually be deemed valid.An employer can only rely on a post-contractual non-compete clause if the employmentis terminated by the employee by no fault of the employer, or if the employee behavesin such a manner that would give grounds for immediate termination. In all other casesthe non-compete clause is enforceable only if the employer continues to pay the salaryof the former employee during the non-compete period.The parties can agree that an employee must pay a penalty if he/she breaches the noncompeteclause. If the employer insists on payment and the employee pays the agreedamount, he/she is then free to work for a new employer. The court can reduce theamount under certain conditions, the main case being that the amount is unreasonable.The non-complete clause is only enforceable provided the employee was earning EUR2,400 during the last month of employment.bFixed Term ContractsAn employment contract for a fixed term is valid under Austrian law. However, it is notgenerally possible to enter into a series of employment contracts for limited periods.Unless special economic or social reasons are present, such a series of contracts will bedeemed to be a chain employment contract and thus ineffective as fixed periodcontracts. The employment relationship will be deemed to be employment for anindefinite period. As a result, notice periods have to be observed.cEmployment for a Probationary PeriodEmployment for a probationary period for up to one month is permitted under Austrianlaw. During this time, the employment contract may be terminated by either party atany time (Art. 19 (2), Salaried Employees Act and Art. 1158 (2), ABGB) without givingany reason.It is not possible to add one probationary period to another, thereby extending theprobationary period beyond one month. Any probationary period of more than onemonth will be deemed to be a valid one month probation, which may be terminated atany time, followed by a fixed term contract for the remaining period.Unless specifically provided for in the applicable bargaining agreement, a probationaryperiod must be expressly agreed upon.dContracting Out of any Right to Compensation or Indemnity onTerminationAny contracting out of a right to compensation or indemnity upon termination will bedeemed invalid.- 47 -

iveFreedom to Agree ProvisionsThe employer and employee are free to agree on contractual provisions which are nototherwise regulated or compulsory by statute or by collective agreements. For example,the parties may agree on extended periods of notice, longer vacation, additional travelallowances, enhanced redundancy rights, stricter confidentiality provisions, anticompetitioncovenants, etc.Foreign EmployeesThe legal requirements relating to the form and content of employment contracts apply to allemployment contracts in Austria. No distinction is made in this regard between contracts withforeign national employees and with Austrian employees.Also non-resident employers, e.g. representative offices of foreign companies which employstaff in Austria or relocate staff to Austria are subject to Austrian labour law.III Termination of EmploymentiGeneralaForm of TerminationUnless otherwise provided for in the employment contract or in the applicable collectiveagreement, a notification of termination of employment need not be in writing.However, the notification of termination must be clearly given and the words‘notification of termination’ (‘Kündigung’) or ‘giving notice of termination’ (‘kündigen’)must be used.bLength of NoticeThe length of notice to be given by the employer and the employee will depend onvarious factors:a) Minimum notice periods as fixed by law (see II.iii.a above).b) The minimum notice periods may be provided for in the applicable collectivebargaining agreement and/or the terms of the employment contract.c) The maximum notice period available to be given by an employee is six months.d) The length of notice to be given by the employer may not be less than that given bythe employee. There is no cap on a maximum period.e) In contracts for a definite period the contract may provide that it may not beterminated at all during its period of validity unless grounds for immediate terminationarise.cSalary in Lieu of NoticeExcept in the case of immediate dismissal, both the employer and the employee mustalways give the applicable notice of termination and the employee has the right to bepaid his or her salary until the end of the notice period. However, it is possible for theemployer to release the employee from his or her duties during this period. This mayonly be done at the discretion of the employer and not the employee.dInforming the Workers’ CouncilIn enterprises where a workers’ council has been established, the employer must informthe workers’ council about any proposed termination of an employee at least fiveworking days before giving notice of termination. The workers’ council has the right togive its opinion or request consultation. Notice which is given prior to the workers’- 48 -

council having been given five days to give its opinion is invalid. When the workers’council has raised objections against the termination but the employer has neverthelessterminated the employee, the termination can be appealed at the Labour Courts withinone week by the workers’ council. If the workers’ council has not objected to thetermination or has refrained from making an appeal, the employee can appeal to thecourt. Possible grounds for appeal are illicit reasons for the termination or its violation ofsocial justice.eProtected EmployeesThere is a certain number of protected employees. Employees who are on sick leave forany reason are not protected from having their employment terminated. However, thefollowing types of employees are to a certain extent protected from having theiremployment terminated.Members of Workers’ Councils and Youth Welfare Councils established forLarger Business ConcernsThe prior consent of the Labour Court must be obtained before notice can be given.Consent will only be given if:(i)(ii)(iii)the business operations have been stopped or limited either wholly or in part andthe relevant member cannot be employed further; orthe member is not able to carry out the work he or she was contracted for and itis not expected that he or she will ever be able to do this; orthe member has persistently breached his or her employment duties.Workers within the Scope of the Protection of Mothers and Fathers Leave ActAs a general rule, effective notice may not be given to female workers from thecommencement of their pregnancy to the expiry of four months after the birth. If eitherthe mother or the father makes use of the right to take parental leave they may not begiven notice during the leave and up to the expiry of four weeks after the end of suchleave.Exceptions are:(i)(ii)if the female employee does not notify the employer of her pregnancy within fiveworking days after notice of termination of her employment has been given, or ifthe prior consent of the Labour Court has been obtained.Military ServicemenThose employees who have been drafted for military service may not be given noticefrom the time of the announcement or service of the draft order until the expiry of onemonth after the end of the military service. This protection will not apply if the employeefails to inform the employer of having been drafted without delay after receipt of theorder. Otherwise, military servicemen may only be given notice for limited reasons(Article 12 (3), Security of Job Position Act (Arbeitsplatzsicherungsgesetz) and with theprior consent of the Labour Court.An employment contract for a definite period will expire on the last date irrespective ofwhether the employee is carrying out his military service at that date.ApprenticesAn apprentice is given a fixed term contract. It can be terminated only on limitedgrounds i.e. expiry of term, the apprentice passing all examinations or death orincapacity of the master or apprentice.- 49 -

An apprenticeship may be terminated by consent which must be in writing. If theapprentice is under age, i.e. younger than 18, mutual termination is subject to theconsent of his or her guardian.Unilateral termination by either party must be in writing and only for the reasons statedin the Act.Invalids and Victims of Political PersecutionSuch employees may only be given notice upon receiving the consent of the InvalidsCommittee, an administrative department of the provincial Disabled Persons’ Office,after a hearing has taken place.A notification of termination to any of the above in breach of the rules concerningtermination will be deemed ineffective and the employment contract will continue toapply.fOlder EmployeesOlder employees who have been employed by the same employer for at least sixmonths can appeal against their termination at the Labour Courts within one week oftermination – even if no workers’ council has been established – based on violation ofsocial justice. In cases where the employer first hired the employee when the employeewas above 50 years of age, two years of service are required.gFactors Relating to TerminationFactors such as salary, seniority and age, except for those factors listed above, do nothave any effect on termination.hMandatory LawsThe laws on termination of employment may be varied to a certain extent by collectiveagreements and the employment agreement itself. The limitations are as follows:(i) The period of notice given must not be less than the minimum statutory periods.(ii) The period as given by the employer may never be shorter than the period to begiven by the employee.(iii) An employee in general cannot effectively contract out of his statutory entitlementsupon termination.iiTermination Without NoticeaWhere PermittedAn employment contract may be terminated without notice only for an importantreason.Termination by EmployerAn important reason sufficient to justify instant dismissal of an employee is if thatemployee has caused serious detriment to the employer’s interests.What amounts to behaviour considered a good reason for termination will depend onwhether the employee is a manual worker (‘Arbeiter’) or a salaried or non-manualemployee (‘Angestellter’).Manual worker:According to the Business Code (Gewerbeordnung) a manual worker can bedismissed immediately if he/she- 50 -

(i)(ii)presents false papers or gives false information about his/her otheremployment;has proved to be incapable of carrying out the work contracted for;(iii) becomes habitually drunk and is warned about this on several occasionswithout effect;(iv) steals, misappropriates funds or commits any other punishable offence whichmakes him/her unworthy of the employer’s trust;(v) betrays a business or operational secret or carries out other business which isdetrimental to his/her employment without the permission of the employer;(vi) leaves his/her work without authorisation or neglects his/her dutiespersistently or attempts to incite the other employees to1. disobedience or insubordination against the employer; or2. misconduct; or3. act in an immoral or illegal manner;(vii) 1. commits a serious defamation, physical injury or dangerous threat againstthe employer, his or her dependants or the other employees of the samebusiness;2. goes about carelessly with fire and light although he/she has beenpreviously warned about this;(viii) 1. suffers from repulsive illness; or2. is unable to carry out his/her work through his own fault; or(ix) is imprisoned for more than fourteen days.Salaried employee:According to the Salaried Employees Act (Angestelltengesetz), a salaried employeemay be dismissed if he/she(i)(ii)is disloyal in his or her employment, enables or allows unauthorisedadvantages to third persons while carrying out his work without theknowledge or consent of the employer or commits an act which makes him orher unworthy of the trust of the employer;is incapable of performing the promised services or those services consideredreasonable in the circumstances,(iii) without the consent of the employer1. carries out an independent commercial business; or2. makes transactions for his/her or another’s benefit in the premises of theemployer, or3. for employees of a trader, breaches a prohibition against competition;(iv) 1. fails to carry out his work duties for a lengthy period without a legalreason, or2. persistently refuses to carry out his/her duties; or3. does not carry out the authorised instructions of the employer; or4. tries to induce other employees to disobedience against the employer;(v) 1. serves a lengthy term of imprisonment; or- 51 -

2. is absent from work for a considerable period unless for an illness orinjury;(vi) commits an act of violence, breach of morality or serious defamation againstthe employer, his or her representatives or family members or otheremployees of the same business.These grounds for dismissal are not exhaustive if other serious reasons exist.Termination by EmployeeManual worker:According to Article 376(47) of the present Business Code and Article 82a of theprevious Business Code, a manual worker may leave the employment withoutnotice if:(i)(ii)he/she is not able to continue working without seriously damaging his/herhealth;the employer commits an insult or a serious defamation against him/her orthe members of his/her family;(iii) the employer or members of his family attempt to incite the employees or themembers of their families to act in or carry out immoral or illegal activities;(iv) the employer improperly withholds the agreed salary or breaches otheressential provisions of the contract;(v) the employer is not able to or refuses to give the employee his earnings.Salaried employee:According to Article 26, Salaried Employees Act an important reason entitling anemployee to leave his or her employment without notice is present if:(i)(ii)(iii)(iv)the employee becomes incapable of carrying out his/her duties or cannot dothis without damaging his/her health or morals;the employer reduces or withholds improperly the salary owing to theemployee, disadvantages him/her with regard to his/her perquisites byimposing unhealthy or insufficient food and unhealthy accommodation orbreaches other essential terms of the contract;the employer refuses to carry out obligations he/she is obliged to carry outaccording to law to protect the employee’s life, his/her health or his/hermorals;the employer commits insults, damage to the morals of or seriousdefamations against the employee or his/her family members or refuses toprotect the employee or his family members against such actions.b Where not PermittedThe termination of employment without notice is not permitted without importantreasons. In the case of improper termination, the following rights arise:For the Employer:A claim for damages arises. Assessment may, of course, be rather difficult.For the Employee:As a general rule, even if the termination is found to be improper there is no right ofreinstatement. Rather, the employee is entitled to claim as follows:- 52 -

(i)(ii)(iii)(iv)Damages. This is calculated as salary for the period to the end of the employmentcontract by way of ordinary notice which would have to have been given by theemployer. For the first three months it is calculated without regard to any newemployment but for the rest of the time, salary received in the new employmentwill be taken into account (Article 29 (1), Salaried Employees Act, Article 1162(b),General Civil Code).Pro-rata vacation compensation. This is calculated on the basis of the vacationallowance for a year which has not been used, and the point during that yearwhen employment ends.Proportionate share of the Christmas remuneration, additional holiday payment(the 13th and 14th salaries) and other remunerations allowed under Austrian law.Any applicable severance pay or as agreed, (see D.1.a.iv) below).iiiTermination With NoticeaWhere PermittedProvided that termination with notice is permitted, there is no requirement to show cause orgood reason in order to give notice. The only requirement for such termination is that theproper period of notice is adhered to and the notice itself is properly given. See III.i.b.b Where not PermittedTermination with notice will not be permitted unless certain conditions are met in thefollowing cases:Multiple TerminationsEvery employer must notify the relevant government employment office(Arbeitsmarktservice) in writing not less than 30 calendar days before, if within a 30-dayperiod(i)(ii)(iii)(iv)in businesses with 21–100 employees, the employer intends to terminate five ormore employees,in businesses with 100–600 employees, the employer intends to reduce thenumber of employees by at least 5 per cent,in businesses with more than 600 employees, the employer intends to reduce thenumber of employees by at least 30, andin any businesses, the employer intends to terminate five or more employeesabove the age of 50 years.The notification of termination procedure may then only take place upon obtaining theapproval of the employment office.Please refer to III.i.e above with regard to the following:Members of Workers’ Council.Workers within the Scope of the Protection of Mothers Act and Fathers Leave Act.Military Servicemen.Apprentices.Invalids and Victims of Political Persecution.- 53 -

ivLegal Consequences for Employer and Employee on TerminationaRights of Employee on Termination by EmployerTermination on NoticeWhen the employee’s contract has been terminated by the employer, he or she hascertain minimum entitlements:(i)(ii)(iii)(iv)(v)A certain amount of free time each week to seek new employment. This time isoften fixed by collective agreements and in any event the Salaried Employees Actstates that an employee is allowed at least eight hours per week to seek newemployment, unless the employee is the party who terminated the contract.Wages to the end of the applicable notice period. If the employer does notcomply with the notice period, the employee is in any event entitled to thosewages.Pro-rata vacation leave not yet taken. This is calculated on the basis of thevacation allowance for a year which has not been used and the point in timeduring that year at which employment ends. Proportional share of the Christmasremuneration holiday payment and other remunerations due under Austrian law,including any variable compensation.Severance payment scheme. In general, severance payments have beenabolished for all employees who commenced their current employment on or after1 January 2003.Employees who began work before that date and whose employment contract isterminated either by the employer giving notice, by mutual agreement betweenthe parties or by the employee for a valid reason and who have worked with thesame employer for at least three years are still entitled to a statutory severancepayment (‘Abfertigung’). The amount will depend on the period the employee hasworked and is calculated as follows:Employment Severance payafter 3 years 2 monthly remuneration paymentsafter 5 years 3 monthly remuneration paymentsafter 10 years 4 monthly remuneration paymentsafter 15 years 6 monthly remuneration paymentsafter 20 years 9 monthly remuneration paymentsafter more than 25 years 12 monthly remuneration paymentsThe ‘monthly remuneration payment’ is the average amount an employeereceived per month, including pro-rata 13th and 14th salaries, bonus payments,payments for regular overtime, commissions etc.In case of dismissal by the employer for a valid reason or in case of ordinarytermination by the employee no severance payment is due.An employee is also entitled to severance payment if the employment isterminated by his retirement. The family of a deceased employee is entitled tohalf of the severance pay the employee would have been entitled to at the time ofhis death if the employment had been terminated. Similarly, pregnant women areentitled to terminate their employment and nonetheless receive half of theirseverance pay.Employee Benefit Funds. In order to promote the mobility of employees and toallocate available human resources more efficiently, the system of severancepayments has been abolished for all employees who started work on or after 1January 2003 and has been replaced by a different system set out in theEmployee Benefit Act (“Mitarbeitervorsorgegesetz”) as follows:- 54 -

1. The employer must enter into an agreement with an Austrian EmployeeBenefit Fund which are mainly institutions affiliated with banks and/orinsurance companies.2. For each employee, the employer must pay monthly instalments of 1.53per cent of the employees’ gross monthly salary (incl. 13th/14th salaries).The amounts are paid together with the regular social security paymentsand the social security authorities then transfer the respective amounts tothe Employee Benefit Fund.3. The employer must pay the contributions to the Fund from the start of theemployment (with the exception of the first month); no minimum durationof the employment relationship is required.4. Once the employment relationship comes to an end, the employee doesnot have a claim against the employer, but instead against the Funddirectly. Entitlement is not dependent on the way in which theemployment was terminated and therefore even employees who are terminatedfor cause retain their entitlement.5. After three years of employment, an employee can request that the Fundpays out the accumulated amounts in the event that the employer terminatesthe employment, the employment is terminated mutually or theemployee terminates the employment for good cause. In the event of theemployee’s death, his/her heirs can claim the amounts.6. Alternatively, the employee can choose to leave the accumulated amountsin the same Employee Benefit Fund for further investment, transfer theamounts to the Employee Benefit Fund of a new employer, transfer theamounts to an insurance company of their choice as a one-off paymentfor an insurance policy to be used as an additional pension, transfer theamounts to a pension fund at which the employee already has anentitlement or transfer the amounts to a financial institution of theirchoice for the purchase of shares in a pension investment fund understipulation of an irrevocable pay-out plan.7. From an Austrian taxation point of view, all contributions made to theEmployee Benefit Fund are expenses that can be written off on the part ofthe employer.8. Persons who were employed prior to 1 January 2003 may remain underthe old severance pay system (see above), or may at their discretionwholly or partly transfer to the new severance pay system. This requires awritten agreement between the employee and the employer.Dismissal Without NoticeIn general, the employee does not have a right to reinstatement. However, he doeshave the right to damages and the entitlements referred to in a).bRights of Employer on Termination by EmployeeThe improper termination of the employment contract by an employee, i.e. if withoutnotice there is no important reason or, if with notice the period of notice prescribed isnot complied with, terminates the employment relationship with immediate effect. Theemployer will generally only have a claim for damages. The decision on the quantum ofdamages must be assessed by the court and will be calculated on what is fair andreasonable in the circumstances.- 55 -

vSpecial Provisions relating to Plant Closures, Cutbacks etcThere is no legally defined concept of plant closure or cutback. However, there is somestatutory regulation relating to closures and cutbacks of larger business concerns as follows:aStatutory RequirementsPrior Approval of Government Employment OfficeAn employer must notify the relevant government employment office(Arbeitsmarktservice) in writing by completion of a specific form not less than 30calendar days before if, within a 30-day period(i)(ii)(iii)(iv)in businesses with 21–100 employees, the employer intends to terminate five ormore employees;in businesses with 100–600 employees, the employer intends to reduce thenumber of employees by at least 5 per cent;in businesses with more than 600 employees, the employer intends to reduce thenumber of employees by at least 30; andin any businesses, the employer intends to terminate five or more employeesabove 50 years of age.If notice of the intended reduction is not given at least 30 days before giving notice tothe employees then any such notice to employees is ineffective.Consultation with Workers’ CouncilAn employer must inform the workers’ council of any limitation or shutdown of thewhole or a part of the business operations (as well as other significant changes to thebusiness operations). The notification must be given with sufficient time to allow theworkers’ council to give their opinion on the measures contemplated. The workers’council may make suggestions to prevent, add or reduce any consequences of themeasures undertaken which are disadvantageous to the employees.If there are considerable disadvantages for all or most of the employees in businesseswhere there is an average of at least 20 employees, then measures may be fixed inorder to prevent, avoid or reduce these consequences. In case of dispute concerningsuch measures between the employer and the workers’ council, an application may bemade to a statutory arbitration board for resolution of the dispute. (Article 109, WorkersConstitution Act).b Special PaymentsThere are no special payments to be made to employees made redundant as a result ofplant closure or cutback. The payments due are those accorded to all employees upontermination of the employment relationship, including severance payments, whereapplicable, in accordance with the statutory provisions, collective agreements and theemployment contract.cOther Rights of a Redundant EmployeeWith the exception mentioned above, there is generally no right for an employee toobject to his or her dismissal provided the employer has otherwise complied with hisobligations upon termination and the employer is not breaching the terms of thecontract by terminating, e.g. by giving notice on a fixed term contract which does nothave provision for early termination.The employee’s only right to complain is if he or she is in any way not treated equallywith regard to the termination or if an employee is terminated for an implicit reason. An- 56 -

viexample would be if some employees were given arbitrarily longer periods of notice thanothers. The remedy will not be reinstatement but rather financial compensation.Provisions upon Takeover of a BusinessIn the event a business is taken over, the buyer of the business is obligated to also ‘takeover’ the employees of the business. The obligations to all employees become the mandatoryobligations of the buyer. The buyer has no choice as to the employees who should or shouldnot be retained in the business. This protection to employees is given under the law relatingto employment contracts (Arbeitsvertragsrechts-Anpassungsgesetz – AVRAG), which cameinto effect partly on 1st July 1993 and finally on 1st January 1994. Also an asset deal maycome under these rules if for instance a particular business line is sold or closed andoutsourced.vii Foreign EmployeesThe legal requirements governing the termination of employment contracts apply both toAustrians and to foreign nationals equally. There is no distinction made between theemployees in this regard.IV Equal PayThe Equal Treatment Act 2004 requires in the private sector that there be equal pay andconditions for equal work. There are also provisions for employees in the public sector andmany collective agreements provide for such equality.If an employer breaches the terms of equal pay for equal work provided for under a collectiveagreement, the employee’s remedy is to take the matter to the Labour Court to have theappropriate remedy determined. The court has power to require the employer to pay thedifference between the actual salary paid and that salary which the court determines shouldbe paid.VDiscriminationThere is an Equal Treatment Act (Gleichbehandlungsgesetz, mainly for private employmentand areas outside the field of employment) and the Federal Equal Treatment Act (mainly forfederal public service) which both outlaw discrimination on the grounds of sex, marital status,ethnic background, religion or philosophy of life, age or sexual orientation in employment, inparticular with regard to:- entering into employment;- salary;- offering social services to employees;- measures related to educational and vocational training with an employer;- promotion;- other employment conditions;- termination of employment, as well as other areas of the employment world.Discrimination on the grounds of disability is not permissible either.The Acts provide for various remedies which range from damage payments for not havingbeen interviewed for discriminatory reasons, to being entitled to the difference between whatone received as salary, and what one should have received. Penalties can also be imposed onemployers for breaching the Acts.- 57 -

The provisions are mainly enforced through the Equal Treatment Commission which isresponsible for hearing claims by employees of discrimination and for fixing all relatedregulations. The Commission may award damages and impose fines in accordance with theActs.VI The Right to StrikeIn Austria there is no special legislation relating to strikes and lock-outs. Therefore, thegeneral provisions of public and private law apply. Therefore, civil law and penal provisionswill determine the limits of permissible behaviour and activities in strikes.As a result of this situation, it is certainly possible that the participation by an employee in along-term strike could represent a ground for dismissal. This may however be a questionableground because it is unlikely that his situation in relation to a breach of the employmentcontract would not have been fully explained to him by the unions.VII Trade UnionsiThe Role of Trade UnionsIn Austria there are two types of trade associations representing employees’ interests.aVoluntary Trade AssociationsThe most important voluntary trade association in Austria is the Austrian Trade UnionsAssociation (Österreichisches Gewerkschaftsbund – ÖGB). The ÖGB is a nongovernmentalorganisation and consists of sixteen branches according to differentindustries. Its duties are determined in its statutes. Its activities focus on protecting theemployees’ interests in the areas of employment, social welfare and service law, socialpolitics, other economic policies and workers’ education. In addition, membership alsooffers special benefits such as legal protection and solidarity insurance cover.bCompulsory AssociationsIn addition, there are trade association bodies in Austria which represent employees’and employers’ interests with compulsory membership. The trade association foremployees are the workers’ chambers (Arbeiterkammern).In comparison to the ÖGB, which is established as a private law association and is alegal entity in its own right, the workers’ chambers are organisations of public lawestablished by special statutes. They are established as the statutory representatives ofthe members of certain areas of employment. Membership of the different chambers isdetermined by law and is compulsory. The chambers are self-governing bodies.The roles of the workers’ chambers include the following:a) to prepare reports, suggestions and opinions concerning matters relating toemployees’ interests for statutory bodies and authorities;b) to prepare opinions on drafts of legislation, regulations and other legal provisionsrelating to these matters;c) to have representatives in organisations and offices or to make suggestions onsuitable representatives if and to the extent provided for by law;d) to be involved in all measures and arrangements concerning the employmentrelationship or the economic and social position of employees;e) to be involved in the supervision of maintenance of employment protection provisionsas well as to establish apprentice and youth protection offices and through them to- 58 -

iilook after the apprentice and occupational education rights as well as youthprotection;f) to act for employees in negotiating collective agreements.Special Treatment of Trade UnionsDelegates to the workers’ chambers and Trade Union representatives must be given time offwork by their employers to be able to attend to their union duties.VIII Arbitration/ConciliationThere are two authorities acting as arbitration or conciliation panels in employment disputesin Austria:1. Arbitration boards. An arbitration board (Schlichtungsstelle) has authority to decidedisputes concerning the entry into and amendment or termination of enterpriseagreements in matters provided for in the Act upon application by one of the parties tothe dispute. The arbitration board, which consists of a chairman and four co-arbitrators,will sit at the district where the relevant business operation is situated. An arbitrationboard has jurisdiction to conciliate between the parties, make suggestions to resolve theissues and to be involved in reaching an agreement between the parties. If necessary, itmust also give a decision. It is not possible to appeal against any such decision.2. Labour Court. This court (Arbeits-und Sozialgericht) is the main authority supervising therelationship between employers and employees. The court has power to resolvedisputes, give rulings on disputed issues and act as conciliator. The court is situated withevery district court throughout Austria.IX Workers’ Participation in ManagementWorkers’ participation in management is limited to companies which have both a workers’council and a supervisory board. In these instances at least one third of the members of thesupervisory board must be employees and are delegated by the workers’ council to sit on thesupervisory board.Supervisory boards are mandatory in joint stock corporations and in certain limited liabilitycompanies as a second tier of governance which has the task to appoint, dismiss and controlthe board of directors.- 59 -

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- CHAPTER S IIX -PENSIONS AND SUPERANNUATIONIState PensionAustria with its traditionally very strong social welfare policies has a very comprehensive statepension system. As a result, every employee is a participant as a beneficiary of the pensionsystem. As has been the case in most European countries over the past few years, Austriaunderwent a major pension reform in 2003 which has brought and will bring major cuts incomparison to the previous system. The following are some specific features of the pensionsystem:iPension AuthoritiesThere are several large state authorities responsible for the maintenance of records,collection of contributions and distribution of pensions. The authority which is relevant willdepend on the residence and occupation of the employee. For example, the relevantauthority for an office worker resident in Austria is the Pensionsversicherungsanstalt fürAngestellte and for blue collar workers it is the Pensionsversicherungsanstalt für Arbeiter.Other pension authorities are in charge of public servants, agricultural workers, farmers,entrepreneurs etc.iiContributionsContributions to the state pension fund are compulsory and are paid in approximately equalportions by the employer and employee. The employer has the duty to pay the contributionsby:iiia) paying his contribution directly to the fund, andb) withholding the employee’s contribution from his or her salary and paying it to thefund on behalf of the employee.Amount of PensionThe amount of a pension received by a former employee will depend on the years ofemployment and the amount of his or her salary. As a result, a highly paid employee who hasworked for 40 years will receive a higher pension than an employee who has earned a lowersalary and/or worked for a shorter period.ivRight to PensionThe right to a pension will arise when the employee has:a) Retired at the age set down by the law provided the employee has had contributionspaid in for at least 15 years. At present the compulsory retirement age for men is 65years and for women 60 years.b) Retired due to ill health or other recognised incapacity to work, provided generallythe employee has worked for at least a minimum amount of time which depends onhis/her age and other criteria, unless the incapacity is due to a work accident oremployment related illness.c) Died, provided the employee has worked for at least a minimum amount of yearsdepending on his/her age and the length of the marriage. In this case, spouse anddependant children are the recipients.- 61 -

It is no longer possible to go into early retirement due to long employment althoughexceptions exist for manual workers. Before 1st January 2004, pensions were calculated onthe basis of the last 180 months of employment however the basis will increase to the last480 months by 2028. Income earned in past years will be revalued at a far lower rate thanpreviously. It is also no longer possible to retire due to long unemployment.vTreatiesAustria has signed an extensive number of bilateral treaties with other countries with regardto the transfer of pension rights from one country to the other. At present Austria has signedtreaties with the following countries: Australia, Belgium, Bosnia-Herzegovina, Bulgaria,Canada, Chile, Croatia, Czech Republic, Cyprus, Denmark, Hungary, Finland, France,Germany, Great Britain, Greece, Ireland, Island, Israel, Italy, Korea, Kosovo, Liechtenstein,Luxembourg, Macedonia, Moldavia, Montenegro, Netherlands, Norway, Philippines, Poland,Portugal, Romania, Serbia, Slovakia, Slovenia, Spain, Sweden, Switzerland, Tunisia, Turkey,Uruguay and USA.II Private Pension Arrangements/SuperannuationIn 1990, the Austrian Parliament passed two statutes on non-state pension arrangementscalled the Pensionskassengesetz (Pension Funds Act) and the Betriebspensionsgesetz(Company Pensions Act). The purpose of these statutes is to overhaul the laws on privatepensions which had been scattered throughout various statutes and thus to provide for themost relevant regulations to be contained in these two statutes. Additional regulations arecontained in the tax laws and regulations. The Acts contain a system of strict control over andsupervision of the entities running pension funds.iRestrictions on who may set up a Non-state PensionA pension fund may only be operated by a stock corporation (Aktiengesellschaft) which isregistered in Austria. The various legislative requirements for such a company include thatthe paid up capital of a pension fund entity must be at least EUR 5 million (approximatelyGBP 3.5 million).The control over who may set up a non-state pension is given to the Austrian FinancialMarket Authority. An enterprise wishing to set up a pension fund must apply to the AustrianFinancial Market Authority for a special business licence. According to Article 9 of the PensionFunds Act, the application for a licence will be rejected if:The Articles of Association or the business plan (which must also be submitted withthe application) do not contain provisions which ensure the fulfilment of thepension fund’s obligations or the proper administration of the pension fund;The shareholders who own at least 10 per cent of the paid up capital of the funddo not have the prerequisites required to properly manage the pension fund;The structure of a group of companies with shareholders owning at least 10 percent of the pension fund’s paid up capital would prevent effective supervision ofthe fund;The pension fund is not intended for at least 1,000 beneficiaries;The capital is not available in an unlimited and unencumbered manner to the boardof directors as required in Article 7 of the Act;The seat of the pension fund is outside of Austria;It is not intended that the pension fund should be in the form of a stockcorporation;A member of the board of directors has been found guilty of committing apunishable offence contained in Article 13 of the Business Licence Act 1994;- 62 -

A criminal investigation is under way against a member of the board for a crimepunishable with a sentence of more than one year of imprisonment, until theinvestigation has ended;A member of the board of directors does not have the appropriate training or thenecessary characteristics and experience;Not at least one member of the board is a resident of Austria;Not at least one member of the board speaks German;The pension fund does not have at least two members of the board of directorsand if the articles of association do not exclude a right of sole representation or acommercial power of attorney for the entire business operation;A member of the board of directors of the pension fund entity has another mainoccupation besides acting for the pension fund;With regard to corporate pension funds, the intra-business agreement and/or othercontracts with regard to the formation of the corporate pension fund do not complywith the provisions of the Company Pensions Act.The Financial Market Authority also has the power to withdraw licences.iiForms of Pension ArrangementsThe pension arrangements between the employer and employee will be contained in eitherthe contract of employment or an applicable enterprise agreement and they must be inaccordance with the provisions of the Company Pensions Act. The employer is then requiredto enter into a contract with the pension fund and this contract must correspond with theagreement between the employer and the employee.iii Legal StructureAs stated above, a non-state pension must be by way of an undertaking by the employerwhereby the contract regulates the duties to be performed by the pension fund in relation tothe beneficiaries. The undertaking does not have to be in writing to be enforceable.iv Registration RequirementsThere is no requirement as such to register a non-state pension arrangement with any officialregistration body. However, as a pension fund is not permitted to operate without a businesslicence granted by the Austrian Financial Market Authority, details of all operating pensionfunds in Austria will be maintained by the Authority.vTypes of InvestmentsThe Pension Funds Act contains the following provisions on investments by pension funds:Article 1(3) – Pension funds may not carry out any business which is not related to theadministration of pension funds. By implication this excludes speculative activities.Article 14 – Hedging transactions are only permitted when they serve as auxiliary transactionsin connection with securing investments according to Article 25.Article 25(1) – A pension fund must invest its assets in either:1. - Investment stock in which the payment of a fixed amount is promised,- loans to the Republic of Austria, its provinces or another EU member country, or loansin relation to which the Republic of Austria, its provinces, an EU country or a bank areliable for repayment and interest,- mortgage loans,- loans to employers contributing to the pension fund.- 63 -

2. shares, securities for participation capital and supplementary capital, rights of options,and3. income yielding land and buildings in an OECD country.Article 25(2) - The above investments are subject to conditions and restrictions, the mostimportant of which are as follows:1. Securities under fig. 1. and 2. above, with some exceptions, must in general be quotedat a national stock exchange or a stock exchange of an OECD country,2. Investments in assets in Euro under fig. 1. must have a value of at least 35 per cent ofthe total assets,3. A maximum of 50 per cent of the total assets may be invested in assets under fig. 2.above.4. A maximum of 20 per cent of the total assets may be invested in assets under fig. 3.above.5. A maximum of 50 per cent of the total assets may be invested in assets in foreigncurrencies according to (1) fig. 1. and 2. as well as assets according to (1) fig. 3 inforeign countries,6. A maximum of 10 per cent of the total assets according to (1) fig. 1. above may beinvested in assets from the same issuer,7. A maximum of 5 per cent of the total assets may be invested in commercial papers,8. Investments in index certificates are only permissible if they are from a financialinstitution with its seat in a “Zone A” country.Article 25(3) - Investments in share certificates of capital funds are permissible as long as1. the allocated assets, when added to the pro-rata assets held in the capital investmentfund do not breach (1) and (2) above,2. the share certificates are from a capital investment company with its seat in an OECDcountry, and3. there are no cost disadvantages to the beneficiaries.Note: The above is a summary of detailed provisions on investments which include definitionsand explanations on various provisions. The above should thus be seen only as a generalsummary of the requirements and restrictions.vi Minimum or Maximum Funding RequirementsAs stated above, pension funds are required to maintain a minimum capital of EUR 5 million.Furthermore, there are detailed provisions in the Pension Funds Act concerning calculation ofassets and funding.vii Favourable Tax TreatmentThe Income Tax Act (Einkommensteuergesetz) provides that pension contributions paidunder the Pension Funds Act in most circumstances will be recognized as tax deductable.viii Insurance RequirementsAccording to the Pension Funds Act, an application to the Austrian Financial Market Authorityfor a business licence to operate as a pension fund must be accompanied by a business plan.This business plan must contain details of the services which will be offered, an explanationof the circumstances which will protect the interests of the beneficiaries and will enable thecontinuing fulfilment of the pension fund’s obligations and detailed accounting of the contributionsand performances. Further, insurable risks which, from the business plan thepension fund is not able to pay itself, must be covered by an insurance company.- 64 -

ixSurplus of AssetsThe Pension Funds Act contemplates both a surplus and a deficit of assets. There are detailedprovisions of the accounting in both circumstances. Article 24a(6) states that if there is asurplus of assets above the assets provided for in the business plan or by way of directorsresolution, there must be an annual cancellation of 10 per cent of the difference. Although itis not specifically stated, this will presumably be by way of debiting the pension accounts.xPension Aspects of purchasing or selling BusinessesAny pension arrangements established with employees must be transferred to the purchaserwho must take over the obligations of the previous employer with regard to the pension.The Income Tax Act lays down strict rules with regard to taxable accounting of pensioncontributions and benefits. These are contained in Article 124 of the Act and, for example,contain provisions of what will be considered a liability and what an asset. Contingentliabilities must also be considered.xiAdditional AdvisersAccording to the system of controls built into the Pension Funds Act to protect beneficiaries ofthe funds, pension funds are required to obtain additional advice from the following:a) An actuary who is responsible for preparing, or directing the preparation of, the businessplan and to supervise compliance with the plan. The actuary must be appointed by thepension fund’s supervisory board.b) A supervisory actuary who must be an independent adviser and who must in particularsupervise the following:a) Whether the operations of the business correspond to the business plan;b) Whether changes to the contributions or services provided are necessary;c) Whether and to what extent the employer must provide any cover; andd) Whether the requirements for insurance have been satisfactorily taken intoaccount.Furthermore, the supervisory actuary must give his approval to the business plan as well asany amendment to it before the authorisation of the Austrian Financial Market Authority isgiven.© Law Offices Dr. F. SchwankApril 2013- 65 -

Law Offices Dr. F. SchwankStock Exchange BuildingWipplingerstrasse 34ViennaA-1010 AustriaTel.: +43-1-533 57 04Fax: +43-1-533 57 06Fax: +43-1-535 63 41E-mail: offices@schwank.comOffice hours: 8.00 - 19.00 (CET)- 66 -

How to Invest in Brazila guide to investors2014

INDEX OF CHAPTERS1. FOREIGN INVESTMENT CAPITAL AND CENTRAL BANK OF BRAZIL .................. 32. THE BRAZILIAN ANTITRUST ACT (LAW 12,529/2011) AND THE PRE-MERGERREVIEW SYSTEM ..................................................................................................... 83. COMPANIES .............................................................................................................. 104. INDUSTRIAL PROPERTY .......................................................................................... 245. REAL ESTATE ........................................................................................................... 276. TAX SYSTEM ............................................................................................................. 317. LABOR LAW AND SOCIAL SECURITY ..................................................................... 488. INFORMATION TECHNOLOGY ................................................................................ 569. INOVATIONS TO BID – PUBLIC AUTHORITY CONTRACTS .................................. 6110. PUBLIC-PRIVATE PARTNERSHIPS IN BRAZIL (PPP) .......................................... 6511. ELECTRIC POWER SECTOR ................................................................................. 7212. ENVIRONMENT AND SUSTAINABILITY................................................................. 7813. MANAUS FREE TRADE ZONE, EXPORT PROCESSING ZONES AND AREASOF FORMER SUDENE AND SUDAM ..................................................................... 8014. FISCAL INCENTIVES ............................................................................................... 8415. ACQUISITION OF COMPANIES .............................................................................. 9116. FOREIGN INVESTMENT IN THE FINANCIAL MARKET ………….......................... 9317. REMITTANCE OF PROFITS AND DIVIDENDS TO INVESTORS DOMICILEDABROAD ….…………………………………………................................................. 9418. REPATRIATION OF INVESTMENT ......................................................................... 9419. INTERNATIONAL TREATIES .................................................................................. 9520. ENTRY OF FOREIGN WORKERS INTO BRAZIL ................................................... 10521. ARBITRATION .......................................................................................................... 10822. HEALTH UNDER BRAZILIAN LAWS ....................................................................... 11023. MINING ..................................................................................................................... 11624. OIL & GAS................................................................................................................. 12125. ABOUT L.O. BAPTISTA, SCHMIDT, VALOIS, MIRANDA, FERREIRA, AGEL........ 1282

1. FOREIGN INVESTMENT CAPITAL AND CENTRAL BANK OF BRAZIL1.1. Foreign Direct InvestmentAssets, machinery and equipment brought into the Country without an initial outlay of foreign currency,to be employed in the production of goods or services, and financial or monetary resources admittedinto the Country for investment in business activities, are considered foreign capital, provided that inboth cases they belong to individuals or corporate entities residing, domiciled or based abroad, andmust be registered electronically with Central Bank of Brazil (BACEN), through an investor-recipientrelated code called RDE-IED, which was initially instituted through the repealed BACEN Circular 2,997of 11 August 2000, and currently ruled by Resolução 3.844, as of March 24, 2010 ("Resolução 3.844")and Circular 3.689, as of June 12, 2013 ("Circular 3.689"), both issued by the Central Bank.Registration at BACEN is a condition for the remittance abroad of profits and dividends, and intereston owners‟ equity, obtained by means of investments made in the Country and guarantees theinvestor the possibility of repatriating the resources invested.The investor can also invest in Brazilian companies through the conveyance of tangible goods(machinery and equipment), provided that such goods are imported, without the obligation of apayment to a nonresident. In this case, the registration must be made, firstly, in the ROF – Registro deOperação Financeira (Financial Operation Registration) module of the RDE, and, subsequently, in theIED module of the RDE as foreign direct investment. This Registration in the RDE-ROF module mustbe linked to the cleared Import Declaration (Declaração de Importação – DI).In addition to investments in corporeal property to be employed in the production of goods andservices, BACEN also accepts such intangible goods as trademarks, patents and know-how, as thesubject of investment as foreign capital. The registration of intangible goods in BACEN should also bedone through the RDE-ROF module, linked to an invoice or equivalent document that characterizesthe importation of the intangible goods, provided that approved by the agency responsible for theregistration and control of industrial property rights in the Country, namely the INPI (Brazilian Patentand Trademark Office). Finally, the registration is conducted in the RDE-IED module.According to the Circular 3.689 rules, the technology transfer subject to INPI registration does notcharacterize an intangible good for the purposes of the financial operation registration designed for thepayment of the capital of Brazilian companies.The foreign investor may also make investments through the conversion of credits that are capable ofgenerating transfers abroad, such as foreign loan principal and interest duly registered in the RDE-ROF Module, profits or dividends, interest on owners‟ equity and other amounts remittable abroad.3

On the basis of the declarations and data informed electronically to the Electronic Central BankSystem – SISBACEN, by companies or their representatives, a Consolidated Foreign DirectInvestment Registration Statement will be generated. This statement is the appropriate document toevidence the investment made by the foreign investor before third parties.The investment registration procedure shall be formalized within 30 days from the investment’s entryinto Brazil. In relation to foreign investments through tangible goods, the registration period is 30 daysfrom the customs clearance date of the goods, on pain of submitting the recipient company of theinvestment to the application of a fine of up to R$ 250 thousand, in conformity in accordance with theprovisions of the Resolução nº. 4.104, as of June 28, 2012, issued by Central Bank.The aforesaid registration will be made in the foreign currency actually brought into the Country or inthe amount declared in the import document of the goods.Profits distributed by companies established in Brazil and allocated to residents and individuals orcorporate entities domiciled abroad, but that are reinvested in the same companies from which theyoriginated or in another sector of the Brazilian economy, are also subject to registration as foreigncapital, with BACEN.Foreign investors with ownership interests in Brazilian companies may transfer these interests to thirdparties abroad. The foreign purchaser, notwithstanding the price paid for the acquisition, must alter theConsolidated Foreign Direct Investment in Brazil Registration Statement, obtaining a new RDE-IEDregistration number, which will identify its investment in substitution of the assigning investor, in orderto permit future remittances, profit reinvestment registrations and any repatriation of the investment.Lastly, it is important to mention that individuals or companies domiciled or based abroad, that haveownership interests and other assets in Brazil are obliged to register in the CPF (Federal Register ofIndividual Taxpayers) and CNPJ (Federal Register of Corporate Taxpayers), respectively.1.2. Foreign Investment in Local CurrencyIn 2007, BACEN published new foreign exchange rules permitting the registration in local currency ofownership interests held by a foreign partner, which, up to that time, could not be made at BACEN,due to there being no evidence of the regular entry of the resources into the Country (via thecontracting of foreign exchange, as determined in the prevailing foreign exchange regulations). Thissituation was known as “tainted capital” (capital contaminado). The consequence of this situation,among others, was that of not permitting the remittance of profits and dividends abroad on theunregistered portion of the capital/investment.4

In accordance with the new rules, foreign capital should only be registered with BACEN, in localcurrency, if the respective amount is stated in the accounting records of the Brazilian recipientcompany of the foreign capital, and if there is documentary evidence with respect to the ownership ofthe foreign capital.Once the registrations are regularized with BACEN, the foreign investor is authorized to return abroadthe total computed profits and dividends, among others, up to the limit of the holdings held in thecompany.Lastly, the capitalization of profits and dividends, interest on owners‟ equity and profit reserves,originating from the portion of the capital registered in local currency, are subject to the sameregistration modality.1.3. Foreign Loans1.3.1. Foreign loans via the foreign exchange marketThe foreign loan contracting process is conducted through the electronic declaratory registration, bymeans of the Financial Operation Registration Module (ROF) of SISBACEN, which dispenses with thepresentation of documents to BACEN, prior to the receipt of the loan resources. The electronicregistration is thus prepared through the declarations and data informed electronically in SISBACEN,in two phases: (i) prior registration, relating to the general conditions of the operation, to allow for theentry of resources into the Country and (ii) registration of the payment scheme, done after the closingof the foreign exchange and entry of the resources into the country, enabling remittances to be madeabroad as payment, both of the principal and interest.It is important to mention that the aforementioned prior registration may be denied by the system, if thecosts of the operation are not compatible with normal market conditions and practices or if theproposed structure of the operation is not compatible with the standards of the system.BACEN does not currently call for any minimum or maximum average term for the debt amortizationand repayment of the loan principal, or for the renewal and extension of loans. However, such termsmay be fixed by BACEN in accordance with the Country’s current foreign exchange and monetarypolicy. The interest varies in accordance with the term contracted, and may be fixed or variable, oreven non-applicable, provided that, as previously mentioned, they are within the parameters prevailingin the international market. Spreads are also permitted.5

Still in relation to the interest, the term for its calculation will begin to run on the date that the fundsenter the Country, namely, the settlement date of the foreign exchange contract. However, when thedisbursement of the funds abroad occurs up to five (5) consecutive days before their entry into theCountry, the disbursement date may be used as the initial date for the reckoning of the term.After the entry of the funds into the Country, the payment scheme must be registered, in order topermit remittances of the payments of the interest and principal abroad.As a general rule, the interest will be taxed by withholding income tax, at the rate of 15%.The Tax on Financial Operations – Currency Exchange (IOF – currency exchange) is 0.38% for loansexceeding 360 days, and 6% for operations under the limit mentioned above.However, besides IOF – currency exchange the loan is also subject to IOF – credit, which is usually0.0041% a day plus the additional 0.38% over the operation amount.If it does, there is no TFO on the principal amount. When the principal amount and interests are paid,there is no TFO, regardless of the term of the loan. We emphasize that such parameters are oftensubject of amendments, which can be in effect from their publication by decree.Loans (principal and interest) may, as a general rule, be converted into foreign direct investment, aftertheir registration in the ROF, by means of the performance of simultaneous foreign currency purchaseand sale operations.The accelerated payment of the loan principal (either total or partial) is permitted, it being sufficient toinclude, in the ROF, the payment date of the principal and interest, and the sum of the interest due upto the payment date.1.3.2. Foreign loans via the issuance of securitiesThe RMCCI regulates the electronic declaratory registration, by means of the Financial OperationRegistration Module (ROF), of foreign loan operations obtained by means of the placement ofconvertible securities (issued by an institution based in the Country and placed abroad, whichrepresent rights over shares or quotas of its own issuance) and securities exchangeable into shares orquotas (issued by an institution based in the Country and placed abroad, which represent rights overshares or quotas issued by another institution based in the Country) or also warrants (purchaseoptions of shares or quotas, placed abroad by institutions based in the Country).6

Moreover, BACEN legislation also establishes that, prior to the date of the conversion, exchange orexercise of the purchase option by the holders of warrants, the distribution of dividends and exerciseof subscription will constitute rights of the issuer institution of the securities abroad.Promissory notes issued for placement in the international market, whether under the privateplacement regime or otherwise, are known as Floating Rate Notes or Fixed Rate Notes, depending onwhether their remuneration is stipulated in variable or fixed interest.The entity issuing the notes does not require a specific legal form or special registration for theirissuance, and BACEN is directly and exclusively responsible for their control, in the same format asloan registrations. However, the difference lies in the existence of an issuing agent figure of the notes,which shall necessarily be an authorized financial institution, responsible for issuing and obtainingfunds from entities abroad.1.3.3. Local Currency LoansIn 2007, BACEN published new foreign exchange rules permitting the registration in local currency offoreign loans, which, until that time, could not be registered at BACEN, due to the non-existence ofevidence of the regular entry of the resources into the Country (via the contracting of foreignexchange, as determined in the prevailing foreign exchange regulations).The direct consequence of this situation was that the borrower of the resources in Brazil wasprecluded from remitting to the foreign creditor the interest due on the loan or the principal itself.Nevertheless, in accordance with the new rules, as long as documentary evidence exists with respectto the ownership of the foreign capital (i.e., in the name of the foreign creditor) and the indication of thenumber of the operation conducted via International Transfer in Reais (“TIR”) through which theresources were remitted to the country, the same may be registered with BACEN, in the local currencyloan registration modality, according to the terms and criteria established by BACEN. Thus, once theregistrations are regularized, the borrower of the resources may remit abroad the respective interestdue or the principal itself.1.4. Foreign Exchange MarketIn 2005, BACEN published new rules with a view to simplifying foreign exchange operations in Brazil,indicating the probability of a future complete foreign exchange opening. Additionally, the measures inquestion are designed to combat illegal transfers linked to drug and armament traffic, and terrorism.The main rules currently in force are:7

a) unification of the free and floating rate markets;b) individuals and corporate entities may purchase and sell foreign currency or make transfers of anynature, without limitation of value, though transfers on behalf of third parties are prohibited;c) Brazilian investment abroad does not depend on authorization and/or any kind of priorcommunication to/from BACEN and is not subject to any limitation of value;d) nonresident individuals or corporate entities in Brazil may maintain accounts in the Country called“nonresident accounts”, with financial institutions authorized to operate in Brazil by BACEN, thoughthe use of such accounts to make transfers on behalf of third parties is, however, forbidden.2. THE BRAZILIAN ANTITRUST ACT (LAW 12,529/2011) AND THE PRE-MERGERREVIEW SYSTEMThe new Brazilian antitrust act (Law 12,529/2011), in force since May 29, 2012, significantly changedthe entire antitrust framework in Brazil, formerly regulated by Law 8,884/94.In fact, the new law introduced the pre-merger review system for the first time in Brazil. Based on thislaw, new regulations were issued.The key change introduced by Law 12,529/2011 is that it consolidated the investigative, prosecutorialand adjudicative functions of the Brazilian authorities into one single agency – the AdministrativeCouncil for Economic Defense (CADE).Today, CADE is composed of: (i) an Administrative Tribunal for Economic Defense, comprised ofsix Commissioners and one President; (ii) a General Superintendence, which took on the formerfunctions of the Secretariat of Economic Law of the Ministry of Justice (SDE/MJ) and the Secretariatfor Economic Monitoring of the Ministry of Finance (SEAE/MF) under Law 8,884/94; and (iii) aDepartment of Economic Studies, responsible for preparing opinions and economic studies, eitheron its own initiative or upon request of the Board of the Administrative Tribunal for Economic Defense,the President of the Administrative Tribunal for Economic Defense, a Reporting Commissioner or theGeneral Superintendent.As stated above, with regard specifically to merger control, Law 12,529/2011 introduced a pre-mergerreview system. If a notifiable transaction is consummated prior to CADE's clearance, the partiesinvolved will be subject to fines ranging from BRL 60 thousand to BRL 60 million. Moreover,administrative proceedings can be initiated and the transaction can be considered void.8

Today, consolidations, acquisitions, mergers, association agreements, consortiums and joint venturesmust be notified to CADE. These transactions cannot be consummated prior to CADE's final decisionif at least one of the economic groups involved in the transaction registered gross revenues or a totalbusiness volume in Brazil of at least BRL 750 million in the last fiscal year preceding the transaction,and another economic group involved in the transaction registered gross revenues or a total businessvolume in Brazil of at least BRL 75 million in the last fiscal year preceding the transaction.Law 12,529/2011 also stipulates that association agreements, consortiums and joint ventures createdspecifically for the purpose of participating in public bids are not regarded as economic concentrationfor the purposes of Law 12,529/2011. Consequently, they do not need to be submitted to or approvedby CADE.Moreover, CADE Resolution 02 of May 29, 2012 establishes the criteria for identifying when anacquisition of shares that does not entail a change of control is subject to CADE's clearance. Thefollowing transactions must be notified:(i)Transactions as a result of which the purchaser becomes the major single investor in the targetcompany;(ii)If the investee is not a competitor and is not active in a vertically related market: (a) transactions as aresult of which the purchaser holds, directly or indirectly, 20% or more of the company's total or votingshares; and (b) transactions in which the purchaser already holds 20% or more of the company's totalor voting shares and acquires from a single seller an additional stake of 20% or more of the total orvoting shares; and(iii)If the investee is either a competitor or active in a vertically related market: (a) transactions as a resultof which the purchaser holds, directly or indirectly, 5% or more of the company's total or voting shares;and (b) the last of a series of acquisitions that, individually or together with the others, results in anadditional stake of 5% or more, in case the investor already holds 5% or more of the company's totalor voting shares.CADE's Resolution 02 also defines "economic group" for the purpose of calculating gross revenues.Under this resolution, an "economic group" is: (i) a group of companies under common (internal orexternal) control; and (ii) a group of companies in which any of the companies mentioned in item (i)holds, directly or indirectly, at least 20% of the total or voting shares.9

If the transaction involves investment funds, the gross revenues of the following entities must beconsidered: (i) funds under the same management; (ii) the managing entity; (iii) investors that hold,directly or indirectly, more than 20% of at least one of the funds mentioned in item (i); and (iv) theportfolio companies in which the fund holds, directly or indirectly, at least 20% of the total or votingshares.Even though notifiable transactions are not allowed to be consummated before CADE issues its finaldecision, Law 12,529/2011 gives the reporting Commissioner the option to allow the parties toconsummate the transaction prior to CADE's decision in complex cases. However, in this case, therewill be limitations on asset liquidation; integration of activities; layoffs; closing of points of sale;extinction of brands or product lines; and/or changes in marketing plans.Under CADE's regulations, transactions involving public offerings may be consummated prior toCADE's clearance provided that the purchaser refrains from exercising any voting rights in relation tothe acquired shares or exercises such rights – subject to CADE's prior approval – solely for thepurpose of safeguarding the investment made.Finally, differently from Law 8,884/94, the pre-merger control system introduced by Law 12,529/2011imposes no deadline to notify a transaction. The maximum period of time for CADE to review anotified transaction is 330 calendar days from the notification date (the initial period of 240 days maybe extended by 60 or 90 days).However, so far CADE has reviewed fast-track cases – transactions that are less likely to raisecompetition concerns – in approximately 30 business days.3. COMPANIESBrazilian law provides for different forms of association for the conduct of economic activities gearedto the production or circulation of goods and services.Among the corporate entity types of companies, the most recommendable are the corporation(“sociedade anônima – S/A”) and the limited business company (“limitada - LTDA.”), which may betransformed from one type to the other, as set forth in law.Companies that develop business activities are subject to registration at the Commercial Board(“Junta Comercial”)10

3.1. Corporation (S/A)S/As are governed by their corporate bylaws and regulated by Law 6,404/76.3.1.1. CostA S/A involves more formalities than a LTDA. for its organization and operation, notably by virtue ofthe mandatory publication of certain corporate acts and documents; consequently, its cost is higherthan that of a LTDA. As an example of this cost, a S/A will currently spend a minimum amount ofapproximately R$ 30 thousand (US$ 18 thousand) annually, on publications alone. However, closelyheld S/As with less than 20 shareholders and with shareholders‟ equity, on the balance sheet date, ofless than R$ 1 million (equivalent to approximately US$ 430 thousand), are not required to publishfinancial statements and other management documents; they are only required to register a certifiedcopy of such documents with the Commercial Board. In addition, closely held S/As with a netshareholders’ equity of less than R$ 2 million (approximately US$ 1 million) on the date of the balancesheet are not required to prepare and publish cash flow statements, which considerably reduces thecost of publications.3.1.2. NameAn S/A name must necessarily be followed by the expressions “sociedade anônima” or “companhia”,in full or in abbreviated form.3.1.3. TypesS/As may be of two types:a) publicly held (“open”): when their issued securities are admitted for trading on the stock market.Publicly held companies involve a greater number of formalities, and are also subject to the specificlegislation of the capital market, which has as its main supervisory body the Brazilian SecuritiesCommission (Comissão de Valores Mobiliários - CVM), corresponding to the U.S. Security ExchangeCommission (SEC);b) closely held (“closed”) - when their issued securities are not admitted for trading on the stockmarket. Their operation is less formal and several requirements that are obligatory in relation topublicly held companies are optional in the case of closely held companies.11

3.1.4. CapitalThere is no minimum capital requirement, except in special cases (financial institutions, tradingcompanies, obtainment of permanent residence visa, etc.). S/As may be organized with authorizedcapital and with less subscribed capital than that authorized by the bylaws: in this case, the increaseof the subscribed capital, up to the authorized limit, will not depend on a bylaws reform.The capital stock may consist of cash assets or any kind of assets with a monetary worth. At least10% of the cash-subscribed capital (or 50% in the case of financial institutions) must be paid-up at thetime of the company’s incorporation and the remainder, within the term prescribed in the company’sBylaws.3.1.5. Liability of ShareholdersThe liability of shareholders is limited to the issue price of the subscribed or acquired shares, except incase of proven violation of the law or of the corporate bylaws. A corporation has a distinct existencefrom that of its shareholders, hence the capital autonomy in relation to the partners. It is the assets ofthe corporation that serve as security for creditors for debts incurred on its behalf. However, this rule isnot absolute. For the protection of third parties, Brazilian legislation sets forth some cases where theshareholders are exceptionally accountable for the debts of the corporation. Examples: liability of thecontrolling shareholder for abuse of power; in certain situations, the liability of the shareholders forlabor, tax and social security debts, liability for damages caused to consumers, liability for violationsagainst the economic order (Antitrust Law), all resulting from the application of the „piercing thecorporate veil‟ theory. These are exceptions established by law that cannot be quashed by acontractual or bylaw provision.3.1.6. SharesThe capital stock is divided into shares, which may have a face value or not. The minimum number ofshareholders is 2.The shares may be common, preferred or usufructuary, depending on the nature of the rights oradvantages that they grant to their holders.The common shares of closely held companies and preferred shares of publicly held or closely heldcompanies may be of one or more classes, according, among other particularities, to the policy-relatedadvantages that they confer for the election of administrators.12

The number of non-voting preferred shares or preferred shares with restricted voting rights may notexceed 50% of the total shares of the company. This rule, however, is only binding on companiesincorporated as of 01 November 2001. Thus, publicly and closely held companies existing prior to thatdate can continue under the former regime, which permits the issuance of up to 2/3 of preferredshares, in relation to the total shares issued by the company. The law regulates the way in which nonvotingpreferred shares shall enjoy this right.For preferred shares issued by closely held companies, the advantages may consist of: (i) priority inthe distribution of fixed or minimum dividends; (ii) priority in the reimbursement of capital, with orwithout a premium, or (iii) the accumulation of the advantages indicated in items (i) and (ii).Additional asset advantages shall be conferred on preferred shares traded on the stock market, incomparison to those conferred on preferred shares issued by closely held companies.As to form, the shares will always be registered.The shares may be freely transferred and assigned without the need of a bylaws amendment,operating through a term entered in the Transfer of Registered Shares book, dated and signed by thetransferor and transferee, or their lawful representatives. However, the corporate bylaws of closelyheld companies may impose limitations on the transfer of shares, as long as they regulate suchlimitations in detail and do not impede their trading or subject any shareholder to the discretion of themanagement bodies of the company or the majority of the shareholders.3.1.7. Mandatory DividendThe corporate bylaws of a S/A shall fix the mandatory dividend to be paid to the shareholders; if thebylaws are imperfect or incomplete in this respect, the shareholders are entitled to receive as amandatory dividend, for each year, the amount determined pursuant to law.3.1.8. Shareholders’ AgreementsShareholders‟ agreements are allowed to deal with such matters as the purchase and sale of shares,the preemptive right to acquire them, the exercise of voting rights or of the control power; however, forsuch agreements to be observed by the company, they must be filed in its registered office.3.1.9. Minority ShareholdersThe protection of minority shareholders is provided for by law, and may be extended throughprovisions in the corporate bylaws and shareholders' agreements.13

3.1.10. Shareholders’ MeetingThe Shareholders‟ Meeting is the supreme body of the company, with due regard to the law and anybylaw and contractual provisions.In the first call, the Shareholders‟ Meeting shall convene with the presence of shareholdersrepresenting, at least ¼ of the voting capital. In the second call, it will be called together with anynumber. The voting quorum is, as a general rule, more than half of the voting shares (“maioriaabsoluta”). The voting quorum will be two thirds of the voting capital, in the first call, only when theShareholders’ Meeting is called with the purpose of amending the Bylaws. In the second call, theMeeting will be called with any number.Shareholders‟ Meetings may be annual (AGO) or special (AGE).The AGO has the powers to: (i) receive the administrator accounts and resolve on the financialstatements; (ii) decide on the appropriation of net profits for the year and the distribution of dividends;(iii) elect the administrators and members of the Audit Committee, if applicable. The AGO shall be heldannually, in the first 4 months subsequent to the end of the fiscal year.The AGE has the powers to decide on any other matters brought to the approval of the shareholders,such as: (i) reform the corporate bylaws; (ii) authorize the issue of debentures; (iii) suspend theexercise of shareholder rights; (iv) resolve on the valuation of assets contributed by shareholders forthe formation of the capital stock; (v) authorize the issue of participation certificates; (vi) resolve on thetransformation, merger and spin-off of the company or its absorption into another; (vii) its dissolutionand liquidation, elect and depose liquidators and decide on their accounts; (viii) authorize theadministrators to confess bankruptcy and petition for judicial reorganization.For the voting of the following matters a qualified quorum is necessary (approval of shareholdersrepresenting at least half the voting shares, if a larger quorum is not prescribed by the corporate bylaws):a) creation of preferred shares or increase of existing classes of preferred shares, withoutmaintaining a proportion with the other classes of preferred shares; b) alteration in the preferences,advantages and conditions of the redemption or amortization of one or more classes of preferredshares, or creation of a new more privileged class; c) reduction of the mandatory dividend; d) spin-off,merger by or of the company; e) participation in a group of companies; f) alteration of the corporatepurpose; g) suspension of the state of liquidation of the company; h) creation of participationcertificates and (i) dissolution of the company. The AGE may be held at any time, whenever the needarises.14

Special attention should be given to a reform of the bylaws with the aim of increasing or decreasingthe capital.A capital increase may take place in any of the following ways: a) by capitalization of profits orreserves, which implies the alteration of the par value of the shares or distribution to the shareholdersof the new shares corresponding to the increase; b) by the public or private underwriting of shares. Acondition for this type of increase is that at least ¾ of the capital stock have been paid up. Theshareholders have the preemptive right for the subscription of the increase, in proportion to thenumber of shares held thereby.A capital decrease may occur in one of the following situations: a) loss up to the sum of accumulatedlosses; b) if excessive. In order to protect any creditors, the Law determines that the decrease of anyexcessive amount of the capital will only become effective 60 days after the publication of the AGEminutes that decided same.3.1.11. AdministrationThe administrative bodies of S/As are the Board of Directors (mandatory for publicly held companiesand authorized capital companies) and the Board of Executive Officers. The Board of Directors isresponsible for determining the company’s general business orientation. The Board of ExecutiveOfficers is the company’s executive body, with exclusive responsibility for representing the S/A beforethird parties.The members of the Board of Executive Officers will be individuals residing in the Country, whereasthe Board of Directors may be made up of individuals residing and domiciled abroad also, providedthat they have attorneys-in-fact residing in Brazil, duly empowered to receive summons. The Board ofDirectors shall be composed of at least 3 members, whereas the Board of Executive Officers shall becomposed of at least 2 officers, who may be shareholders or otherwise. Up to 1/3 of the members ofthe Board of Directors may be elected to the Board of Executive Officers.The term of office of administrators may not exceed 3 years, re-election being permitted. The Board ofDirectors is elected and deposable at any time by the Shareholders‟ Meeting and the Board ofExecutive Officers is elected and deposable at any time by the Board of Directors (when there is one)or by the Shareholders‟ Meeting (when there is no Board of Directors). There is no minimum ormaximum limit for the remuneration of administrators.Administrators are not personally liable for the obligations they incur on behalf of the corporation andby virtue of regular management acts. However, they are civilly liable for the losses they cause, whenthey act: I – with fault or fraud or deceit, within their duties or powers; II – with violation of the law or of15

the bylaws. Moreover, the same exceptions determined in connection with the liability of shareholders,detailed in the paragraph “Liability of Shareholders” above apply to administrators.3.1.12. Advisory CommitteeS/As may optionally have an Advisory Committee, whose members may reside abroad and beremunerated by the Brazilian company.3.1.13. Audit CommitteeA corporation will have an Audit Committee, whose constitution, when its operation is not permanent,may occur in any shareholders‟ meeting, as provided by law. The duties of the Audit Committeeinclude: (i) supervise the acts of the administrators and verify the fulfillment of their legal and bylawobligations; (ii) opine on the annual management report; (iii) opine on proposals from theadministrative bodies to be submitted to the Shareholders‟ Meeting concerning, among other matters,the modification of the capital stock, distribution of dividends, transformation, merger by incorporation,merger and spin-off; (iv) report to the administrative bodies or the Shareholders‟ Meeting any errors,frauds or crimes that it discovers and suggest courses of action that are useful to the company; (v)analyze, at least quarterly, the trial balance and other interim financial statements drawn up by thecompany, and (vi) examine the financial statements for the fiscal year and opine thereon. The AuditCommittee shall be composed of a minimum of 3 and maximum of 5 members and alternates in anequal number, who may be shareholders or otherwise, elected by the Shareholders’ Meeting.3.1.14. Financial StatementsAt the end of the fiscal year, the Board of Executive Officers shall have the following financialstatements drawn up: I- balance sheet; II- profit and loss statement; III-income statement, and IV- thecash flow statements. Publicly held companies are also required to prepare a value added statement.The financial statements shall be (i) available to the shareholders at least one (1) month before thedate scheduled for the AGO;(ii) published in the Official Gazette and in a newspaper of generalcirculation at least 5 days before the date scheduled for the AGO; (iii) the subject of an opinion of theAudit Committee, if in operation; and (iv) submitted to the decision of the Annual Shareholders‟Meeting and subsequently filed in the Commercial Registry, along with the AGO minutes thatapproved them.3.1.15. Publicly held CompaniesPublicly held companies are under the control of the CVM and are subject to specific rules, in additionto the general rules applicable to closely held companies. The public distribution of securities cannot16

occur without prior registration at CVM. The sale of the control of a publicly held company is subject tocertain conditions (e.g. public offerings) in accordance with CVM rules. Moreover, such companiesshall have independent auditors and comply with a series of disclosures determined in the rulesissued by CVM.Law 6,404/76, which regulates corporations, was amended in 2001, with the aim of increasingtransparency and increasing the rights of minority shareholders. Therefore, at least theoretically, thereform privileged the inclusion of rules that may be classified as being of corporate governance,including the following: (i) reduction, in the capital of the company, of the number of preferred shareswithout voting rights or subject to restriction in the exercise of this right; (ii) increased advantages ofthe preferred shares of publicly held companies (iii) tag along: in the event of the sale of the direct orindirect control of a publicly held company, the acquirer will be required to conduct a public offering forthe acquisition of the voting shares held by the other shareholders, at the amount equivalent to at least80% of that paid per voting share of the control block; (iv) increase in the period of time preceding thepublication of the Shareholders‟ Meeting to 15 days in the 1st call and 8 days in the 2nd call (the timefor closely held companies is 8 and 5 days, respectively); (v) right to elect and depose one memberand one alternate for the Board of Directors to shareholders with more than 15% of the total votingshares and to holders of preferred shares without the right to vote or with restricted voting rights thatrepresent 10% of the capital stock; (vi) inclusion of the spin-off among the cases that entail the right ofwithdrawal, if the spin-off implies the reduction of the mandatory dividend, participation in groups ofcompanies or changes in the corporate purpose; (vii) obligation of the controller of a publicly heldcompany, of the shareholders and group of shareholders that elect a member of the Audit Committeeto immediately apprise CVM, the Stock Exchange and organized over-the-counter entities ofmodifications to their shareholder statuses in the company; (viii) in the event of the going private of thecompany, the obligation of the controlling shareholder or of the company itself to make a publicoffering for the acquisition of all the shares at a fair price; (ix) increased independence of the AuditCommittee, permitting any member to supervise the acts of the administrators, verify compliance withlegal and bylaw obligations, and report any errors, frauds or crimes to the administrative bodies, and incase of failure to carry out the necessary measures, by such bodies, to the Shareholders‟ Meeting,suggesting courses of action that are useful to the company.3.1.16. New RulesNew rules for large-sized companies, whether S/As or LTDAs, were introduced by Law 11,638/07,requiring them to adopt a series of measures, with a view to the modernization and harmonization ofthe corporation law with the fundamental principles and best international accounting practices, inorder to correct imperfections of the law theretofore in force, adapt the law to the social and economicchanges in the market and strengthen the capital market itself. These measures include (i) alterationsconcerning the recording and drawing up of financial statements, based on international standards17

(IFRS – International Financial Reporting Standards) and (ii) the requirement of an independent audit.For the purposes of the new law, a large-sized company shall be construed as any company that hadtotal assets, in the previous year, in excess of R$ 240 million (US$ 120 million) or an annual grossturnover of more than R$ 300 million (US$ 150 million).3.2. Limited Company (LTDA)The lives of LTDAs, which were previously regulated in a somewhat flexible and relatively simplemanner by the provisions of Decree 3,708/19, are now disciplined in detail by the new Brazilian CivilCode, approved by Law 10,406/02, which came into force on 11 January 2003.3.2.1. CostIn accordance with the new Civil Code, the organization and operation of LTDAs are less flexible andmore burdensome than before, also requiring publications in certain cases. Nevertheless, the cost ofLTDAs continues to be lower than that of S/As (see item 3.2.12 below).3.2.2. Articles of associationThe bylaws of LTDAs are called “articles of association” in Brazil. The articles of association allow fora series of provisions established between the partners and can be very flexible.3.2.3. NameA LTDA may adopt a firm (name of partners) or name (fictitious name), but must always beaccompanied, at the end, by the expression “limitada” or its abbreviation (“Ltda”). The company nameshall inform the purpose of the company in a summarized manner.3.2.4. Capital and quotasThe minimum number of partners is likewise 2 in this type of company. Similarly to the S/A, the capitalof a LTDA may consist of cash assets or assets with monetary worth. However, there is no need forthe initial payment of any minimum capital subscribed in cash.The capital of LTDAs is divided into ideal parts (quotas), which are divided among the partners inpercentages and are not physically represented by certificates. As the number of quotas held by eachpartner is established by the articles of association, any transfer or assignment of ownership over thequotas depends on an amendment to the articles of association.18

The quota capital may only be increased after all the quotas have been paid up, observing thepreemptive right of the partners to participate in the increase, in proportion to their quota holdings. Thecapital may be decreased by means of a corresponding amendment of the articles of association: (i)after its payment, if there are irreparable losses and (ii) if excessive in relation to the nature ofbusiness of the company.Unless otherwise provided in the articles of association, the transfer to third parties of the quotas orpreemptive right to participate in a capital increase, among partners, is not subject to the consentthereof; however, when involving a transfer to third parties, the approval of partners representing atleast ¼ of the quota capital is required.3.2.5. Liability of PartnersOnce the capital of a LTDA has been fully paid up, the partners are, in principle, no longer personallyliable for the company’s obligations before third parties, except in the cases of violation of law or of thearticles of association. The same provisions contained in the paragraph “Liability of Shareholders”under the heading S/A above, apply to LTDAs as regards the liability of the partners. However, if thecapital has not been fully paid up, each partner is personally and jointly liable for the company’scorporate obligations, though limited to the total missing amount for the full payment of the quotacapital.Moreover, the partners are jointly and severally liable for debts with the social security authorities, aswell as for labor credits, as a result of the application, in these specific cases, of the “disregarding thecorporate entity” theory.3.2.6. AdministrationLTDAs are administered by one or more administrators, who may be Brazilian or foreign individuals,residing in Brazil, and not necessarily partners. If the articles of association allow the administration tobe exercised by a non-partner, the designation of the latter will require the unanimous approval of thepartners, when the quota capital is not fully paid up, or the resolution of the partners representing atleast 2/3 of the quota capital, when the capital has been paid up. In addition, the deposal of anadministrator who is a partner of the LTDA, duly nominated in the articles of association, requires theapproval of partners representing at least 2/3 of the quota capital, unless the articles of associationdetermine otherwise.The responsibility of the administrator of a LTDA before third parties, in principle follows the previouslymade comments applicable to administrators of S/As. In practice the administrators of LTDAs are19

eing held to answer in the labor and social security fields, jointly with the company, regardless of thecause of the event.The new Civil Code permits the creation of a Board of Directors and Audit Committee for LTDAs,whose respective duties and operation shall be regulated in the articles of association.The remuneration of the administrators of a LTDA is not subject to a minimum amount or limit.3.2.7. ProfitIt is not necessary to determine the minimum profits to be distributed to the partners in this type ofcompany. The participation of partners in the company profits, in a different proportion to suchpartners’ interests in the quota capital is permitted. However, no rule that excludes a partner fromprofit sharing is permitted.3.2.8. ResolutionsThe law stipulates some minimum quorums for the approval of certain matters, such as: (i) theamendment of the articles of association, and the merger by incorporation, merger, spin-off ordissolution of the company (3/4 of the quota capital); (ii) designation of an administrator by a separateinstrument to the articles of association, deposal of non-partner administrators, fixing of theremuneration of administrators and petition for judicial reorganization (more than half the quotacapital); (iii) other cases provided for in law or in the articles of association, if the latter does not call fora higher quorum (majority vote of those present).Partner resolutions shall be passed in a partners’ meeting (for companies with up to 10 partners) or ina general meeting (for companies with more than 10 partners). If the articles of association are silenton the subject, the rules of the law that disciplines general meetings will apply, which are very similarto the rules applicable to the shareholders’ meetings of S/As.A general or partners’ meeting shall be held annually during the first 4 months subsequent to the endof the annual accounting period for the approval of the administrator accounts and distribution ofprofits for the year.3.2.9. Exclusion of partnersThe law provides for the possibility of the non-judicial exclusion of any partner who is jeopardizing thecompany’s continuity, by virtue of acts of undeniable gravity, as resolved by the partners representing20

more than half the quota capital, as long as the articles of association provide for exclusion for goodcause and with due regard to the legal procedures.3.2.10. Partners’ AgreementThe execution of Partners’ Agreements in LTDAs is also possible, similarly to S/As.3.2.11. Supplementary RegulationIn accordance with the new Civil Code, Law 6,404/76 (Corporation Act) no longer subsidiarily appliesto LTDAs, except when so determined in the articles of association. In cases where the new Code andarticles of association are imperfect and incomplete, the general rules provided in the new Civil Codefor so-called simple companies (companies designed to perform an intellectual activity, of a scientific,literary or artistic nature) will, in principle, be applied.3.2.12. New RulesLaw 11,638/07 determines the application of the aforesaid Law 6,404/76 to large-sized LTDAs, inrespect of matters concerning the recording and preparation of financial statements and therequirement of an independent audit; see the explanation on this matter in the New Rules paragraphof item 3.1. Corporation (S/A). In this context, among the new determinations for large-sized LTDAs,there is some discussion going on as to whether these companies are also required to publish theirfinancial statements, there being conflicting opinions with regards to the interpretation of the rule. Forthe purposes of this new law, large-sized LTDAs are those companies that have total assets, in theprevious year, in excess of R$ 240 million (US$ 110 million) or annual gross turnover of over R$ 300million (US$ 130 million).3.2.13. Adaptation of the Articles of AssociationWith the provisions brought by the new Civil Code, many of the advantages that previously existed forLTDAs have disappeared, notably their structuring flexibility. This should lead to greater reflection withregards to the choice of company type: LTDA or S/A. The choice will depend on each specific case,but by and large, one may say that LTDAs work very well for the operation of subsidiaries whose totalquota capital is held by foreign companies, whereas possible joint ventures in Brazil should elect forthe adoption of a S/A, owing, among other things, to the legal security conferred by the alreadyofficially accepted interpretation of the rules that govern this type of company.21

3.3. Branch Offices of Foreign CompaniesA foreign company may directly operate in Brazil through a branch office, i.e, through an extension ofthe foreign corporate entity itself. However, this procedure presents some disadvantages incomparison with the establishment of a business concern in Brazil through ownership interests, for thefollowing reasons:a) the need of prior authorization, through an act of the Federal Executive Branch;b) prohibition of the remittance of royalties to the head office abroad for the use of trademarks andexploitation of patents, andc) tax disadvantages, as indicated in item 6.1.1.2 below.3.4. Corporate Reorganization Operations and Sale of EstablishmentsCorporate reorganization operations involving the transformation, spin-off, merger and merger byincorporation of companies may be conducted both by S/As and by LTDAs.In a transformation, the company is transformed from one type of company to another, without thedissolution or interruption of its activities.In a spin-off, the company transfers portions of or even its total equity (assets and liabilities) to one ormore companies, with the continuation of the spun-off company, if its equity has been partiallytransferred, or with its extinction, if all its equity has been transferred. The law stipulates specificsuccession rules for the obligations of the spun off or extinguished company.In a merger, two or more companies are combined to form a new company, which succeeds them toall their original rights and obligations.In a merger by incorporation, one or more companies will be absorbed by another company, whichsucceeds them to all their rights and obligations. S/As and LTDAs may further sell their industrial orcommercial establishments, in which case the acquirer will succeed to all their respective rights andobligations. In this regard, please refer to the notes contained in chapter 17 below, notably as regardsthe new Bankruptcy Law.22

3.5. ConsortiumDifferent organizations, S/As or LTDAs, under the same control or otherwise, may set-up a consortiumto carry out a specific undertaking.Through a consortium several companies, by mutually associating, are able to assume certainactivities, which could not be carried out individually by each company, due, in most cases, totechnical or economic financial conditions.As a general rule, a consortium is not a corporate entity and its members, in principle, are only boundunder the conditions provided for in its incorporation agreement. Each member company isaccountable for its own obligations, without the presumption of joint and several liability.However, exceptionally, just for federal tax purposes, this rule does not apply, since in operations inthe consortium’s own name, the consortium will satisfy the respective tax obligations and the membercompanies will be jointly responsible for these obligations. In the labor, tax and consumer fields,however, such joint and several liability may also be constituted, as applicable.This type of association is common for participation in procurement processes and in the sectorsresponsible for the concession of public and private works and services, and imports and exports.The consortium incorporation agreement and its amendments must be filed at the Commercial Board(Junta Comercial) of the venue of its headquarters.3.6. Undisclosed joint venture partnership (SCP)This type of association does not appear to third parties, for it consists merely of a private agreement,entered into by two or more participants, with the purpose of permitting the exploitation of a businessopportunity or specific business activity. SCPs do not have a distinct legal identity from that of theirparticipants.The law differentiates two types of participants: (i) the visible partner: develops the componentactivities of the company purposes in his individual name and assumes responsibility for the companyobligations in an exclusive manner, and (ii) the secret partner: appears merely as an investor, notappearing to third parties; assumes responsibility towards the visible partner within the limit providedin the company’s formation instrument.23

The formation of an SCP is not subject to any formality, and may be proved by means of any evidencepermitted by Brazilian law. It is most commonly used in particular operations, such as import, export,and participation in transactions, procurements and others.3.7. Wholly owned subsidiaryThe Corporation Law also provides for the wholly owned subsidiary, which is a strictly unipersonalcorporation, whose only shareholder shall necessarily be a Brazilian company. Its creation can beoriginated or derived. In the former case, it will be incorporated by public deed. Its creation will bederived when the company is converted into a wholly owned subsidiary through the acquisition, by aBrazilian company, of all its shares or through the incorporation of all the shares of the capital stockinto the net equity of another Brazilian company.4. INDUSTRIAL PROPERTYIndustrial Property is regulated by Law 9,279/96, the Industrial Property Act (Lei da PropriedadeIndustrial - LPI), which was drawn up with the purpose of adapting Brazilian legislation to therequirements established by the World Trade Organization (WTO). Therefore, the protection conferredby the LPI on patent and trademark rights’ owners located both in Brazil and abroad is consistent withinternational industrial property protection standards.Invention patents are valid for a period of 20 years and the utility model type, for the period of 15years, as from the date of the respective filing. Patents filed in Brazil are only valid in Brazil. However,in this case, because of the Patent Cooperation Treaty (PCT) the process for filing patents abroad willbe simpler.The LPI permits the compulsory license of patents when their owner exercises the rights resultingtherefrom in an abusive manner, commits abuse of economic power through them, when there is noexploitation of the patent’s subject matter in the Brazilian territory or the incomplete manufacturethereof. In these cases, the license may only be applied for by an interested party with a legitimateinterest in and the technical capacity for the efficient exploitation of its subject matter, three years afterthe patent granting date.It is important to point out that though pharmaceutical products and processes have been patentablesince the enactment of the LPI, the granting of patents in this segment is contingent on prior approvalfrom the Brazilian Sanitary Surveillance Agency (Agência Nacional de Vigilância Sanitária – ANVISA).24

With respect to trademarks, the Law permits the forfeiture of the respective registration, at the requestof third parties with legitimate interests, if its use has not been commenced in Brazil after the passageof 5 years from its granting date or if its use has been interrupted for more than 5 consecutive yearsor, further, if during this period, the trademark has been used with a modification altering its primitivedistinctive characteristics.Following the Paris Union Convention for the Protection of Industrial Property (art. 6 bis 1), Law9,279/96 left it clear that well-known trademarks, including service trademarks, enjoy specialprotection, regardless of whether they have been previously applied for or registered in Brazil.However, there is no objective criterion to classify a trademark as a “well-known” trademark; this willbe decided on a case by case basis based on the documents submitted by the applicant showing thatthe trademark is “well-known”.In 2013, the Brazilian Patent and Trademark Office (INPI) published Resolution 107/13, whichregulates the procedures for obtaining protection to famous marks. Famous marks, unlike “wellknown”trademarks, enjoy protection in a range of specialties, that is, they are not related to only onespecific activity carried out by their owner.The law also provides for the punishability of crimes against industrial property, including patents,industrial designs, trademarks, geographical and other designations, and against unfair competition,also consolidating the dispersed rules on the subject.Trademarks, patents and industrial designs shall be registered at the Brazilian Patent and TrademarkOffice (INPI).Moreover, the acts and contracts related to the licensing of industrial property (use of trademarks andexploitation of patents), technology transfer, franchise, technical, scientific and other support servicesare subject to registration with INPI. The said registration is a condition for:a) the publicity, i.e., the validity of the acts or contracts before third parties;b) the remittance abroad of payments due, within the legal limits;c) the tax deductibility of the amounts paid, within the limits of the law.Trademark and patent royalty payments are only permitted in the cases of invention or registration oftrademarks granted by INPI. Trademarks or patents that have merely been applied for, but are notregistered, entitle their holders to enter into licensing agreements, but do not make the receipt ofremuneration as a result of the license established lawful. The privilege or registration of an extincttrademark, or trademark in the process of annulment or cancellation, or privilege or registration of atrademark whose owner is not eligible for remuneration, will not qualify for royalties.25

The deductibility of royalty expenses (for the use of trademarks, patents or industrial designs) and withremuneration for technology transfer and the provision of technical support by a subsidiary, is limitedto a maximum of 5% of net sales revenue, with due regard to the specific limits for each industrialactivity sector (Ordinance 436/58 of the Ministry of Finance). The tax deductibility for the use oftrademarks is in all cases limited to 1%.The tax deductibility of the remittances to the licensor or grantor overseas depends not only on theregistration of the respective contracts with INPI, but also their registration with BACEN, today doneelectronically by the commercial bank responsible for the payment remittance, through the ElectronicDeclaratory Registration (Registro Declaratório Eletrônico – RDE), in which the conditions registeredand authorized by INPI are checked online, at the time of the remittance.Controlled companies established in Brazil may also remit royalties for the exploitation of inventionpatents, use of trademarks and remuneration for technology transfer and the provision of technical,scientific or similar support services to their parent companies abroad.INPI, based on its own interpretation of the federal tax legislation, understands that generally theamount to be remitted in cases of control relations may also not exceed the maximum annual limit ofup to 5% of net sales revenue of the product manufactured or sold.At the time of the remittance of royalties, remuneration for technical support and similar services orpayment for technology transfer, there is withholding of Income Tax at Source (IRF), at the rate of15%, except when there is an international agreement to avoid double taxation determining a lowerrate (art. 710 of the RIR and art. 2A of Law 10,168/00). However, if the royalty remittance is made infavor of a person domiciled in a Tax Haven, the aforesaid rate rises to 25% (art. 685 of the IncomeTax Regulation (RIR)). This position was recently reaffirmed in art. 17 of Normative Instruction(Instrução Normativa – IN) 1,455/2014.In addition to IRF, the remittance will also be subject to the payment of the economic domainintervention contribution (CIDE) at the rate of 10%, which is earmarked for funding technologicaldevelopment and interaction programs between Brazilian universities and research centers andprivate enterprise (art. 2 paragraph 4 of Law 10,168/00).Remittances abroad for the payment of technical, management and similar support services that donot imply technology transfer are also subject to the payment of IRF and CIDE (art. 2 paragraph 2 ofLaw 10,168/00).In addition to the IRF and the CIDE, remittances of royalties are also subject to IOF (IOF-Câmbio) atthe rate of 0.38% on the amount of the remittance (art. 11 of Decree 6,306/07).26

If Brazil has signed an agreement to avoid double taxation with the country licensing the technology,then income tax exemption or credit mechanisms will certainly be applied in that country according tothe provisions of the relevant treaty and local laws, but only in relation to the portion withheld as IRF,excluding the possibility of the set off of amounts withheld in the way of CIDE.There is a possibility of the Municipality of São Paulo additionally exacting ISS (Service Tax) at therate of 5% for “The assignment of the right of use of trademarks and advertising signs” or of 2% for“The licensing or assignment of the right of use of computer programs”, since such operations arecurrently listed as service by the São Paulo Municipal Tax Administration (art. 1, item 1.05 and item3.01, respectively, of Municipal Decree 53,151/02).5. REAL ESTATE5.1. Acquisition of real propertyThe most common method of acquiring real property between living persons is the registration of thetitle deed at the Real Estate Registry Office.Another method of acquiring real property is usucaption: those who, for 15 years, without interruption,or opposition, possess a property as their own, acquire its ownership, regardless of title and goodfaith; and may request that the judge declares as much by a judgment, which will serve as the title forregistration in the Real Estate Registry Office. This period may be reduced in certain cases. It may bereduced to 10 years, for example, if the possessor has established his habitual residence on theproperty, or carried out works or services of a productive nature on it. There are other cases ofusucaption provided for in law.The purchase of urban properties can be freely made by:a) a foreign individual or corporate entity residing or domiciled abroad, whereas the investment madein the property purchase is not subject to registration as foreign capital with Central Bank (BACEN),andb) by a corporate entity based in Brazil but controlled by foreign capital, whereas the investment madein the property purchase is subject to registration with BACEN, as foreign capital invested in theBrazilian company.27

There are restrictions in statutory law with respect to the acquisition of real property located in nationalsecurity and rural areas, by foreign individuals or corporate entities, or by Brazilian corporate entitiescontrolled by foreigners residing or based abroad.Rural real property is subject to the following basic rules:a) the total sum of the rural areas owned by foreigners cannot exceed 1/4 of the surface area of theMunicipalities and persons of the same nationality cannot own more than 40% of the said limit;b) the surface areas are divided into module units, whose areas, depending on the locality, varybetween 5 ha. (in the Greater São Paulo region) and 100 ha. (according to the region of the Country);c) foreign individuals residing in Brazil may freely purchase areas of up to 3 module units for undefinedexploitation, provided that the above surface area restrictions are observed and it is the foreignindividual’s first purchase (in practice, it is recommended that the National Land Development Agency(Instituto Nacional de Colonização e Reforma Agrária – INCRA) is consulted to ensure that thepurchase complies with the surface area restrictions); for areas in excess of 3 and up to 50 moduleunits, and for the operation of a second purchase, authorization from INCRA must be obtained,whereas for areas of between 20 and 50 module units, a land use project will also have to besubmitted; for areas of 50 to 100 module units, approval needs to be obtained from the President ofthe Republic, and it will have to be evidenced that the project is of national interest and approved bythe National Defense Council; for the purchase of areas in excess of 100 module units authorizationfrom Congress will have to be obtained;d) foreign corporate entities authorized to operate in Brazil or corporate entities based in Brazil butcontrolled by individuals or corporate entities residing or based abroad, must obtain authorization fromthe Ministry of Land Development, through the competent agency, in this case INCRA;e) a foreign individual that has Brazilian children or is married under the partial or community propertysystem with a Brazilian person are free to purchase rural property.Recently, there was a significant change in the understanding that was being applied to item “d”above.Until July 2010, the understanding that prevailed was that of the former AGU (Office of the FederalAttorney General) opinion in the sense that there was no distinction between the Brazilian company ofnational capital and the Brazilian company of foreign capital. Therefore, a company based in Brazil,whose capital was controlled by a foreign corporate entity, did not suffer any type of restriction, eitherto purchase or lease rural property in Brazilian territory, provided that the property was not located inthe Country’s frontier strip.28

After August 2010, through a new AGU opinion, signed by the then President of the Republic LuizInácio Lula da Silva, Brazilian companies whose capital is controlled by a foreign corporate entityreceived the same treatment as a foreign company, and began to suffer the restrictions set forth inLaw 5.709, of 7 October 1971, namely: (i) cannot acquire a rural area that has more than 50 modulesof undefined exploitation; (ii) only rural real property to be used for the implementation of cattlebreeding, agricultural and industrial projects and that are linked to the corporate purposes set forth intheir corporate bylaws or articles of association and approved by the Ministry of Land Developmentand INCRA may be acquired or leased.On 3 December 2012, the Office of Judicial Administration of the State of São Paulo Supreme Court(Corregedoria Geral de Justiça do Tribunal de Justiça do Estado de São Paulo) issued Opinion461/2012-E holding that Law 5,709/71 is unconstitutional and advising the State of São Paulo notariesto ignore the restrictions and guidelines set forth in that Law. This is a hot topic that must be analyzedon a case by case basis, taking into account the negotiated terms and the State in which the propertyis located.Furthermore, it is important to remember that a determination exists whereby the sum of the ruralareas belonging to foreign persons or Brazilian companies controlled by foreign companies shall notexceed 25% of a municipality.Special restrictions are also imposed on rural properties located in areas known as frontier strips,which are considered indispensable to national security. This area is defined as the 150 kilometerwideinternal strip (equivalent to 93 miles), running parallel to the borderline of the national territory.The purchase of rural land within the frontier strip, by a foreign individual or corporate entity, or by acompany that has any foreign ownership interest (whether majority or minority, as a shareholder ormember of the Board), will depend on prior approval from the National Defense Council (Conselho deDefesa Nacional).Prior approval from the National Defense Council will also be required for the establishment oroperation, within the frontier strip, of industries that are of interest to national security, listed as such inan Official Decree, and for the establishment, in this same strip, of companies engaged in thefollowing activities:a) prospecting, extraction, exploitation and utilization of mineral resources, except for those ofimmediate application in civil construction, as classified in the Mining Code, andb) land settlement and rural developments.29

The companies listed in the foregoing paragraph shall, necessarily, satisfy the following conditions:i) at least 51% of the capital must be held by Brazilians;ii) at least 2/3 of the employees must be Brazilians, andiii) the majority of the administrators and managers shall be Brazilians, who shall be guaranteedpredominant powers.Rural real property is subject to the Rural Land Tax (ITR), levied pursuant to the respective Tax Table.The rate ranges between 0.03% and 20%, in accordance with the size of the property, its utilizationand the efficiency of its exploitation and is applicable on the “bare land” value, which is construed asthe total worth of the property, minus the value of its buildings, facilities, improvements, permanentand temporary crop cultures, cultivated and improved pastures and planted forests. The respectiverates and other legal provisions concerning the ITR are set forth in IN/SRF (NormativeInstruction/Federal Revenue Department) 256, of 11 December 2002. An increase in the Rural LandTax rate may occur, in accordance with the utilization ratio of the land and efficiency of the property’sexploitation; this increase is a penalization factor, aimed at discouraging the maintenance ofunproductive properties.Moreover, city properties are subject to a land tax levied on plots of land, and to a building tax - forbuildings. In the City of São Paulo, the rates of this tax for 2006 vary between 0.8% and 1.6%, forresidential properties and 1.2% to 1.8% for commercial property and land, calculated on the fairmarket value of the property, as determined by the Local Government Authority.5.2. MortgageA real property may be given in mortgage as security for the debts or obligations of its owner or ofthird parties. The mortgaged property is subject, by a real relationship, to the performance of theobligation.5.3. Deed of Trust Form of Mortgage (“Alienação Fiduciária”)Law 9,514, of 20 November 1997, which disciplines the Real Estate Financing system, instituted thedeed of trust form of mortgage (“alienação fiduciária”) of real property. Prior to this law, this guarantywas only permitted to finance the purchase of movables. As in a mortgage, the assets given in“alienação fiduciária” are subject, by real relationship, to the performance of the obligation.30

5.4. Construction RightOwners may erect constructions on their land as they deem convenient, respecting the right ofneighbors and administrative regulations. The neighborhood right is regulated in the Civil Code. Theadministrative regulations (construction rules and zoning restrictions) are mainly set forth in municipallaws. Special attention should be paid with respect to the location and authorization for theestablishment of manufacturing plants, which require the approval of the zoning and pollution controlagencies.6. TAX SYSTEM6.1. Main Federal Taxes6.1.1. Income TaxCorporate entities taxed by Actual Taxable Income may determine their income on the basis of theannual balance sheet at 31 December of each year or by quarterly trial balance sheets (arts. 220 and221 of the Income Tax Regulation approved by Decree 3,000 of 26 March 1999 – RIR).Corporate entities that have profits, earnings and capital gains from abroad, are obliged to determineActual Taxable Income (art. 246, III and 394 of the RIR).Income tax is levied at the rate of 15% on the Actual Taxable Income calculated annually (annualActual Taxable Income) or quarterly (quarterly Actual Taxable Income) by corporate entities, inaccordance with their accounting records, prepared pursuant to the commercial and tax laws (art. 541of the RIR). .Under specific circumstances, the tax administration may arbitrate the income amount (art. 530 of theRIR); the applicable rate on taxable income for these cases is also 15%, with due regard to thecomments made further on relating to the tax base of the tax.Corporate entities with partners or shareholders resident or domiciled abroad may calculate incometax by Presumed Income, providing that total income in the previous calendar year did not exceed theR$ 78 million limit, equivalent to approximately US$ 33 million, or R$ 4.65 million, equivalent toapproximately US$ 2.75 million, multiplied by the number of months of activity in the precedingcalendar year, when less than 12 months (art. 13 of Law 9,718 of 27 November 1998 with the wordingintroduced by art. 7º of Law 12,814, of 16 May 2013).31

Companies, including branch and representative offices or agencies of foreign corporate entities inBrazil with their main offices abroad that present monthly taxable, presumed or arbitrated income inexcess of R$ 20 thousand, equivalent to approximately US$ 8.5 thousand, will be subject to anincome tax surtax levied at the rate of 10%Actual Taxable Income is the net income (considered as the algebraic sum of operating income, nonoperatingresults and ownership interests) corresponding to the base period, adjusted by theadditions, exclusions or offsets determined by law (art. 247 of the RIR).The Presumed Income, on which income tax is levied, corresponds to the result of the application ofthe percentages predetermined by the tax administration on gross income, of between 1.6% and 32%,according to the type of activity performed by the corporate entity (art. 519, paragraph 1 of the RIR).For companies electing for the annual Actual Taxable Income calculation system, the tax losses andnegative basis for Social Contribution on Net Profits (CSLL) may be offset up to the maximum limit of30% of net income adjusted by the additions and exclusions permitted by the income tax and CSLLlegislations. For quarterly Actual Taxable Income, the tax loss of a quarter can only be carried forwardup to the limit of 30% of the Actual Taxable Income of the subsequent quarters. In the case ofPresumed Income, it is not possible to offset tax losses.6.1.1.1. Remittances AbroadRemittances of profits and dividends abroad, on the basis of the results determined as from 1 January1996, are not subject to Withholding Income Tax (“IRRF” - art. 692 of the RIR).Remittances of interest are subject to the IRRF at the rate of 15% (art. 1 of Law 9,959/2000). This rateis increased to 25% if the recipient of the remittances resides in a tax haven or tax favorablejurisdiction.Interest remitted abroad may be deducted from the calculation of taxable profit of a corporate entity inBrazil, with limitations.In the case of the payment of interest to related persons residing abroad in an other than tax haven,interest may be deducted up to an amount that does not exceed the value calculated based on thespecific rate plus a percentage margin as spread, as defined by the Ministry of Finance based on themarket average. In the event of transactions in dollars, the rate applicable to Brazil’s sovereign bondsissued in the foreign market in dollars will apply. In the event of transactions in reais, the rateapplicable to Brazil’s sovereign bonds issued in the foreign market in reais will apply. In the remainingcases, the London Interbank Offered Rate – LIBOR is applicable for a period of six (6) months (art. 2232

of Law 9,430 of 27 December 1996). In addition, the debt must not exceed up to twice the amount ofthe related party’s (creditor) interest in the net worth of the legal entity residing in Brazil (art. 24 of Law12,249 of 11 June 2010).In the case of remittances of interest to a beneficiary that is not a related party, but that is a resident ina tax haven, the interest will only be deductible, on proportional terms, as long as the debt does notexceed 30% of the net worth amount of the corporate entity residing in Brazil (art. 25 of Law12,249/2010).In both cases, the total amount of the aggregate indebtedness of the corporate entity resident inBrazil, cannot be higher than these limits (twice and 30% of the net worth, respectively.Remittances of royalties, or of remuneration for technical support or similar services or the payment oftechnology transfer, are subject to the IRRF, at the rate of 15%, except when there is an internationalagreement to avoid double taxation, providing for a lower rate (art. 710 of the RIR and art. 3 ofProvisional Measure (Medida Provisória - MP) 2,159-70/01). It is important to note that suchremittances are also subject to the levy of the Economic Domain Intervention Contribution (CIDE), atthe rate of 10% (see comments in item 6.1.6.5).Earnings from labor, with or without an employment relationship, and income from the provision ofservices of a personal nature paid, credited, delivered, employed or remitted to persons resident ordomiciled abroad, are subject to the levy of withholding income tax at the rate of 25%, with due regardto the cases of agreements to avoid double taxation (art. 685, II, “a” of the RIR).The income tax rate levied on any amounts that constitute remuneration of invested capital, includingthe remuneration produced by variable income securities, such as interest, bonuses, commissions,premiums, discounts and profit sharing, and positive results received on investments in investmentfunds and clubs, produced by federal government securities, purchased as of 16 February 2006, whenpaid, credited, delivered or remitted to beneficiaries resident or domiciled abroad is reduced to zero,except in countries that do not tax income or that tax it at a maximum rate of under 20% (art. 1 of Law11,312/06).The income tax rate levied on income received on investments in Equity Holding Funds, EquityHolding Quota Investment Funds and Emerging Company Investment Funds when paid, credited,delivered or remitted to individual or institutional beneficiaries resident or domiciled abroad thatconduct financial transactions in the Country in accordance with the rules and conditions establishedby the National Monetary Council (art. 3 of Law 11,312/06) is reduced to zero as well.33

Any amounts paid, credited, delivered, employed or remitted for any reason, either directly orindirectly, to individuals or corporate entities resident or established abroad and residents of taxhavens will only be deductible from the taxable income of a corporate entity in Brazil if the effectivebeneficiary of the entity abroad and recipient of such amounts is identified, if there is proof of theoperating capacity of the individual or entity abroad to carry out the operation, and documentary proofof the payment of the respective price and receipt of the goods, rights or use of the service (art. 26 ofLaw 12,249/2010).6.1.1.2. Branch Office of a Foreign CompanyAs previously indicated in item 3.3 above, the establishment of a branch office produces the following,among other disadvantages of a tax nature: impossibility of deducting expenses paid or credited to thehead office, in the way of royalties, technical and administrative support or similar services (art. 353,III, “a”, of the RIR).6.1.1.3. Capital Gains on Financial InvestmentsEarnings and capital gains derived from financial investments by corporate entities with their principalplace of business and administration in Brazil, of Brazilian or foreign capital, for fixed income orvariable income funds are subject to the levy of withholding income tax at the following rates: 22.5%on investments with terms of up to 180 days; 20% on investments with terms of 181 to 360 days;17.5% on investments with terms of 361 to 720 days; 15% on investments with terms of over 720 days(art. 1 of Law 11,033/04 and RFB Normative Instruction (Instrução Normativa – IN) 1,022 of 5 April2010).Earnings from financial loan operations between corporate entities or between corporate entities andnatural persons are subject to the same tax as fixed-income investments (art. 38 of RFB IN1,022/2010). In the case of intercompany loans, the tax levy also occurs when the operation isconducted between parent companies and subsidiary, associated or related companies. The tax isalso levied on income earned by means of combined operations, conducted in or out of the stockexchanges (art. 730, I of the RIR).The tax is not levied on earnings (fixed or variable income) owned by financial institutions in generaland from investment fund portfolios (art. 14, I and 56, I and II of RFB IN 1,022/2010).These earnings and gains shall constitute the Actual Taxable or Presumed Income and the taxwithheld or paid may be offset against the tax due in the monthly or annual calculation of ActualTaxable Income, or quarterly calculation, in the case of Presumed Income.34

Earnings and capital gains derived from financial investments by individual or institutional investorsresident or domiciled abroad suffer the levy of withholding income tax, at the rate of 15% for fixedincome funds, and at rates of between 10% and 15% for variable income funds (art. 29 of MP 2,158-35/01, art. 16 of MP 2,189-49/01 and art. 68 of RFB IN 1,022/2010).Capital gains received by foreign investors from operations conducted in stock, commodity, futuresand similar exchanges are not subject to the levy of income tax (art. 69 of IN 1,022/2010), with theexception of capital gains from combined operations in the put and call option markets in the stock,commodity and futures exchanges (“box”), in the forward market in the stock, commodity and futuresexchanges, in sales operations with guaranty and without daily adjustments, in the over-the-countermarket, and also in operations with gold (financial asset) outside the exchanges, which are taxed asfixed-income financial investments at the rate of 15% (art. 684 of the RIR).The tax system relating to foreign fixed and variable-income investments, transcribed above, does notapply to investments originating from a country that does not tax income or that taxes it at a rate ofunder 20%, i.e. the “Tax Havens”, which will be subject to the same rules established for personsresident or domiciled in the Country (art. 7 of Law 9,959/00).6.1.1.4. Treaties to Avoid Double TaxationIt is important to mention that Brazil has signed treaties to avoid double taxation of income tax that arecurrently effective, with the following countries: South Africa, Argentina, Austria, Belgium, Canada,Chile, China, Korea, Denmark, Ecuador, Spain, the Philippines, Finland, France, Hungary, India,Israel, Italy, Japan, Luxembourg, Mexico, Norway, Peru, Portugal, the Netherlands (Holland), Sweden,the Czech Republic, Slovakia, Ukraine and Venezuela (the latter only for taxes relating to air transport– Decree 86,354/81) (art. 997 of the RIR).6.1.2. Import Duty on Foreign Products – (Imposto sobre a Importação de ProdutosEstrangeiros - I.I.)As a general rule and unless otherwise provided for by law, products imported into the Brazilianterritory are subject to duties at rates of between 0% and 35% (the latter with regards to automobiles)on the customs value (generally, CIF). However, most taxed products are subject to rates of between10% and 20%. See also paragraph 23.2.35

6.1.3. Export Duty on National or Nationalized Products (Imposto sobre a Exportação deProdutos Nacionais ou Nacionalizados - I.E)Although virtually inapplicable in practice, exports of some few national or nationalized products aresubject to export duty at rates of 0% to 150%, unless otherwise provided by law.6.1.4. Tax on Industrialized Products or Excise Tax – (Imposto sobre Produtos Industrializados– IPI)IPI is levied on the manufacture and importation of products. It is a tax on consumption, the mechanicsof which obey the product selectivity principle, in accordance with the product’s essentiality. Productsdeemed to be superfluous are subject to a higher tax burden, whereas those with a higher degree ofessentiality are treated differently.IPI rates currently range between 0% and 300%, the latter applicable to cigarettes. Most products aresubject to rates of 10% to 20% (Decree 7,660 of 26 December 2011 – The IPI Table – TIPI).IPI is a non-cumulative tax; this mechanism consists of offsetting what is due in each operation, by thecredit system, against the tax charged on the previous operation.We should point out that, in addition to industrialized products destined for export, books, newspapers,periodicals and the paper used for their printing; gold, when defined by law as a financial asset orexchange instrument; electric power, petroleum by-products, fuels and minerals of the Country are notsubject to IPI (art. 18 of Decree 7,212 of 15 June 2010 - IPI Regulation – “RIPI”).6.1.5. Tax on Credit, Insurance and Foreign Exchange Operations, or on Operations relating toNegotiable Instruments and Securities – (Imposto sobre Operações de Crédito, Seguro eCâmbio, ou sobre Operações relativas a Títulos e Valores Mobiliários – IOF)(i) Credit operationsIOF is levied on credit operations at the time of the total or partial delivery of the sum or of the amountthat constitutes the subject matter of the obligation, or its availability to the interested party (art. 3 ofDecree 6,306 of 14 December 2007).The taxpayers are the borrowers of the credit. IOF is charged at the maximum rate of 1.5% per day onthe credit operation amount, corresponding to the principal sum that constitutes the subject matter ofthe obligation, or the amount made available to the interested party, and may be reduced to zero inexpress cases provided for in the legislation (arts. 6 and 8 of Decree 6,306/07).36

Currently, the generally applied rate is 0.0041% per day in the aforementioned operations (art. 7 ofDecree 6,306/07), which, as a general rule, is limited to the product of the multiplication of the dailyrate by three hundred and sixty five days.Moreover, an additional 0.38% rate is levied on credit operations, regardless of the term of thetransaction and of whether the borrower is an individual or corporate entity.(ii) Foreign exchange operationsIn this case, the IOF is levied on the delivery of the local or foreign currency, including the documentrepresenting the same, or its availability to the interested party, in a sum corresponding to the foreignor local currency delivered or made available thereby, at the time of the settlement of the foreignexchange operation (art. 11 of Decree 6,306/07).IOF taxpayers are the buyers or sellers of foreign currency in operations concerning financial transfersto or from abroad, respectively, including manual foreign exchange operations and the companiesauthorized to operate exchange transactions are responsible for the payment (art. 13 of Decree6,306/07).The tax base for the calculation of IOF is the sum in local currency received, delivered or madeavailable, corresponding to the sum, in foreign currency, of the foreign exchange operation. Themaximum rate is 25%, currently reduced to thirty-eight hundredths of a percent (0.38%), except for theevents below (arts. 14, 15 and 15-A of Decree 6,306/07):on foreign exchange transactions related to the remittance to Brazil of revenues arising from theexport of goods and services: 0%;b) on foreign exchange transactions to remit to Brazil cash donations received by public financialinstitutions controlled by the federal government and aimed at preventing, monitoring and fightingdeforestation and promoting the conservation and sustainable use of Brazilian forests pursuant to Law11,828 of 20 November 2008: zero;c) on foreign exchange transactions to transfer from and to abroad sums related to investments ininvestment funds abroad, subject to the limits and conditions determined by the Brazilian SecuritiesCommission (Comissão de Valores Mobiliários – CVM): zero;d) on foreign exchange transaction carried out by international air transport companies headquarteredabroad to remit their local revenues: zero;37

e) on foreign exchange transactions to remit foreign currencies to Brazil to cover the expensesincurred in Brazil with the use of credit cards issued abroad: zero;f) on foreign exchange operations of an interbank nature between institutions that make up theNational Financial System authorized to operate in the foreign exchange market and between thelatter and financial institutions overseas: zero;g) on the settlement of foreign exchange transactions to remit from or to Brazil the sums paid asforeign loan and financing, except for the transactions under “r” below: zero;h) on the settlement of foreign exchange transactions to remit interest on shareholders’ equity anddividends paid to the foreign investor: zero;i) on the settlement of foreign exchange transactions carried out by the foreign investor to remit toBrazil – including through concurrent operations – sums to be used in meeting the initial or additionalmargin requirements of stock, commodities and futures exchanges: six per cent;j) on the settlement of foreign exchange transactions carried out by a foreign investor as from 1December 2011 to remit from abroad sums to be invested in variable income investments in Brazilianstock or commodities and futures exchanges, as regulated by the Brazilian Monetary Committee(Conselho Monetário Nacional – CMN), except for the transactions involving fixed income derivatives :zero;l) on the settlement of foreign exchange transactions carried out by a foreign investor as from 1December 2011 to remit to Brazil sums to be used to pay for stocks bought at a public offeringregistered or exempt of registration with the Brazilian Securities Commission (Comissão de ValoresMobiliários – CVM) or to subscribe shares, provided that, in both cases, the issuing companies arelisted for trading on the stock exchange: zerom) on the settlement of foreign exchange transactions carried out by a foreign investor as from 1December 2011 to remit to Brazil – including through concurrent operations – sums to be used in thepayment of purchases of quotas in any such equity holding funds, equity holding quota investmentfunds and emerging company investment funds as approved by the Brazilian Securities Commission(Comissão de Valores Mobiliários – CVM): zero;n) on the settlement of concurrent foreign exchange transactions carried out as from 1 December2011 to remit sums to Brazil through the cancellation of depositary receipts, to invest in the stockmarket: zero;38

o) on the settlement of concurrent foreign exchange transactions carried out as from 1 December2011 to remit to Brazil sums arising from the change of regime applicable to the foreign investor –from direct investor under Law 4,131 of 3 September 1962 to stock market investor as regulated bythe CMN: zero;p) on foreign exchange transactions for the fulfillment of obligations imposed by credit card managersor commercial or multiple banks acting as the credit card issuer, as a result a purchase of goods andservices abroad by the credit card user, subject to the provisions in clause "q" below: six point thirtyeightper cent;q) on foreign exchange transactions for the fulfillment of obligations imposed by credit card managersor commercial or multiple banks acting as the credit card issuer, as a result a purchase of goods andservices abroad, whenever the credit card user is the federal, state or municipal government or theFederal District, or any of their related companies: zero;r) on the settlement of foreign exchange transactions carried out as from 5 December 2012 to remitsums to Brazil – including through concurrent operations – in relation to a foreign loan subject toregistration with the Central Bank of Brazil (Banco Central do Brasil), whether directly or through theissuance of bonds in the foreign market with a payment term of up to three hundred and sixty days:six per cent;s) on the settlement of foreign exchange transactions carried out by a foreign investor to remit to Brazilsums to be used in the payment of any such bonds or securities as issued under arts. 1 and 3 of Law12,431 of 24 June 2011: zero; andt) on the settlement of foreign exchange transactions carried out by a foreign investor – includingthrough concurrent operations – to remit from abroad sums to be used to invest in Brazilian DepositaryReceipts - BDR, as regulated by the Brazilian Securities Commission (Comissão de ValoresMobiliários – CVM): zero.(iii) Insurance Operations.In insurance operations, the taxable event of IOF is the receipt of the premium. The expression“insurance operations” includes life and related insurance, personal and occupational accidentinsurance, and insurance covering property, values, things and other non-specified insurance. Thetaxpayers are the insured persons and the persons responsible for the collection and payment are theinsurance companies or financial institutions that make the payment of the premium (arts. 18, 19 and20 of Decree 6,306/07).39

The tax base for the calculation of IOF is the sum of the premiums paid. The rate is 25%, but isreduced (arts. 21 and 22 of Decree 6,306/07):a) on the following operations: reinsurance; mandatory insurance, related to the financing of housing,conducted by an agent of the Financial Housing System; export credit insurance and internationaltransport of goods insurance; insurance taken out in Brazil, relating to the coverage of risks inconnection with the launching and operation of the Brasilsat I and II satellites; in which the sum of thepremiums is earmarked for funding life insurance plans with coverage for survival; aeronauticalinsurance and civil liability insurance paid to air carriers and performance bond: 0%;b) on life and related insurance, personal and occupational accident insurance operations, includingthe mandatory insurance for personal injuries caused by overland automotive vehicles and by vessels,or by their cargo, to persons transported or otherwise and excluding those dealt with in item “f” of subsectionI: 0.38%;c) on private health care insurance operations: 2.38%, andd) on other insurance operations: 7.38%.(iv) Operations relating to notes and securitiesThe taxable event of IOF is the purchase, assignment, redemption, renegotiation or payment forsettlement of notes and securities. Its taxpayers are: (a) the purchasers, in the case of the purchase ofnotes and securities and the holders of financial investments, in cases of redemption, assignment orrenegotiation; (b) the financial institutions and other institutions authorized to operate by Central Bankof Brazil (arts. 25 and 26 of Decree 6,306/07).The tax base for the calculation of the tax is the operation amount (of the purchase, redemption,assignment or renegotiation) and the maximum rate is 1.5% per day (arts. 28 and 29 of Decree6,306/07).Gold, as a financial asset or foreign exchange instrument, is currently also subject to IOF at the rate of1%, on the first purchase by a financial institution (arts. 36 and 39 of Decree 6,306/07).6.1.6. Social and other Contributions40

6.1.6.1. Social Integration Program - PlSThe objective of the PIS contribution is to finance the Unemployment Insurance Program and theAnnual Bonus of one minimum wage. The purpose of unemployment insurance is to providetemporary financial aid to jobless workers, whether dismissed without cause or owing to the partial ortotal stoppage of the employer’s activities.The contribution is payable by companies from the private sector, including financial institutions, withtheir own funds, on the basis of monthly turnover, meaning all the revenue earned by the corporateentity. The type of activity performed by such corporate entity and the accounting classificationadopted for such revenue is irrelevant, and some deductions are permitted. (art. 1 of Law 10,637 of 30December 2002).It is relevant to note that Law 10,637/02 introduced a new PIS calculation mechanism in relation tocorporate entities taxed by actual taxable income. The said Law instituted the rate of 1.65%, butallows companies to deduct from the PIS payable, credits relating to the PIS paid on prior operations,such as: goods purchased for resale; goods and services, used as inputs for the provision of servicesand for the production or manufacture of goods or products intended for sale, including fuels andlubricants; rents of buildings, machinery and equipment, paid to a corporate entity, used for thecompany’s business activity; electric power consumed in the company’s establishments, and othercases (arts. 2 and 3 of Law 10,637/02).Moreover, it is important to mention that the former PIS calculation method, i.e., the application of therate of 0.65%, without the right to the aforementioned credits, is still valid for corporate entities taxedby income tax on the basis of presumed or arbitrated income, tax-immune corporate entities, therevenues derived from the provision of telecommunication and information technology services, andother cases (art. 8 of Law 10,637/02).The PIS contribution is not imposed on income from exports of goods abroad and services rendered toindividuals or companies resident or domiciled abroad, on sales to trading companies with the specificpurpose of exportation (art. 5 of Law 10,637/02 and Law 10,865 of 30 April 2004) and on issues ofgoods destined for the Manaus Free Trade Zone for sale or industrialization (art. 2 of Law 10,996 of15 December 2004).On the other hand, the rate of the PIS contribution is 1.65% upon entry of imported goods andservices (art. 8 “I” of Law 10,865 of 30 April 2004).41

6.1.6.2. National Social Security Institute – (Instituto Nacional de Seguro Social – INSS)Business concerns generally contribute monthly to the INSS, with their own funds. These companiesare required to pay 20% of the total compensations paid or credited in any way to employees, duringthe month; 20% to insured executives, self-employed workers, free lancers and other individuals(insured individual taxpayers, art. 22, I of Law 8,212 of 24 July 1991). Moreover, for the financing ofthe benefit relating to occupational accidents, companies pay: 1%, if the risk of an occupationalaccident is considered slight, 2% if the risk is average and 3% if the risk is serious (art. 22, II, of Law8,212/91). In addition, the contribution must be paid at 5.8% of the compensation paid to employeesand allocated to other sectors. Some corporate entities, such as financial institutions and insurancecompanies, in addition to the contributions mentioned above, are subject to a surcharge of 2.5%assessed on the same tax base on which the rate of 20% applies (art. 22, paragraph 1 of Law8,212/91, altered by Provisional Measure (Medida Provisória - MP) 2,158-35/01).Companies are also required to make the discounts and payments of the social security contributionsof their employees. These contributions range from 8% to 11%, of the respective compensation,observing the ceiling established by law (art. 20 of Law 8,212/91).Another thing that should be pointed out is that under Provisional Measure (Medida Provisória – MP)540 of 2 August 2011, converted into law 12,546 of 14 September 2011, the federal governmentintroduced a policy to lower payroll taxes in certain branches of economic activity. The purpose here isto help keep existing jobs and create new jobs.The companies engaged in the business activities covered by this new policy must calculate the INSSdifferently: they must apply a rate that may vary from 1 to 2% of the gross revenue arising from suchactivities, excluding any revenue arising from export and international cargo transport, the IPI and theICMS (Tax Substitution) passed on to buyer, cancelled sales and unconditional discounts.Whenever a company is hired to perform the services covered by the policy through an assignment oflabor, the hiring company must withhold and pay 3.5% of the value of the bill of sale or service invoice.If the company performs activities covered by the policy as well as activities not covered by the policy,then such company must calculate the INSS based on two different systems – payroll and revenue –according to the proportion of the revenue generated by each activity in the company’s total revenue.For example, if an activity covered by such policy accounts for 70% of the company's total revenues,then the company must pay the INSS by applying a rate of 1 to 2% on 70% of the company's totalrevenues and by applying a 20% rate on 30% of the company's payroll.42

Today, this new system is expected to be followed until 31 December 2014 and is mandatory for thecompanies engaged in the branches of economic activity covered by the policy, including:(i) maintenance and repair of aircrafts, engines, components and related equipment; (ii) internationalcargo transportation; (iii) international passenger transportation; (iv) long-distance, coastal and inlandmaritime transport of cargo and passengers (v) maritime and port support navigation; (vi) maintenanceand repair of vessels; (vii) specific retail activities; (viii) provision of information technology (IT) andinformation and communication technologies (ICT) services; (ix) companies engaged in the hotelindustry; (x) collective passenger transport by road; and (xi) industrialization of any products whoseMercosur Common Nomenclature (NCM) is listed in Law 12,546/11.It is important to point out that the application of this system involves many different details that mustbe analyzed on a case by case basis.6.1.6.3. Contribution for the Funding of Social Security - (Contribuição para Financiamento daSeguridade Social – COFINS)COFINS is entirely allocated for the maintenance of Social Security and, under the cumulative system,is levied at the rate of 3% (art. 8 of Law 9,718 of 27 November 1998) on the monthly turnover, andsome deductions provided in law are permitted (art. 3, paragraph 2 of Law 9,718/98).For financial institutions, the COFINS contribution is imposed at the rate of 4% (art. 18, of Law10,684/03).Revenues generated with the sale of goods or services destined for the foreign market are exemptfrom the COFINS contribution (art. 14, I and II of MP 2,158- 35/01), and also the sale made by atrading company specifically for export purposes (art. 6, III of Law 10,833/03) and issues of goodsdestined for the Manaus Free Trade Zone for sale or industrialization in that area (art. 2 of Law10,996/04).It is important to mention that Law 10,833/03 introduced the COFINS non-cumulative system forcorporate entities taxed by actual income. Under such system, COFINS is payable at 7.6%, butpermitting that companies calculate and discount from the due amount of the contribution, creditsrelating to certain previous operations, such as: goods purchased for resale; goods and services, usedas inputs for the provision of services and in the production or manufacture of goods or productsintended for sale, including fuels and lubricants; rents of buildings, machinery and equipment, paid toa corporate entity, used in the company’s business activity; electric power consumed in the company’sestablishments, and other cases (arts. 2 and 3 of Law 10,833/03).43

In addition, it is important to mention that the former COFINS calculation mechanism, i.e., theapplication of the rate of 3%, without the right to the aforesaid credits, is still valid for corporate entitiestaxed by income tax on the basis of presumed or arbitrated income, tax-immune corporate entities andthe revenues derived from the provision of telecommunication and information technology services.On the other hand, the rate of the COFINS contribution is 7.6% upon entry of imported goods andservices (art. 8 II of Law 10,865/04). In relation to certain specific goods, an additional 1% rate mustbe paid (art. 8, paragraph 21 of Law 10,865/04 coupled with the Exhibit to Law 12,546 of 14December 2011).6.1.6.4. Social Contribution on Net Income of Corporate Entities - (Contribuição Social sobre oLucro Líquido da Pessoa Jurídica – CSLL)The CSLL contribution is levied at the rate of 9% on the net income of corporate entities, before thededuction of the contribution itself, with due regard to certain adjustments provided by law.Provisional Measure 413 of 3 January 2008, which was converted into Law 11,727 of 23 June 2008,raised the CSLL rate of financial institutions, private insurance and special savings companies to 15%.The verification of its tax base follows practically the same income determination method used forCorporate Income Tax - IRPJ (actual, presumed or arbitrated), the only difference being some expressdeductions set forth in specific legislation.6.1.6.5. Economic Domain Intervention Contribution – (Contribuição de Intervenção no DomínioEconômico –CIDE) - TechnologyThe CIDE contribution was instituted on 29 December 2000, through Law 10,168/00, as a means offunding technological development and interaction programs between Brazilian universities andresearch centers and private enterprise. This contribution, which was established at a rate of 10%, hasas its tax base the payment, credit, delivery or remittance to persons residing or domiciled abroad, ofremuneration derived from the license of use or acquisition of technological know-how, as well asagreements that imply technology transfer (defined by the law as those relating to the exploitation ofpatents or use of trademarks and the supply of technology and technical support).Moreover, art. 6 of Law 10,332 of 19 December 2001 extended the coverage of CIDE, as of 1 January2002, to include remittances abroad as payment for technical and administrative support and similarservices that do not imply technology transfer.44

Of the total resources collected by CIDE, 50%, at least, are invested in programs to fostertechnological qualification and support scientific research and technological development (arts. 1 and2 of Law 10,332/01).6.1.6.6. Economic Domain Intervention Contribution - CIDE - FuelsMoving ahead with the alterations in the tax legislation by virtue of the opening of the fuel market toforeign investors, the CIDE-Fuels was created, which is levied on the importation and sale of oil andits by-products, natural gas and its by-products and ethyl alcohol fuel (art. 1 of Law 10,336 of 19December 2001).CIDE taxpayers include the producer, formulator and importer of the fuels mentioned above.The tax base of the contribution is the unit of measure defined in law, which varies for each type offuel. The rates are also specific for each type of product (Law 10,336/01). For instance, the rateapplicable to gasoline is R$ 860 per cubic meter.6.2. Main Taxes Levied by the States and Federal District6.2.1. Tax on Operations Involving the Distribution of Goods and Interstate and Inter-municipalTransportation and Communication Service Renderings or State VAT – (Imposto sobreOperações Relativas à Circulação de Mercadorias e sobre a Prestação de Serviços deTransporte Interestadual e Intermunicipal e de Comunicação – ICMS)ICMS is a state tax levied on the distribution of goods by any establishments, as well as on the entryof merchandise imported from abroad, and also on the provision of interstate or inter-municipaltransportation and communication services, even when the respective distribution or service renderingare originated abroad.Similarly to IPI, ICMS is a non-cumulative tax. It can also be a selective tax, depending on theessentiality of the goods and services.Among the cases in which ICMS is not due, by express constitutional or legal provision, the followingare of general interest to the foreign investor:a) on transactions transferring industrialized products abroad, and renderings sending servicesabroad, provided that the tax amount charged in previous transactions can be recorded and set off(art. 155, paragraph 2, X, “a” of the Federal Constitution);45

) on transactions transferring oil, including lubricants, liquid and gaseous fuels derived therefrom andelectric power to other States (art. 155, paragraph 2, X, “b” of the Federal Constitution);c) on gold, when it is considered a financial asset or foreign exchange instrument (art. 155, paragraph2, X, “c” of the Federal Constitution);d) on the exportation of merchandise and renderings that send services abroad (via an exportingcompany, including trading companies.It is important to note that some States of the Federation grant tax incentives in relation to the ICMSwith the aim of attracting the establishment of industrial projects, although sometimes such incentivesfail to meet the validity requirements laid down by the Federal Constitution.For transactions where sender and recipient are located within the same state (or the Federal District),the ICMS rate will be set by such state in relation to the relevant goods and services, subject to thelimits set in the applicable federal laws. In the state of São Paulo, for instance, the rate may vary from4 to 25%. In general, a 18% rate is applicable. In relation to communication services for consideration,a 25% ICMS rate is applicable.For transactions involving the exit of goods or services from one state to another to ICMS taxpayers, a12% rate is generally applicable. When such transactions are made in the South and Southeastregions and when the destination of such transactions are the North, Northeast and Midwest regionsor the state of Espírito Santo, then the rate will be 7%.In January 2013, however, Resolution 13, issued by the Senate on 25 April 2012 came into force.Under such Resolution, a 4% ICMS rate is applicable to interstate transactions involving importedgoods, provided that, after customs clearance, such goods (i) do not undergo any industrializationprocess and (ii) result in goods with an Import Content over 40% after undergoing any processing,improvement, assembly, packing, repacking and renovation process.This 4% rate is applicable even when the interstate transaction is not carried out immediately after theimport transaction. The Senate’s Resolution 13/2012 is applicable to all interstate transactions carriedout after importation.However, the 4% ICMS rate is not applicable to interstate transactions involving (i) imported goodswithout similar counterparts locally manufactured in Brazil, as defined in a list issued by the Council ofMinisters of the Chamber of Foreign Trade (Câmara de Comércio Exterior - CAMEX); and (ii) naturalgas imported from abroad. In these cases, the 7% or 12% rate applicable to interstate transactionswill be applicable, depending on the state of origin and state of destination of the goods.46

In order to regulate Resolution 13/2012, the National Public Finance Policy Council (ConselhoNacional de Política Fazendária - CONFAZ) enacted SINIEF rulings 19 and 20, which set out theprocedures and ancillary obligations that taxpayers are required to follow and comply with.Finally, it must be noted that under ICMS Agreement (Convênio) 123/2012, no tax benefit is availableas from 1 January 2013 in relation to interstate transactions involving goods that are subject to the 4%ICMS rate, except: (i) if the tax benefit results in an interstate tax burden that is lower than 4%; and (ii)in case of tax exemption.6.2.2. Inheritance and Gift Tax – (Imposto sobre transmissão causa mortis e doação dequaisquer bens ou direitos – ITCMD)ITCMD is levied on the transfer of property or rights (shares, quotas, local or foreign currency,deposits, etc.) taking place by legal or testate succession, including provisional succession, and bygift.The tax base of the ITCMD is the market value of the property or right transferred, expressed in localcurrency. The generally applicable rate is 4% .6.3. Main Municipal Taxes6.3.1. Service Tax - ISSISS is a tax levied by municipal governments (and the Federal District) on service renderings of anynature specified by complementary law and not included in the list of services subject to ICMS(mentioned in item 6.2.1 above). The ISS is calculated based on the price of the service and the rategenerally ranges between 2% and 5%.Among the services subject to the tax are consulting, technical advisory services, plans anddealerships, among others. At this time each municipality establishes its rates for the services taxed.It is important to mention that several municipalities require the registration of companies located inother Brazilian municipalities that render services to recipients based in within such municipality, onpain of the recipient of the service being required to carry out the withholding and payment of the ISS.ISS is also charged on certain imports of services. Hence, the legal provisions of each Municipalityshould be analyzed for specific cases.47

6.4. Summary of the Tax Burden on Corporate Entity Profits and Labor and Social SecurityCharges of Companies6.4.1. Tax Burden on ProfitsIn summary, the tax burden incurred on company profits, up to their final distribution to partners orshareholders abroad, amounts to approximately 34% (25% as IRPJ and 9% as CSLL).Specifically in the case of the payment of Interest on Owners‟ Equity (Juros sobre Capital Próprio –“JCP”) Withholding Income Tax (IRRF) will be levied at the rate of 15% upon payment to the partners.However, these amounts paid are deductible for the purposes of Corporate Income Tax (IRPJ) andSocial Contribution on Net Income (CSLL), which reduces the tax burden of corporate entities to 19%with respect to the amounts paid as Interest on Owners‟ Equity.6.4.2. Labor and Social Security ChargesThese charges, including employee labor rights, amount to an average of approximately 100% of thepayroll amount.6.5. A Summary of the Tax Burden on Service ImportsWhen involving the importation of services – but not those subject to ICMS – , this transaction will begenerally subject to the levy of ISS, IRRF, PIS, COFINS and CIDE-Technology and IOF, totalingapproximately 50% of the service amount.7. LABOR LAW AND SOCIAL SECURITYThe Consolidation of Labor Laws (Consolidação das Leis de Trabalho - CLT) is the main set of rulesthat regulates labor relations in Brazil. It contains a number of definitions, principles and rulesdesigned to protect the interests of employees and workers in general.7.1. EmployeeIs a natural person who personally provides services to another person, on a habitual basis and undersubordination, in exchange for remuneration.The following criteria must be observed for the hiring of employees in Brazil:48

(i) Minimum age of 16;(ii) From 14 to 16 only as an apprentice and provided that the employee is studying in the naturalsciences area that he or she intends to work;(iii) Over the age of 18 for night, unhealthy and hazardous work.7.2. EmployerIs an entity, with or without a legal personality, with the purpose of generating profit or otherwise, andthat has employees. The employer, in the majority of cases, is the company, but liberal professionals,associations, etc. may also be employers.7.3. Individual Employment ContractIs the tacit or express agreement, corresponding to the employment relationship.The adoption of a written contract is more advisable.Contracts may be for an indeterminate or determinate period, though contracts for indeterminateperiods are more common, since determinate period contracts are only allowed to be signed inspecific situations set forth in law.7.4. Work and Social Security Booklet (CTPS)The work and social security booklet is obligatory and proves the existence of a written or verbalemployment contract.7.5. Rights of employeesEmployee rights include:a) Working hoursOrdinary working hours are 8 hours a day and 44 hours a week. The law provides for shorter workinghours in certain situations (e.g. minors, women, etc.) and for certain professions (e.g.: railroadworkers, physicians, telephone operators, journalists, bank workers, etc).49

The working day will be diurnal, when it is between 5:00 a.m. and 10:00 p.m., in urban centers, withother criteria for rural areas. Nocturnal work generally occurs when the work is performed between10:00 p.m. of one day and 5:00 a.m. of the following day.Overtime refers to the hours worked beyond the normal limits fixed by law, collective bargainingagreements, normative sentence or individual employment contracts. Overtime is classified into fivetypes:(i) Overtime resulting from an extension agreement, not exceeding 2 hours per day;(ii) Compensation of hours system;(iii) Overtime worked for the purpose of the conclusion of non-postponable services or theexecution of which may cause losses to the employer;(iv) Overtime worked to recover work stoppage hours;(v) Overtime worked in case of force majeure.b) Remunerated weekly rest periodIs the remunerated weekly rest period of 24 consecutive hours, preferably taken on Sundays andwithin the limits of the technical requirements of companies, or on public and religious holidays, inaccordance with local tradition. The employee's full attendance at work during the week is a conditionfor the maintenance of the remunerated weekly rest period.c) Rest breakEmployees who work 8 hours daily are ensured a break for a meal and rest of at least one hour.d) VacationAll employees will have the right to vacation, after each 12-month period of a valid employmentcontract, without prejudice to the remuneration. Its duration depends on the assiduity of the employee,suffering a reduction in proportion to the employee's unjustified absences (maximum of 30 andminimum of 12 days' vacation).It is forbidden to discount the employee's absences at work from the vacation period. The employershall grant vacation during the 12 months subsequent to the acquisition period. Otherwise, theemployer must pay double the amount of the vacation pay.50

During vacation, employees receive the same amount of salary as if they were working, plus a 1/3bonus. As a rule, the law does not allow employees to trade their entire vacation time for pay. Only1/3 of the vacation time can be traded..e) WagesThe law does not define wages, but indicates its components and fixes the rules for its payment andprotection.The Government establishes the minimum wage amount annually. In March 2013, it was fixed at R$722.00 (approximately US$ 306), which will continue valid until January 2015.Severance pay, profit sharing, pension plan benefits and their supplements, and intellectual rights arenot regarded as wages.Wages may be paid in cash, check or via bank deposit and in fringe benefits.The law requires the payment to be made in Brazil’s local currency and considers payment in foreigncurrency as not made, though the latter may serve as the calculation basis for conversion into nationalcurrency, at the time of payment.Payment in fringe benefits is the payment method whereby the employee receives such economicgoods as food, housing, the use of an automobile, credit card, payment of household bills, etc, aspayment of part of his or her wage, though it should be pointed out that at least 30% of the total wageamount shall necessarily be paid in money.The wage amount may be freely stipulated, provided that such stipulation is not conflicting with thelabor protection provisions, collective bargaining agreements and judicial rulings.The following constitute special types of wage:(i) Advances: advance in money or wage advance established as a result of temporary needs.(ii) Additional overtime pay: is at least 50% and is incorporated into the base compensation for thepurpose of calculating the additional amounts to which the worker is entitled (13th wage, vacation,etc.).51

(iii) Additional night pay: is 20% of the contractual wage due, as a rule, for services rendered after10:00 p.m., in urban centers, and it is incorporated into the base compensation for the purpose ofcalculating the additional amounts to which the worker is entitled;(iv) Health hazard allowance: is due to employees that render service in an environment that isconsidered unhealthy – it is 10%, 20% or 40% of the minimum wage, according to the degree ofhealth hazard (minimum, average and maximum, respectively) – and it is incorporated into theemployee's base compensation for all purposes.(v) Hazard pay: is due to employees that render services under highly risky conditions -– it is 30%of the contractual wage – and is incorporated into the employee's compensation (except for thepurposes of bonuses, gratuities and profit sharing).(vi)Additional transfer pay: is due to any employee that is transferred by the employer to anotherlocality and its amount is 25% of the contractual wage.(vii)Others: commissions, bonuses, gratuities and premium bonuses.f) Thirteenth wage (or "Christmas bonus")Is a mandatory bonus in compliance with the law and is of a wage nature.It corresponds to one wage of the employee and must be paid in two installments, the first of which onor before November 20 and the second on or before December 20 of each year.For employees that worked less than 1 year, the 13th wage is proportional to the months of service, inthe order of 1/12 per month, considering a fraction of 15 days or over as a full month and disregardingsmaller fractions.g) Unemployment Compensation Fund - FGTSThe FGTS is a bank account that the worker can use on the occasions provided by law, which isformed by monthly deposits made by the employer.Every month, the company has to deposit, with its own resources, in a specific account in the name ofeach employee, the equivalent of 8% of the employees‟ compensation. For employment contracts fora determinate period, the rate is 2%.52

The sums deposited will be the property of the employee and withdrawals shall be made in thesituations set forth in law, such as in the case of unfair dismissal.In the latter case, the company is also obligated to pay the employee an indemnity of 40% of theFGTS account balance and pay the sum of 10% of the same balance, as social contribution.h) TenureIs the right of an employee to remain in the job, even against the employer's wish, while there is norelevant cause expressed in law and that permits the employee's discharge.It is the law that sets forth the cases of job tenure, e.g. the tenure of union leaders andrepresentatives, victims of accidents, committee representatives, expectant mothers and employees'representatives in the CIPA (Internal Commission for the Prevention of Accidents).i) Collective bargaining agreementsIn addition to the previously described benefits, companies must observe the rules established in thecollective bargaining agreements entered into between the unions that represent the professionalcategory.7.6. Termination of employeesAn employee may be dismissed for cause or without cause. The grounds for dismissal for cause areset out in the law.Dismissal for cause allows the employer to terminate the employment contract without extra cost (e.g.payment of severance pay, percentage on FGTS deposits, 13th wage and vacation, etc.).In case of dismissal without cause, the employee will have the right to, among other things, receivethe following amounts: proportional notice period, proportional 13th wage, vacations due, proportionalvacations, 40% of the FGTS deposits and any other amounts as set out in the collective agreement.The termination of employment contracts with a duration period of more than one year shall behomologated by the Ministry of Labor and Employment (MTE) or by the employees' union of thecategory to which the employee belongs.53

7.7. Labor Union / Trade Association LawThe core business activity of the company and the number of trade associations existing in itsgeographical area are what will determine the trade association to which a given company will belong.The respective employees’ labor union will represent all the employees of the company, with theexception of those belonging to officially recognized professional categories, such as secretaries,drivers, economists and journalists, who will be represented by their own particular unions.Both the employees and the companies shall, necessarily, pay the union contributions to therespective labor union/trade association.As a rule, negotiations are held annually between the trade association of the company and the laborunion of the employees of the same category. The collective labor agreements resulting from thesenegotiations are filed at the Labor Court and have force of law.7.8. Social securityThere is more than one social security regime in Brazil:(i) The general regime: regards the INSS (Brazilian Social Security Institute) for the private sector;(ii) The public sector regime: instituted by the Federal Government, the States and Municipalities; and(iii) The supplementary regime: both in the public and private sectors, with the purpose ofsupplementing the pensions from the official social security regime or public sector.The contribution to social security for which the company is responsible, is:(i)20% of the total compensation paid, due or credited, for any reason, during thecourse of the month, to insured (a) employees and (b) free-lancers;(ii) 20% of the total remunerations or compensations paid or credited during the course of themonth to the insured (a) individual taxpayer;(iii)15% of the gross amount of the tax invoice or service bill, with respect to the servicesrendered thereto by (a) cooperative members (through workers' cooperatives);54

(iv) 2.5% of the total gross revenue derived from the sale of rural production when involving acorporate entity that has only the rural production activity as its corporate purpose .There are also other contributions that must be paid on the total compensations paid or credited toemployees, namely:(i)Contribution for the financing of occupational accidents: consists of the degree that thecompany provides for the event of incapacity for work resulting from the environmentalrisks of the work. The percentage of this contribution varies from 1% to 3%.(ii)Third party contribution: are obligatory contributions imposed on the payroll that areearmarked for private social service and professional training entities linked to theunion system, whose rates vary from 0.2% to 5.8%;(iii)Education salary contribution: consists of a contribution to the Federal Government(União Federal) for the financing of elementary and middle school (ensino básico).The education salary rate is 2.5%.The total charges for the company correspond, on average, to 35.8% (the index for industry). Thesecontributions are paid directly to the INSS, which transfers the contributions that do not pertain theretoto the entitled entities.7.9. Occupational safety and hygieneAs a rule, companies that have more than 20 employees must have an Internal Commission for thePrevention of Accidents (CIPA).A medical exam is obligatory, both at the time of hiring and upon termination, which shall be at theexpense of the employer. In addition, depending on the type of work performed, some employees maybe subject to regular and special medical exams from time to time.Unhealthy activities or operations are those activities that, due to their nature, condition or methods ofwork, expose employees to agents that are harmful to health, beyond the tolerance limits fixed in thelaw.Hazardous activities or dangerous operations are those that, due to their nature or method of work,imply the worker's permanent contact with inflammable products or explosives, under highly riskyconditions.55

All companies are required to maintain their occupational medicine and safety programs renewed,annually, especially those determined by the Ministry of Labor and Employment (MTE), namely:(i)(ii)(iii)(iv)Environmental Risk Prevention Program (Programa de Prevenção de RiscosAmbientais – PPRA);Occupational Health Medical Control Program (Programa de Controle Médico deSaúde Ocupacional – PCMSO);Technical Report on the Environmental Conditions at the Workplace (Laudo Técnicode Condições Ambientais no Trabalho – LTCAT);An occupational health and safety risk assessment (Perfil ProfissiográficoPrevidenciário – PPP).Law 7,347/85 disciplines the public civil action for liability for damages caused to the environment, theconsumer, assets and rights of an artistic, esthetic, historical, and tourist value, with which the PublicProsecution Service (“Ministério Público”) has been promoting the protection of the environment andwork environment, in cases where it considers that any violation of law is characterized.7.10. OutsourcingIs the act of transferring the responsibility for the service from one company to another.Notwithstanding the absence of specific legislation on the matter, the practice of outsourcing in Brazilis steadily on the rise. Its great attraction is that of transferring the company's non-core activities tothird parties.Companies are adopting outsourcing as a means of cutting costs and enhancing performance in theshort and medium term.Companies that outsource their non-core activities are secondarily liable for the labor and socialsecurity obligations of the employees of the company that renders the respective service.8. INFORMATION TECHNOLOGY8.1. General InformationThe Brazilian Government has been developing numerous actions, especially since the 90s, with aview to the competitive insertion of the Brazilian information technology industry in the competitive56

market. The policy for the sector is based on three development fronts: (i) hardware, seekingtechnological innovation; (ii) software, and (iii) the microelectronics sector.The past history of changes in the information technology policy relates directly to the preoccupationwith providing support to the industry established in the Country and the requirement of creating anattractive climate for foreign capital, culminating in the approval of Law 8,248, of 23 October 1991(Information Technology Act), concerning information technology tax incentives.The Information Technology Tax Incentives Policy, in particular for the development of hardware isprovided for in the Information Technology Act, and in the legislation concerning the Manaus FreeTrade Zone (Law 8,387/91 and Decree Law 288/67), which have undergone various alterations overthe years (latest alterations: Laws 11,452/2007 and 11,482/2007, the latter amended by ProvisionalMeasures 451 of 2008 and 528 of 2011; Law 11,945/2009; Law 12,469/2011; Law 12,507/2011). As ageneral rule, information technology goods and services produced in the Country are benefited withthe gradual reduction of the IPI (Excise Tax) due up to December 2019, when the benefit will beextinguished, in accordance with the table below and their fiscal classification:Reduction of IPI dueDate100% 12.15.2010 to 12.31.201490% 01.01 a 12.31.201570% 01.01.2016 a 12.31.2019For information technology and automation goods produced in the Mid-West Region and in theregions of influence of ADA – Agência de Desenvolvimento da Amazônia (Amazon DevelopmentAgency) and ADENE – Agência de Desenvolvimento do Nordeste (Northeast Development Agency),there is an IPI reduction, as shown in the table below (art. 3 of Law 11,077/04):Reduction of IPI dueDate95% 01.01.04 to 12.31.201490% 01.01 to 12.31.201585% 01.01.16 a 12.31.2019The maintenance and use of IPI credit relating to raw materials, intermediary products and packagingmaterial employed in the industrialization of goods that enjoy the benefit is guaranteed.The above percentages do not apply to portable microcomputers and to small-capacity digital57

processing units based on microprocessors, priced at up to R$ 11 thousand, equivalent to US$ 6.40thousand, and to magnetic and optical disk units, printed circuits with electric and electronicassembled components, cabinets and power supplies, recognizable as exclusively or mainly designedfor such equipment, which have a specific IPI reduction, but also with the planned extinguishment ofthe benefit in 2019.The tax benefits of the Information Technology Act are not granted to a company generically, butrather to certain products manufactured locally by the company. The list of information technology andautomation goods that may enjoy the tax benefits is contained in Decree 5,906/06 (amended byDecree 6,405/08, the Exhibit I of which was amended by Decree 7,010/2009 in regard to informationtechnology and automation goods), which regulates Law 10,176/01 (amended by Laws 10,664/2003and 11,007/2004), which also alters the Information Technology Act.Moreover, the granting of the tax benefits of the Law is contingent on the satisfaction of the followingrequirements – set forth in the Law and regulated by Decree 5,906/06, amended by Decrees6,405/2008 and 7,010/2009 (the legal requirements, however, remained unchanged):a) the information technology and automation goods shall be manufactured in Brazil, in accordancewith a basic production process (processo produtivo básico) established product-by-product by theExecutive Branch;b) there must be investment, on the part of the applicant company, in Research and Development(R&D), specifically in the information technology field, as mentioned below;c) the applicant company is required to institute a quality program, to be defined by the ExecutiveBranch;d) the applicant company is required to adopt an employee profit or income sharing program.The qualification of a company applying for the enjoyment of tax benefits occurs by means of thepublication of a Joint Administrative Rule (Portaria Conjunta) of the State Ministers of Science andTechnology, Development, Industry and Foreign Trade and Finance, following an analysis process ofthe proposed project at the Ministry of Science and Technology. Decree 5,906/06 establishes, amongother provisions, the rules relating to the submission of the project, the obligations relating to R&D ininformation technology and the procedures for fixing and complying with the basic production processof products eligible for incentives. In addition, it contains the appropriate instructions and a roadmap tobe followed, in accordance with an Administrative Rule of the Science and Technology Ministry andDevelopment, Industry and Foreign Trade Ministry, for submitting the application and proposed R&Dproject.58

The consideration for the benefit is annual investment in R&D in information technology. This researchshall occur in the Country, in a minimum sum of 5% of the gross revenues of the company applying forthe benefit, derived from the sale, in the domestic market, of information technology and automationgoods. For the purpose of the calculation of gross revenues, the taxes imposed on the said sale, andthe purchase cost of the products eligible for the incentive shall be deducted, pursuant to law.The law and its regulation stipulate in detail the method of allocating resources to be invested in R&Dby the applicant company of the benefit, including establishing minimum percentages to be earmarkedfor agreements with official or accredited research and teaching centers and entities.The investment percentage in R&D will be reduced progressively, as shown in the table below:Reduction of Investments in R&DYEAR20% 01.01.04 to 12.31.201425% 01.01 to 12.31.201530% 01.01.16 to 12.31.2019When involving investments related to information technology goods produced in the Mid-West Regionand regions of influence of ADA and ADENE, the reduction of the investment percentage in R&D willobserve the following criteria:Reduction of Investments in R&DYEAR13% 01.01.04 to 12.31.201418% 01.01 to 12.31.201523% 01.01.16 to 12.31.2019The beneficiary companies of the incentives shall submit to the Science and Technology Ministry, onan annual basis, descriptive reports to evidence observance of the investment percentages requiredby law. If the beneficiary company fails to observe the legal requirements, the benefit may besuspended, without prejudice to the reimbursement of already enjoyed benefits, adjusted andincreased by arrears interest and fines.The producer companies of information technology and automation goods, whose plants are locatedin the Manaus Free Trade Zone, shall also invest at least 0.8% of their gross revenues in R&Dannually, in exchange for the tax incentives granted. The funds shall be earmarked for research in theAmazon, in accordance with the project to be submitted by each company to SUFRAMA and to the59

Science and Technology Ministry. The granting of tax benefits for the information technology sector inthe Manaus Free Trade Zone is currently regulated by Decree 5,906/06.CATI – Comitê da Área de Tecnologia da Informação (Information Technology Area Committee) wasset up in February 2002 with the mission of managing the resources collected with the companiesbenefited by the information technology legislation. These resources are earmarked for InformationTechnology research and development activities.8.2. Digital inclusion programIn addition to the above benefits, Law 11,196, of 21 November 2005, which was regulated by Decree5,602/05 and amended by Laws 11,482/07 (amended by Provisional Measures 451/2008 and528/2011, Law 11,945/2009, Law 12,469/2011, Law 12,507/2011), 11,487/07, 11,488/07 (amended byProvisional Measures 413/2008 and 472/2009, Law 11,727/2008, Law 1,933/2009, Law 12,249/2010,Decree 7,212/2010) and 11,727/08, brought the Digital Inclusion Program, which reduces to zero thePIS/Pasep and COFINS rates levied on the gross revenue derived from the retail sale of digitalprocessing units, portable digital automatic data processing machines; automatic data processingmachines; keyboard and mouse that meet certain specifications.These products are also subject to the terms and conditions set forth in the regulations.These benefits are extended to the purchases made by corporate entities and entities of the publicadministration, except companies opting for the SIMPLES (Integrated System for the Payment ofTaxes and Contributions by Small and Very Small-sized Companies) and apply to sales made on orbefore 31 December 2014 (MP 472/09 – converted into Law 12,249/2010 and amended by Law12,788/2013, Law 12,409/2010, Law 12,402/2011, Law 12,490/2011, Law 12,678/2012, Law12,599/2012 and Provisional Measure 608/2013).8.3. SoftwareLaw 9,609, of 19 February 1998, protects computer program-related rights, such as the copyright, fora period of 50 years, reckoned from January 1 of the year subsequent to the computer program’srelease year, or, in the absence thereof, of its creation. This protection does not depend on theregistration of the program, which can, however, at the owner’s discretion, be registered with INPI(Brazilian Patent and Trademark Office).The aforesaid rights are also guaranteed to foreigners domiciled abroad, provided that the program’scountry of origin grants Brazilians and foreigners domiciled in Brazil equivalent rights.60

A foreign company may license a program directly for the exclusive use of the end user in the Countryor may license it to a company that will distribute it in the market. Moreover, the remuneration for theuse or distribution of the software may be freely established by the parties.With respect to the marketing of software in Brazil, the law merely establishes that the use ofcomputer programs in the Country shall be the subject of a licensing contract. However, in the event ofthe absence of such license, the tax document relating to the acquisition or licensing of the programcopy will be sufficient to prove the regularity of its use. In the case of licensing agreements for therights to market computer programs of foreign origin, such agreements shall establish theresponsibility for the payment of imposed taxes and charges. These acts and agreements will alsoestablish the remuneration of the owner of the computer program rights residing or domiciled abroad.The entity remitting the foreign currency amount, in payment of the said remuneration, shall keep in itspossession, for a period of 5 years, all the necessary documents to evidence the lawfulness of theremittances.In the cases of the transfer of computer program technology (specifically in cases involving thedelivery of source codes), the Brazilian Patent and Trademark Office will register the respectiveagreements, in order for them to produce effects in relation to third partiesIn the fiscal sphere, there are many doubts with respect to the applicable taxation, which is an issuethat needs to be analyzed on a case-by-case basis.9. INVITATIONS TO BID – PUBLIC AUTHORITY CONTRACTS9.1. General InformationAccording to a provision of the Brazilian Constitution, as a rule, public works, services, purchases,sales and leases, on the part of the Public Authorities, must be procured by an invitation to bid, toensure that the most advantageous proposal for the Public Administration is selected. Within thefederal sphere, the matter is disciplined by Law 8,666 of 21 June 1993, which also establishes thegeneral rules for the direct and indirect public administration, spanning all governmental spheres.It is important to note that invitations to bid for the concession of public services are regulated by laws8,987 of 13 February 1995 and 9,074 of 7 July 1995 ("Public Service Concession Acts"), due to thehigh relevance for the execution of the public policies of the Brazilian Government and to thepeculiarities involving private investments in this sector. Therefore, the Bidding Law is applicable onlyon a subsidiary basis.61

In accordance with the Constitution and Bidding Law, there are some situations where the invitation tobid is dispensed with or not required, such as when the bidding process is objectively inconvenient topublic interest, owing to the singularity of the intended object - i.e. without equivalents in the market orbecause of the uniqueness of the offerors, or further, on account of an emergency situation of thePublic Administration.Invitations to bid shall, in general, abide by the following informative principles: a formal procedure,equal conditions for all bidders, publicity of the acts, administrative integrity, compliance with thenotice or invitation to bid (which is the internal law of each invitation to bid), confidentiality at the timeof the submission of proposals, objective judgment criteria and compulsory award to the successfulbidder.An invitation to bid may be of distinct kinds, namely: a) competitive bidding, b) auction, c) pricequotation, d) invitation, e) contest, and f) live floor auction.The price quotation, invitation and contest types have simplified procedures, due to the limitation ofthe value of the subject matter to be put up for bid. The live floor auction type applies solely toinvitations to bid organized by the Public Administration for the purchase of common goods andservices, i.e., goods with objectively established quality and performance standards practiced in themarket, regardless of the estimated contracting value.Law 8,666/93 also determines that purchases made by the Public Administration should, wheneverpossible, be processed through a Price Registration System (Sistema Registro de Preços – SRP),which permits the rapid and immediate operation of the Public Administration, with due regard to theisonomy principle and guaranteeing the objective pursuit of the most advantageous contracting. TheSRP is currently regulated by Decrees 3,931, of 19 September 2001 and 4,342 of 23 August 2002.International invitations to bid, thus defined in the notice itself, permit the participation of Brazilianand/or foreign companies either individually or in a consortium, as established in the document. Inorder for foreign companies without operations in Brazil to qualify, they must submit documents thatare as equivalent as possible to the documents required from Brazilian companies, duly certified andauthenticated by the respective consulates, when necessary, and translated by a certified translator.Furthermore, they must have a legal representative in Brazil, with express powers to receive service ofprocess and answer administratively and judicially for the principal.The purpose of the invitation to bid is to guarantee, among other things, the observance of theconstitutional principal of isonomy, the selection of the most advantageous proposal for theadministration and the promotion of sustainable national development.62

The judgment of the proposals shall be objective, having as its criteria the lowest price, the besttechnique or the combination of technique and price, according to the type of invitation to bid.It is prohibited to establish differentiated treatment of a commercial, legal, labor, social security or anyother nature, between Brazilian and foreign companies, including as regards the currency, modalityand place of the payments, even when the financing of international agencies is involved.As a tiebreaker criterion, under equal conditions, preference will be ensured, successively, to thegoods and services: produced in the Country, produced or rendered by Brazilian companies andproduced or rendered by companies that invest in technology research and development in theCountry.In invitation to bid processes a margin of preference may be established for manufactured productsand for domestic services that meet Brazilian technical standards.The margin of preference will be established on the basis of studies reviewed periodically, at intervalsof no more than five (5) years, which take into consideration: the generation of jobs and income, theeffect on the collection of federal, state and municipal taxes, technological development andinnovation conducted in the Country, additional cost of products and services, and, in their reviews,the retrospective analysis of results.For the manufactured products and domestic services resulting from the technological developmentand innovation carried out in the Country, an additional margin of preference to the one provided onthe basis of the criteria listed above, may be established.The preference margins by product, service, group of products or group of services, will be defined bythe federal Executive Branch. The sum of the margins cannot exceed the sum of 25% of the price ofthe foreign manufactured products and services.The above provisions do not apply to the goods and services whose production or rendering capacityin the Country is less than: the quantity to be purchased or contracted.The margin of preference may be extended, totally of partially, to the goods and services originatingfrom the Member States of Mercosur – Southern Cone Common Market.In the case of a consortium between a foreign company and Brazilian company, the Braziliancompany will necessarily assume leadership, regardless of the origin of its capital (national or foreign).At the discretion of the Public Administration, guarantees may be required for the contracting of works,services and purchases, which shall not exceed 5% of the contract value, with the exception of cases63

involving sizeable contracts, of a highly technical complexity and considerable financial risks, for whichthis percentage may reach 10%. The guarantees may be:a) escrow in money or public debt securities;b) insurance guarantee;c) bank guarantee.Laws 11,972/09 and 12,188/10 altered the conditions for the sale of goods of the Public Administration(subject to the existence of duly justified public interest) and cases of the waiver of invitations to bid.On 5 August 2011, Federal Law 12,462/2011 was published originally with the purpose of regulatinggovernment bids and public procurement in connection with the major sports events that will be held inBrazil in the coming years (Confederations Cup, World Cup, Olympic Games and Paralympic Games).This law introduced the so-called Special Public Procurement Regime (Regime Diferenciado deContratações Públicas - RDC). However, after coming into effect, the scope of the RDC wasbroadened to include projects that are part of the government's growth acceleration program(Programa de Aceleração do Crescimento – PAC) (added by Law 12,688/2012) and engineeringservices and works in connection with the public school system (added by Law 12,722/2012).The main innovation of the RDC regime was that it repealed the provisions of the Bidding Law exceptin the cases expressly provided in the RDC law. The result of this new legal framework is that theRDC introduced some changes in relation to the Bidding Law, such as: shorter time periods forbidders to submit their proposals; preference given to electronic bidding; a single appeals stage;introduction of a new contracting method ("Integrated Contracting"), whereby the winning bidder isrequired to prepare both the basic and the executive projects, etc. The constitutionality of the RDC lawis being questioned in two actions of unconstitutionality filed with the Supreme Federal Court(Supremo Tribunal Federal – STF). Judgment is pending on both.9.2. ConcessionsBrazilian Law allows the State to delegate the provision of public services to third parties by means ofconcessions, conducted via invitation to bid procedures, whereby the Public Authority awards toprivate enterprise the right to build or reform the necessary structure to be able to provide the service,exploit it commercially and receive remuneration by charging user fees.Hence, the concessionaire invests in place of the State, at its own expense and risk under theconditions established and unilaterally modifiable by the Granting Power, but under the contractualguaranty of economic-financial equilibrium, receiving remuneration from the exploitation of the service,in general by means of rates charged directly from its users.64

Law 8,987/95 fixes the policies for the delegation of the provision of public services at the federal,state and municipal levels, establishing that any corporate entity or consortium of companies may be aconcessionaire of public services, with due observance, however, of the specific regulations of eachsector.It should be noted that, in the event of a tie between Brazilian and foreign companies, and withoutprejudice to the application of the provisions of the Bidding Act, preference will be given to theBrazilian company, which may be of foreign capital.The following criteria will be taken into consideration for the judgment of proposals:a) the lowest rate value of the public service to be rendered;b) the highest offer, in cases involving payment to the granting power for the concession grant;c) the two-by-two combination of the criteria described in items a, b and g;d) the best technical proposal, with its price established in the bid notice;e) the best proposal in relation to the combination of the best rate value of the public service to beprovided and best technique criteria;f) the best proposal in relation to the combination of the best offer for the concession grant and thebest technique criteria; org) the best payment offer for the grant following the qualification of technical proposals.On the subject of PPPs, further details can be found in the following chapter 10 of this study.10. PUBLIC-PRIVATE PARTNERSHIPS IN BRAZIL (PPP)Public-Private Partnerships (PPPs) are designed for undertakings that would not be otherwiseeconomically attractive, i.e., projects that do not have a natural cash flow that directly permits thestructuring of Project Finance, or other form of conventional financial structure.The general invitation to bid and procurement rules for PPPs within the ambit of the direct and indirectpublic administration, of the three spheres of government are established in Law 11,079/04 (the PPP65

Act), which structures the PPP as a new form of concession, which are substantially more dynamicwhen compared with those provided in the Bidding Act and Public Service Concession and PermissionActs.The PPP Act innovated with respect to guarantees and other provisions. The main aspects of this actare:a) Definition and ObjectA public-private partnership is construed as an administrative agreement with the purpose of:(i) the concession of public services or public works referred to in Law 8,987/95, when theynecessarily involve, in addition to the rate charged from the users, also pecuniary remuneration fromthe public partner to the private partner; it is the so-called Sponsored Concession;(ii) the rendering of services of which the Public Administration is the direct or indirect user, even wheninvolving the execution of works or supply and installation of property; it is the so-called AdministrativeConcession.The following PPPs are prohibited: (i) in amounts of less than R$ 20 million (equivalent toapproximately US$ 11.12 million), (ii) whose service rendering term is less than 5 years or (iii) whenintended solely for the supply of labor, the supply and installation of equipment or the execution ofpublic works.The following guidelines shall be observed in the contracting of PPPs: (i) efficiency; (ii) respect of theinterests and rights of the end users of the services and of the private entities in charge of theirexecution; (iii) non-delegability of the regulation and jurisdictional functions, of the exercise of policingpower and of other activities that are exclusive to the State; (iv) tax liability; (v) transparency; (vi)objective sharing of risks between the parties; (vii) financial sustainability and social-economicadvantages of the partnership project.b) AgreementsIn addition to the essential clauses set forth in Law 8,987/95, PPP agreements shall also determine:(i) a validity term that is compatible with the amortization of the investments made, which shall not beless than 5 years or more than 35; this provision solved the problem of the term established in thebidding act, which cannot exceed 5 years;66

(ii) the penalties applicable to the Public Administration and private partner in case of breach ofcontract, established in a manner that is proportionate to the seriousness of the fault committed and tothe obligations assumed;(iii) the sharing of risks between the parties, including those concerning acts of God, force majeure,factum principes and an area beyond extraordinary economic control;(iv) the types of remuneration and adjustment of contractual amounts;(v) the mechanisms for the preservation of the modernity of the service rendering;(vi) the facts that characterize the monetary default of the public partner, the regularization methodsand term and the method of enforcement of guarantees, when applicable;(vii) the objective evaluation criteria of the performance of the private partner;(viii) the offering, by the private partner, of execution guarantees that are sufficient and compatiblewith the onus and risks involved, with due regard to the pertinent legal provisions;(ix) the sharing, with the Public Administration, of the effective economic gains of the private partner,resulting from the reduction of the credit risk of the financing used by the private partner; this provisiondemonstrates the real partnership, in which, in the case in question, both parties will benefit from anygains that the private partner obtains from its financing entity;(x) the inspection of reversible property, in which the public partner may retain payments to the privatepartner, in the amount necessary to cure any detected irregularities.Optionally, the agreements may additionally determine:(i) the requirements and conditions concerning the transfer of control of a special purpose company(SPC) to its financing entities, with the objective of promoting its financial restructuring and ensuringthe continuity of the service rendering;(ii) the possibility of the issuance of a pledge on behalf of the financing entities of the project in relationto the pecuniary obligations of the Public Administration, which procedure is of great interest to thefinancing entities;(iii) the legality of the financing entities of the project to receive compensation for the earlyextinguishment of the agreement, as well as payments made by the guarantor funds and state ownedcompanies of PPPs, which provision is also of interest to the financing entities.67

It is relevant to mention that, at the end of the agreement, the ownership of the property, as set forth inthe notice with invitation to bid and agreement, shall be of the Public Administration.c) RemunerationThe PPP Act determines that the agreements may establish the payment, to the private partner, ofvariable remuneration, related to its performance in the execution of the agreement, according to thequality and availability goals and standards defined in the agreement. This procedure is a stimulant forthe private partner.The remuneration payable by the Public Administration to the private partner may be paid either at theinvestment stage (“Public Financing”) or during performance of the service subject of the agreement(“Pecuniary Obligation”).Payments due by the Public Administration may be made by bank order, the assignment of non-taxcredits, grant of rights before the Public Administration and grant of rights over public property, as wellas other means permitted by legislation.d) GuaranteesWithout prejudice to other guarantees contemplated in legislation, such as the surety insurance, theLaw determines the following guarantees for PPP agreements, to be granted by the PublicAdministration in favor of the private partner:(i) lien of revenues, with due regard to the legal exceptions;(ii) institution or use of special funds provided in law.It is relevant to mention the existence of the Guarantor Fund (Fundo Garantidor - FGP), which is of aprivate nature and will have separate assets to those of its quota holders and is formed by thecontribution of assets and rights made by the quota holders, consisting of cash, governmentsecurities, immovable property of public domain, movable property, including shares of federalgovernment-controlled (private) companies or other rights with an asset value.The FGP was formalized by Decree 5,411/05, which authorized the initial transfer, to the said Fund, ofthe blue chip shares of 15 state or private companies, which were in the possession of the FederalUnion, representing approximately R$ 4 billion (US$ 2.42 billion). Banco do Brasil S.A., which iscontrolled by the Federal Union, was designated to manage and represent the FGP.68

The guarantees to be granted by FGP, whether to the private partner, or to insurance companies,financial institutions and international organizations, may be classified into the following types,considering the assets of the FGP:(i) surety, without a benefit of order to the surety;(ii) pledge of immovable property or of rights;(iii) mortgage of immovable property;(iv) chattel mortgage;(v) other agreements that produce a guarantee effect;(vi) secured or personal guarantee.Moreover, bearing in mind that, in principle, it will be up to the private partner to obtain the mostsignificant portion of the resources to finance the PPP project, the agreement may provide for theissuance of pledges relating to the obligations of the Public Administration, in favor of the financingentity, that is to say, the remuneration, directly in the name of the financing entity, and the legality ofthe financing entity to receive payments through said funds. It is a true subrogation, since, once theprivate partner has received its remuneration directly from the administration, the financing entitysucceeds to this receipt. This innovative procedure, which is unprecedented in the current Bidding Act,will give the financial entity a greater guarantee for the amortization of the amounts financed to theprivate partner. This mechanism also applies to Common Concessions under the Concession ofPublic Services Laws.The private partner may also grant guarantees to the financing entity, without prejudice to others,represented by receivables, i.e., rate revenues and remuneration originating from the public authority,as the case may be.Furthermore, the Public Administration may require from the private partner with the purpose ofguaranteeing its performance, the guarantees set forth in the Bidding Act, comprising an escrow incash or government securities, surety insurance or a bank guarantee, limited to 10% of the agreementamount, when involving works, services or substantial volume supplies, or to five percent (5%), forsmaller volume agreements.With the enactment of Law 12,024/2009, it was determined that the Union shall not grant guaranteesand make voluntary transfers to the States, Federal District and Municipalities if the sum of expensesof an ongoing nature incurred by the series of partnerships already contracted by such entities has, inthe previous year, exceeded three percent (3%) of net current revenue for the year or if the annualexpenses of the contracts in force during the ten (10) subsequent years exceed three percent (3%) ofthe net current revenues projected for the respective years.69

e) SPC – Special Purpose CompanyPrior to signing the agreement, the private partner shall incorporate a SPC, which may be publicly orclosely held, with the purpose of implementing and managing the PPP object. The SPC will be theowner of the property arising from the investment that the private partner makes during the agreementterm, and shall abide by the standards of corporate governance and adopt standard accounting andfinancial statements, according to regulations.It is prohibited for the Public Administration to hold the majority of the voting capital of a SPC, exceptwhen involving a financial institution controlled by the Government, in case of default of financingagreements.f) Invitation to bidThe invitation to bid process shall be preceded by the administrative procedures set forth in Law,among which authorization from the competent authority, based on a technical study, a budgetaryforecast for the project during the years of its execution, its inclusion in the Government’s multiyearplan, a public consultation for the supply of information and receipt of suggestions and, finally, a priorenvironmental license or issue of rules for the environmental licensing of the undertaking. Thefulfillment of these requirements will strengthen the security, for the private partner, of the effectiveperformance of the PPP agreements by the Public Administration.Sponsored concessions in which more than 70% of the remuneration of the private partner is paid bythe Public Administration will depend on specific legislative authorization.The contracting of PPPs will be the subject of an invitation to bid of the competitive type, with the prequalificationof bidders.The notice with invitation to bid may establish:(i) the agreement proposal and execution guarantees, to be offered by the bidder;(ii) the remuneration guarantees of the public partner to be offered to the private partner;(iii) the use of arbitration, to be held in Brazil, in Portuguese;70

The bidding process for the contracting of PPPs will abide by the current legislation on invitations tobid and administrative contracts and also the following.(i) the judgment may be preceded by a qualification phase of the technical proposals, disqualifyingbidders that do not attain minimum points scores;(ii) the judgment may adopt as criteria, (i) the lowest rate amount of the public service to be rendered,(ii) the best proposal by reason of the combination of the technical proposals and offer of payment forthe grant, (iii) the lowest remuneration amount to be paid by the Public Administration, (iv) the bestproposal by reason of the combination of the criterion of item (iii) with that of the best technique, inaccordance with the weights established in the notice.The notice will define the submission method of economic proposals, permitting written proposals insealed envelopes or written proposals, followed by open outcry bids.g) Management CommitteeAs provided in Law 11,079/04, a collegium Management Committee was instituted by Decree5,385/05. This Committee is formed by representatives from the Planning, Budget and ManagementMinistry, the Finance Ministry and Cabinet of the President of the Republic and will be responsible,within the sphere of the federal Public Administration, for establishing the procedures for thecontracting of PPPs, defining the services considered top priority to be performed under thepartnership regime, authorizing the opening of an invitation to bid process for the contracting andexamination of the execution reports of the agreements. Other prerogatives of the State, FederalDistrict and Municipality will not be confined to this body, inasmuch as they shall legislate to thateffect.It will be incumbent on the Ministries and Regulatory Agencies, in their respective areas of authority, tosubmit the notice with invitation to bid to the Management Committee, conduct the bidding procedure,and monitor and supervise the PPP agreements.It will be incumbent on the Brazilian Monetary Council to establish the rules for the extension of loansto finance PPP agreements.71

11. ELECTRIC POWER SECTOR11.1. Structuring of the SectorThe Brazilian electricity sector is basically divided into (i) generators, in charge of generating electricity;(ii) transmitters, in charge of transporting high-voltage electricity from generators to powerconsumption points; (iii) distributors, in charge of delivering electricity to consumers; (iv) retailers, incharge of buying and selling electricity on the free market; (v) free customers, who are free to choosetheir electricity supplier and are today required to have an installed capacity above a certain voltage;and (vi) captive customers, who are allowed to purchase electricity from their local distributor only. Thesector is organized around the following main offices and entities: (i) the Ministry of Mines and Energy(Ministério de Minas e Energia – MME), responsible for establishing policies and granting concessions;(ii) the Energy Research Company (Empresa de Pesquisa Energética – EPE), responsible forplanning and providing studies in the electricity sector; (iii) the Brazilian Electricity Regulatory Agency(Agência Nacional de Energia Elétrica – ANEEL), which regulates and supervises the activities in thissector; (iv) the National Grid Operator (Organizador Nacional do Setor Elétrico – ONS), who controlsthe physical dispatch of electricity; and (v) the Power Trading Chamber (Câmara de Comercializaçãode Energia Elétrica – CCEE), which is responsible for accounting and settlements in the free energymarket.11.2. CompetitionThere are two power trading environments, namely: the Regulated Market (Ambiente de ContrataçãoRegulada – ACR) and the Free Market (Ambiente de Contratação Livre – ACL). In the RegulatedMarket, ANEEL creates and CCEE holds public auctions where distributors purchase the powernecessary to supply their consumers. In these auctions, generators announce the amount of energyand prices and whoever offers the lowest price is the winner. Distributors are allowed to purchaseenergy only in these auctions, and the prices they pay are passed on to their consumers. In the FreeMarket, there is freedom to negotiate the purchase of energy and continuous negotiations are enteredinto between generators, traders and free customers.11.3. Main Segments11.3.1 GenerationBrazil has a very particular power generation situation, inasmuch as it has the largest hydrographicbasin of the planet and a great unexploited hydroelectric potential in the Country.Nevertheless, alternative electric power generation sources are being exploited more and more, be itto minimize the restrictions imposed by irregular rain patterns, or to protect the environment against72

the impact of flooding caused by the hydroelectric plant's dam reservoirs. A number of incentives havebeen offered to encourage energy generation through alternative sources, including, but not limited to,discounts on the use of and connection to systems that transport energy from alternative sources andreductions on the minimum installed capacity required for consumers to be allowed to freely purchaseenergy directly from such sources. The possibility of conducting energy auctions according to theenergy source is also being considered.Electric power plants may be isolated (i.e., not connected to the National Interconnected System –Sistema Interligado Nacional - SIN), integrated (electrically interconnected to the System and withpower dispatched by the National System Operator (Operador Nacional do Sistema – ONS) andinterconnected (interconnected to the SIN, without dispatch by the ONS).The feasibility of the construction of new plants is managed by ANEEL, which avails itself of the grantsdisciplined by the Administrative Law for this purpose, which can be summarized as follows:(i) exemption of grants for small-scale activities;(ii) need of an authorization grant for medium-scale activities, and(iii) need of a concession grant for large-scale activities.The agents that operate in the electric power generation sector include the (i) Independent ElectricPower Producer (PIE) figure, which can be both a corporate entity or a group of companies united in aconsortium that receives a concession or authorization from the federal government (Granting Power)to produce electric power to be partially or fully commercialized, at its expense and risk; and the (i)Electric Power Self-producer figure, which is a corporate entity or individual or companies united in aconsortium that receives a concession or authorization to produce electric power for its own exclusiveuse and has the right to sell the unused, excess electricity, subject to certain rules.Also concerning generation, it is relevant to mention: (i) the existence of mechanisms for theoptimization of the system's operation, by means of the guaranteed and secondary electric power ofthe plants, and (ii) the existence of the Electric Power Reallocation Mechanism (Mecanismo deRealocação de Energia - MRE), which operates in the compensation of electric power among thegenerators, and also, (iii) the strong growth in the generation of alternative electric power sources,notably co-generation, principally from biomass, wind generation, solar power, and power from SmallHydroelectric Centers (Pequenas Centrais Hidrelétricas – PCHs), which are hydropower plants with acapacity of less than 30MW. As stated above, the federal government has been actively encouragingthe use of alternative energy sources by reducing the burdens on those who buy alternative energy,73

facilitating the purchase of alternative energy by free customers (known as "special" free customers),reducing taxes on equipment, among other measures.Co-generation is an example of this growth. This activity consists of a heat and electric powerproduction process, along with another undertaking, from one single fuel that is common to or a subproductof the latter. For example, the burning of natural gas or organic waste (biomass) generatesthermal energy (heat) and, at the same time, drives the generators.This activity allows companies to become self-sufficient in the production of energy with the help ofgas or of the industrial waste itself. The material that was previously discarded by the pulp industry, forexample, is now used as fuel to heat the boilers.Companies that wish to invest in co-generation must obtain qualification from ANEEL for theimplementation of their projects, as regulated by an ANEEL resolution.Brazil currently has 106 wind farms in operation. The production of wind power doubled in 2012, withan installed capacity of 2.4GW.Today, 125 wind farms with a total of 3.4GW installed capacity are under construction. They areexpected to start operating by 2015, which shows a growing investment interest in this alternative,clean and unlimited energy source. New technologies have also been used. Among otherimprovements, the height of wind turbines has been increased to better capture the wind.Solar power is also an attractive investment opportunity, given Brazil's geography (high solarincidence) and the fact solar power generation is still in an infant stage. Investors have been trying todevelop local equipment because dependence on foreign technology is still high, which hindersaccess to cheaper loans offered by government banks.Finally, energy from Small Hydroelectric Centers also represents an investment opportunity, due to theabove-mentioned government incentives, the shorter amount of time needed for construction andoperation, and the fact that they do not require large dams and reservoirs – they can use the course ofthe abundant Brazilian rivers instead.11.3.2. TransmissionTransmission is the transportation of the electric power generated in high current and voltage bymeans of conductors.74

This and the generation activities are regulated by the federal government, known as Granting Power(Poder Concedente), since they involve a public service.Essentially, it is possible to affirm that the transmission facilities are those that are designed to formthe basic network of the interconnected systems, whose voltage is above 230 kV, usually connectingfree consumers, generators and distributors.These definitions are relevant, since only the transmission facilities that make up the basic network ofinterconnected electric systems are the object of a concession, granted through an invitation to bid.High voltage transmission facilities (below 230kW) are considered subtransmission facilities that forman integral part of the distribution concession. And the transmission facilities of the restricted interestof generating centers are considered component elements of the respective concessions, licenses orauthorizations, e.g. subtransmission lines intended solely for the use of independent production.With the increase in the number of generation plants in various regions of the country – e.g. theconstruction of large hydroelectric power plants such as Belo Monte, Jirau, Santo Antônio, Teles Pires(all located in the North of Brazil) and the wind farms mentioned above – the tendency is for thenumber of transmission lines put up for bid by ANEEL to grow, so as to guarantee the transportation ofpower and avoid power transmission "bottlenecks", which will result in the increase of investments inthis segment.It is relevant to mention, also, that those who wish to connect to the transmission system must sign atransmission system use agreement (Contrato de Uso do Sistema de Transmissão – CUST)regulating the rights and obligations of the system users, and a transmission system connectionagreement (Contrato de Conexão ao Sistema de Transmissão – CCT) regulating the technical issuesrelated to the connection point and maintenance thereof. The revenues of transmissionconcessionaires come from payments of the tariff for the use of the transmission system (Tarifa deUso do Sistema de Transmissão – TUST), and concessions are subject to readjustment and tariffreviews.11.3.3. DistributionTransmission lines transport high-voltage electricity to substations, where power is reduced to lowervoltages and then delivered to end consumers through distribution lines. Therefore, the owners of theutility poles and power networks located in the cities are the electric power distributors. They are alsothe ones that have a direct relationship with end consumers.The provision of public electric power distribution service depends on the granting of a concession bythe federal government, acting as the Granting Power. Electric power distributors must provide free75

consumers and electricity suppliers hired by free consumers with access to their network. In this case,even though the electric power distributor does not receive any money for the power itself, it is entitledto a so-called distribution system use tariff (Tarifa do Sistema de Uso de Distribuição – TUSD). Thosewho access its network must sign a distribution system use agreement (Contrato de Uso do Sistemade Distribuição – CUSD) and a distribution system connection agreement (Contrato de Conexão aoSistema de Distribuição – CCD), similar to the CUST and CCT agreements mentioned above.The electricity distribution market is serviced by 64 state or private concessionaires whose concessionareas are geographically divided. The presence of national and foreign companies in the controlgroups of various private concessionaires can be verified. The opportunities for investment in electricpower distribution are a result of the growing energy demand caused by economic growth and naturalincrease of the population, especially in border areas such as the Midwest, North and Northeastregions of Brazil.Similarly to transmitters, electric power distributors are also subject to tariff readjustments according toANEEL's rules and procedures. Their main source of revenue is electricity supply tariffs and tariffs forthe use of their distribution system.11.3.4. TradeThis segment of the Brazilian electric power sector includes energy trading under the ACL system, i.e.free trading by customers who are not required to purchase energy from distributors. In order to qualifyas a regular free customer, one must have a demand of at least 3,000kW. Recently, the concept of"special" free customer was introduced. "Special" free customer are those who have an installedcapacity of 500kW or above, provided that their energy is purchased only from alternative sources, asa way to promote the use of this type of energy. They enjoy a 50% reduction in the tariffs for the use oftransmission and distribution systems. This market includes generators and traders authorized byANEEL and free customers. Electric power agreements signed in the Free Market as well asgenerating agents must be registered with the CCEE. In addition to buying, selling or just acting as anintermediary in energy transactions, energy traders often represent free customers with the CCEEwhen these customers are not interested is setting up a structure to meet all requirements and monitorthe fulfillment of the rules on the recording and trading of electricity in the Free Market.11.4. Relevant Market InformationThere are no regulatory restrictions in Brazil that prevent free foreign ownership in the capital ofelectric power companies. However, one of ANEEL's concerns in the regulation of the electric powersector is to limit the concentration of economic groups that might jeopardize the country's competitiveenvironment.76

It is relevant to mention that in spite of proposals to amend the Federal Constitution, the restrictionremains for private foreign or Brazilian capital in the exploitation of nuclear services and facilities,which is a direct prerogative of the Federal Government.11.5. Investment opportunitiesThe recent crisis and slowdown in the world economy affected the electric power sector in a morepositive than negative way, since the growth in the demand for power was signaling a possiblecollapse in supply due to the absence of available power for sale.There are already signs indicating that power generation, transmission and distribution activities willbe expanding in the next few years, as well as the energy efficiency goals and diversification of theBrazilian energy mix, in order to keep pace with the growth that is expected from the Country andavoid a power supply crisis. These signs are largely associated with the federal government'sawareness that investments in the sector are needed – given today's dependence on rainfall, in asector in which the predominant matrix is hydropower, and given the prospect of economic growth.One of the main challenges facing the sector will be to come up with a solution that promotes thedevelopment of Brazilian industry and, at the same time, permits the entry of Brazilian and foreigninvestors to add knowledge, technology and capital.This solution should be based on clear rules, security in the performance of signed contracts,guarantee of alternative dispute resolution methods and, above all, on the strengthening ofpartnerships that can enhance the benefits obtained both by Brazilian and foreign investors, whetherpublic or private.The attractiveness of the power sector stems, fundamentally, from the following factors: (i) anexpanding free and captive consumer market; (ii) new policies designed to diversify the Brazilianpower mix; (iii) unexploited or underexploited natural potentials and technological divides (example:wind, solar and nuclear power); (iv) Brazilian industry with a solid base; (v) the existence of incentiveprograms for investors especially designed to reduce taxes and promote alternative energy sources(example: PAC, REIDI, reduction of fees charged on the use and connection to distribution andtransmission systems, and others); and (vi) other factors, including consolidated democracy, foreignexchange stability, commitment to controlling inflation and the outlook of the Country's growth over thecoming years.77

11.6. FinancingBNDES has played an important role in financing the expansion and modernization of the electricpower sector. This has allowed for the execution of projects that call for long maturation periods andsubstantial investments. BNDES' activities in this sector are aimed at guaranteeing the supply ofelectric power with quality, security and affordable rates, meeting the needs of the economy and ofsociety as a whole.Important aspects in the generation segment are not only the financing extended to the hydroelectricpower plants, but also the pursuit for the development of alternative sources of energy (SmallHydroelectric Centers (Pequenas Centrais Hidrelétricas – PCHs, solar, wind and biomass), with lowerinterest rates on loans, provided that a minimum local content percentage and other requirements arefulfilled.In addition to the BNDES, other domestic financing sources may be used, such as the regionalfostering agencies, the commercial banks and investment and equity funds.Lastly, it is relevant to mention, among the foreign loan and financing sources without governmentalguaranties, the Interamerican Development Bank (IDB) and World Bank (IBRD), both of which areoperating in Brazil in the electric power sector.12. ENVIRONMENT AND SUSTAINABILITYRegulation through environmental policies is primarily aimed at directing the behavior ofentrepreneurs and business organizations and guiding public environmental management. TheNational Environmental Policy (Política Nacional do Meio Ambiente) (Federal Law 6,938/1981) is oneof the key legal instruments for guiding existing and future initiatives on the environment, particularlyregarding economic processes and productive sectors that either rely on natural resources or aredeemed polluters or potential polluters.In addition to the federal guidelines laid down by the National Environmental Policy, the state and localgovernments are granted by the 1988 Constitution the same power to pass laws on environmentalcontrol as the federal government, as well as the power to monitor within the limits of their respectiveinterests, pursuant to the Constitution and supplementary laws.This is a complex legal framework that may comprise, at all three government levels (federal, stateand local), a number of subject-specific rules and public policies on air quality, flora, fauna, ground,water resources, basic sanitation, health, solid waste, health surveillance, environmental education,quality of urban life, cultural heritage, protected areas, biodiversity, sustainable development of78

indigenous peoples and communities, and climate change, in addition to regulations enacted by theentities and bodies in charge of implementing the actions set out in the mentioned policies, especiallythose comprising the National Environmental System (Sistema Nacional do Meio Ambiente).Also worth noting is the development of the environmental permitting system, which has becomeincreasingly complex, especially due to the enhancement of control systems (assessments, zoningand specific permits) and the introduction of cultural (archeology) and social (affected communities,such as Indians and quilombolas) aspects in the permitting process.To ensure compliance with such vast legislation, which is based on command and control instruments,there are specific laws regulating civil (strict) liability, administrative liability and criminal liability forenvironmental violations, such as Law 6,938/1981 and Law 9,605/1998.Besides legislation, the financial architecture of projects – particularly infrastructure projects – requirescompliance with sustainability policies and indexes used by financial institutions (Equator Principles,for example), and sustainability reports have been using international methodologies (GlobalReporting Initiative) as reference. Another market initiative worth noting is the creation of the BusinessSustainability Index (Índice de Sustentabilidade Empresarial – ISE), which introduced a tool thatallows for a comparative analysis of the performance of companies listed on the BM&FBOVESPAbased on economic efficiency, environmental balance, social justice and corporate governance.In practical terms, it is important for entrepreneurs and investors to carry out their business in Brazilaware of the environmental laws applicable to their activities – whether due to the need to previouslyassess the viability and risks involved or due to the inevitable need to review the applicable permittingsystem before implementing a project (applicable licenses, authorizations and environmentalassessments, besides interfaces with other regulatory authorizations), or to adapt to new or updatedenvironmental laws, even when the respective project or activity already has an operating license. Inaddition, successor liability arising from the acquisition of a company (whether through the acquisitionof control or purchase of assets) that has environmental liabilities requires an environmental audit tobe conducted prior to the transaction – both from a legal and from a technical point of view – includingin the event of transfer of environmental permits as a result of a purchase of assets.Besides imposing on companies a series of obligations, the environmental laws also create manyopportunities for investment in green economy. For example, the Rio de Janeiro Stock Exchange(Bolsa de Valores do Rio de Janeiro – BVRio) is beginning to develop the market for forest assets,waste (reverse logistics), carbon (emissions) and effluents with the purpose of trading credits asprovided in the law, thus facilitating compliance with environmental obligations.Federal Law 12,305/2010, which introduced the National Solid Waste Policy (Política Nacional deResíduos Sólidos) provides for the closing of all dumps currently in operation in Brazil and establishesan environmentally friendly waste disposal in 2014. In this field, excellent investment opportunities in79

landfills and/or waste reuse facilities exist. A market for recycling is already in place, and a market forreverse logistics (pesticides, consumer electronics, tires, batteries, lamps, medications and lubricants)is beginning to take shape. The Brazilian economic sectors are already discussing and adapting tothis new reality.In the field of water resources management, there are business opportunities in the field of watertreatment and opportunities to develop territorial business plans to allow the implementation ofterritorial adaptation plans, sanitation projects, etc. Another initiative that may be undertaken in thefield of water resources is to provide monetary and/or non-monetary remuneration for environmentalservices to individuals and companies that adopt conservation practices (e.g., protection of forests inthe surroundings of headwaters, for example).There have been discussions on the possibility of transferring the management of protected areas tothe private sector, as well as on public forest concessions already provided for in the law but notwidely disclosed and implemented. The list of goods and services allowed to be exploited underconcession may include wood products, such as logs; non-wood products, such as oil, fruit, resin,ornamental and medicinal plants; residual wood material; and forest services, such as lodging,adventure sports, nature watching and visiting. It is important to highlight that the law allows for thesale of carbon credits in case of reforestation of degraded areas or conversion of areas to anotheruse. Therefore, where the government allows, forest concessions may be used as a tool for theimplementation of sustainable development projects aimed at reducing greenhouse gas emissions.The Annual Plan for Forest Concessions (Plano Anual de Outorga Florestal - PAOF) has identifiedapproximately 4.3 million hectares of forest – located throughout the states of Acre, Amazonas, Paráand Rondônia – for concession in 2014.Lastly, in the urban field, the law allows for institutional agreements and urban consortiums for thepurpose of implementing a number of interventions and measures coordinated by the localgovernment with the participation of owners, residents, permanent users and private investors, withthe aim of implementing structural urban changes, social improvements, and environmental valuationin and for a specific area, resulting in the requalification of urban areas.13. MANAUS FREE TRADE ZONE (ZONA FRANCA DE MANAUS - ZFM) AND EXPORTPROCESSING ZONES (ZONAS DE PROCESSAMENTO DE EXPORTAÇÃO - ZPEs) ANDAREAS OF FORMER SUDENE AND SUDAM13.1. Manaus Free Trade Zone (ZFM)The Manaus Free Trade Zone (ZFM) is a free trade area for imports and exports, located in theWestern Amazon Region, with three activity centers, applying to both the domestic and international80

markets: commercial, industrial and agribusiness (DL 288/67, art. 1). The legal lifetime determined forthe ZFM is until 31 December 2023 (EC 42/03 and article 94 of Decree 7,212/2010).The industries established in ZFM enjoy the following fiscal benefits (with the exclusion of firearms andammunition, tobacco, alcoholic beverages, passenger cars, perfumery products and toiletries and,with some exceptions, cosmetic compounds and preparations), in accordance with art. 3, paragraph 1of DL 288/67, with the alterations of Law 8,387/91, with a view to the substitution of imported goods fornationally manufactured goods:a) Import Duty: exemption (art. 3 of DL 288/67), whereas the goods brought into ZFM may, even ifused, be subsequently exported overseas, with the maintenance of the exemption of the dutiesassessed on the importation (art. 127 of Law 11,196/05). For some sectors the exemption is partial, of88% of the import duty.b) Export Duty: exemption (art. 5 of DL 288/67);c) Excise Tax (IPI): exemption for imported products consumed in ZFM and for products that thoughindustrialized in ZFM are to be sold in another point of the Brazilian territory, except for products thatare industrialized through packing or repacking, in which case they will be subject to IPI and also tothe import duty related to raw materials (RIPI – Excise Tax Regulation, art. 81, II), intermediaryproducts and the imported packaging materials employed therein (art. 7 of DL 288/67 with thealterations of Law 8,387/91).d) State Vat (ICMS): exemption, barring a few exceptions, on the issue operations of industrializedproducts of domestic origin for sale or industrialization in the Municipalities of Manaus, Rio Preto daEva and Presidente Figueiredo in ZFM, provided that the goods are consumed locally and satisfyother legal requirements (RICMS – State VAT Regulation, art. 84 of Annex I);e) Non-rebatable Corporate Income Tax (IRPJ) and surtaxes levied on the profit of the exploitation ofthe undertaking: for the projects approved as of 1 January 1998 a reduction is granted, observing thefollowing percentages: 75% from 1 January 1998 to 31 December 2003, 50% from 1 January 2004 to31 December 2008 and 25% from 1 January 2009 to 31 December 2013, providing that the provisionsof the labor and social security legislation and the environmental protection and control legislation isobserved by the beneficiary company (RIR – Income Tax Regulation, art. 554, paragraph 4). Thesebenefits do not apply in relation to tax periods ending as of 1 January 2014 (RIR, art. 554, paragraph5). This fiscal benefit may be used for up to ten (10) years from the tax period in which the undertakingenters into the operating phase (art. 557 of the RIR); and81

f) PIS (Contribution to the Social Integration Program) and COFINS (Contribution for Funding of SocialWelfare Programs): the rates imposed on sales revenue from goods intended for consumption orindustrialization in the Manaus Free Trade Zone – ZFM, by a corporate entity established outside theZFM are reduced to zero, barring the exceptions set forth in Law 10,996/04.Law 11,196/05 brought the reduction to zero of the PIS and COFINS rates imposed on sales made byproducers, manufacturers or importers established outside of the ZFM, of products subject todifferentiated taxation designed for consumption or industrialization in ZFM (art. 65).The law also instituted tax substitution on the resale of products within the ZFM.The suspension of PIS and COFINS was also introduced on imports, by establishment located in theZFM, of goods intended for industrialization, such as raw material, intermediary products and packingmaterial, as well as new machines, apparatus, instruments and equipment for incorporation into thefixed assets of the importer corporate entity (art. 50 of Law 11,196 and paragraph 1 of art. 14 of Law10,865/04).A considerable number of foreign capital companies are established in the ZFM, on account of thenumerous incentives granted and the absence of restrictions on foreign capital (except for thoseindicated in this study). There are also other incentives, such as the exemption of IPTU (MunicipalProperty Tax), some financial credits and similar incentives, which vary in accordance with the venueof the company's registered office, industrial production sector and other items.13.2. Export Processing Zones (ZPE)ZPE zones are free trade zones designed to encourage the establishment of companies that producegoods for export. They are considered "primary" zones for customs control purposes.ZPE zones receive tax, foreign exchange and administrative benefits, with terms of up to 20 years (art.8, main section and respective paragraphs, of Law 11,508/07).Generally speaking, from a tax perspective, companies authorized to operate within a ZPE enjoy thesuspension of duties and contributions levied on imports and domestic purchases of goods andservices.There are no restrictions on foreign capital, or foreign exchange or customs barriers in the ZPE.There are, however, some limitations: prohibition of the establishment, in an ZPE, of companieswhose projects evidence the simple transfer of industrial plants already established in the Country (art.82

5 of Law 11,508/07), and the prohibition of the sale and manufacture of certain products (firearms andothers) (art. 5, sole paragraph of Law 11,508/07).The creation, in the Country, of 14 ZPE was authorized: Cáceres (MT); Rio Grande (RS); JoãoPessoa (PB); Corumbá (MS); Barcarena (PA); São Luís (MA); Maracanaú (CE); Parnaíba (PI);Macaíba (RN); Suape (PE); Araguaína (TO); Itacoatiara (AM); Nossa Senhora do Socorro (SE) andIlhéus (BA) (Law 7,993/90 and Law 8,015/90).13.3. Former SUDENE and SUDAM Areas (Law 11,196/05, art. 31)Without prejudice to any other applicable benefits, for the goods purchased as of calendar year 2006and up to 31 December 2018, the corporate entities that have approved installation, expansion,modernization or diversification projects in economic sectors that are considered priority for regionaldevelopment, in less developed micro-regions located in the operating areas of the extinct SUDENEand SUDAM, will be entitled to:a) accelerated depreciation incentive, for purposes of the calculation of income tax;b) discount, during the period of twelve (12) months from the acquisition, of certain PIS and COFINScredits, in the event of the purchase of new machines, apparatus, instruments and equipment, listed inregulations, to be incorporated into their fixed assets.The applicable micro-regions, as well as the limits and conditions for the enjoyment of the aforesaidbenefit, will be defined by regulation. The enjoyment of this benefit is contingent on the enjoyment ofthe benefit referred to in art. 1 of Provisional Measure 2,199-14, of 24 August 2001: a 75% reductionon the corporate income tax (IRPJ), calculated based on the profits from the exploration, subject tofulfillment of the applicable conditions and requirements.The accelerated depreciation incentive consists of full depreciation, during the actual year ofpurchase. The accelerated depreciation quota, corresponding to the benefit, will constitute exclusionfrom net income for purposes of the determination of taxable income and will be written up in the taxaccounting ledger.Total accumulated depreciation, including normal and accelerated, may not exceed the purchase costof the asset. As from the tax period in which this limit is attained, the normal depreciation amount,posted in the accounting records, will be added to net income for the purpose of the determination oftaxable income.83

With regard to PIS and COFINS, the credits will be calculated through the application, each month, ofthe PIS and COFINS rates of 1.65% and 7.6%, respectively, on the amount corresponding to onetwelfth (1/12) of the purchase cost of the asset.Except as expressly authorized by law, these tax benefits cannot be enjoyed cumulatively with othersof the same nature.14. FISCAL INCENTIVES14.1. Technological Innovation IncentivesLaw 11,196/05 (“Law of Good”), originated from Provisional Measure 252/05, provides fortechnological innovation incentives.This Law repealed Law 8,661/93, which previously provided for the fiscal incentives for thetechnological capacitation of industry and agriculture.The Industrial Technological Development Programs (Programas de Desenvolvimento TecnológicoIndustrial – PDTI) and Agribusiness Technological Development Programs (Programas deDesenvolvimento Tecnológico Agropecuário – PDTA), and the projects approved on or before 31December 2005 will continue to be regulated by the legislation in force on the publication date ofProvisional Measure 252/05, though migration to the regime set forth in Law 11,196/05 is authorized,as disciplined in the regulations.Currently, corporate entities can benefit from the following fiscal incentives:(i) deduction, for the purpose of the calculation of net income, of the amount corresponding to 160% to180% of expenditures incurred during the tax period with technological research and thedevelopment of technological innovation classifiable as operating expenses by the Corporate IncomeTax (IRPJ) legislation or as payment to universities and educational institutions, as set forth inparagraph 2 of article 17 of the law;(ii) reduction of 50% of the Excise Tax (IPI) levied on equipment, machines, apparatus andinstruments, as well as spare accessories and tools that accompany these products, to be used intechnological research and development;84

(iii) full depreciation during the year when the new equipment, machines, apparatus and instrumentsfor use in technological research and development of technological innovation are purchased for thepurpose of calculation of the Corporate Income Tax (IRPJ) and Social Contribution on Profit (CSL);(iv) accelerated amortization, via the deduction as cost or operating expense, during the tax period inwhich they are incurred, of expenditures relating to the purchase of intangible goods, relatedexclusively to technological research and technological innovation development activities, classifiablein the beneficiary’s deferred charges, for the purposes of the determination of IRPJ;(v) reduction to zero of the withholding income tax rate on remittances made overseas for theregistration and maintenance of trademarks, patents and cultivars.Law 11,196/05 and further regulations also define the concept of technological innovation and thebenefit conditions.Finally, we point out that these benefits do not apply to corporate entities that use the benefits dealtwith in Laws 8,248/91, 8,387/91 and 10,176/01, mentioned in chapter 8 of this guide.14.2. Export incentive programs – REPES and RECAPLaw 11,196/05 also created the Special Taxation Regime for the Information Technology ServiceExport Platform (Regime Especial de Tributação para a Plataforma de Exportação de Serviços deTecnologia de Informação – REPES) and the Special Regime for the Purchase of Capital Goods forExporter Companies (Regime Especial de Aquisição de Bens de Capital para Empresas Exportadoras– RECAP), with the objective of fostering exports through the granting of fiscal benefits.REPES benefits corporate entities that execute predominantly software development activities orprovide information technology services, cumulatively or otherwise, provided that they assume anexport commitment of more than or equal to 50% of their annual gross revenues derived from the saleof goods and services, excluding the taxes and contributions assessed on the sale.Companies that opt for the SIMPLES (Integrated System for the Payment of Taxes and Contributionsby Small and Very Small-sized Companies) are excluded from the benefit.The benefits granted through REPES are:a) in the case of the sale or importation of new goods to be used for the development, in the Country,of software and information technology services, the following enactments are suspended: (i) of PISand COFINS imposed on the gross revenue derived from sales in the domestic market, when the85

espective goods are purchased by a corporate entity, beneficiary of REPES for incorporation into itsfixed assets, and (ii) of PIS/Import and COFINS/Import, when said goods are imported directly by acorporate entity, beneficiary of REPES for incorporation into its fixed assets, according to the termsand conditions set forth in law;b) in the case of the sale or importation of services to be employed for the development of softwareand information technology services in the Country, the following enactments are suspended: (i) ofPIS and COFINS imposed on the gross revenue received by the service provider, when the recipientis a corporate entity, beneficiary of REPES, and (ii) of PIS/Import and COFINS/Import, for servicesimported directly by a corporate entity, beneficiary of REPES, according to the legal terms andconditions.In accordance with the annex of Decree 5713/06, the goods and services benefited by the suspensionare: data storage, management, processing and transmission; software development; technicalsupport in information technology equipment, communication systems and software; maintenance andupdate of information technology equipment, communication systems and software; digital certificationand network management.The above suspensions will be converted into a zero rate after the company attains 50% of its annualgross revenue in exports within the legal term: 3 years maintaining an average 50% of the annualgross revenues derived from exports.The RECAP regime benefits any legal entity that is primarily an exporter, i.e., a legal entity whosegross revenue arising from exports during the calendar year immediately preceding the adhesion tothe RECAP regime was at least 50% of the company’s total gross revenue arising from the sale ofgoods and services during that period, and that agrees to keep such percentage for 2 calendar years.Any legal entity that has recently started operating or that did not reach such 50% export revenue inthe preceding year can adhere to the RECAP regime as long as it agrees to have its gross revenuearising from exports reach at least 50% of its total gross revenue arising from the sale of goods andservices, during 3 calendar years.As to RECAP benefits in case of sales or imports of new machines, apparatus, instruments andequipment provide for the suspension of the following enactments: (i) of PIS and COFINS imposed ongross revenues derived from sales in the domestic market, when the said products are purchased by acorporate entity, beneficiary of RECAP for incorporation into its fixed assets, and (ii) of PISP/Importand COFINS/Import, when the said products are imported directly by corporate entities, beneficiariesof RECAP for incorporation into their fixed assets.86

This benefit is regulated by Decree 5,649/05 and may be enjoyed for up to 3 years from itsauthorization.14.3. REIDIThe General Infrastructure Development Regime (Regime Geral de Desenvolvimento daInfraestrutura REIDI) was instituted by Provisional Measure 351/07, which was converted into Law11,488/2007 and regulated by subsequent rules.The benefit granted by the REIDI regime consists of a suspension of the collection of:a)Social contributions (PIS and COFINS) levied on the revenues arising from: (i) the sale of newmachines, apparatus, instruments and equipment purchased by a legal entity that is a REIDIbeneficiary for incorporation into the infrastructure work to be incorporated into its fixed assets; (ii) thesale of building materials purchased by a legal entity that is a REIDI beneficiary for use orincorporation into the infrastructure work to be incorporated into its fixed assets; and (iii) the provisionof services by a legal entity incorporated in Brazil to a legal entity that is a REIDI beneficiary, when theservices are related to the infrastructure work to be incorporated into its fixed assets; andb) Social contributions (PIS Import and COFINS Import) levied on: (i) ) the purchase of new machines,apparatus, instruments and equipment for incorporation into the infrastructure work to be used in itsfixed assets, when the importer is a legal entity that is a REIDI beneficiary; (ii) the purchase of buildingmaterials for use or incorporation into the infrastructure work to be incorporated into its fixed assets,when the importer is a legal entity that is a REIDI beneficiary; and (iii) the payment for servicesimported by a legal entity that is a REIDI beneficiary, when the services are related to theinfrastructure work to be incorporated into its fixed assets.The REIDI regime applies to companies that have an approved project for infrastructure work in thefollowing areas: (i) transport, including the acquisition of coaches and locomotives and construction ofpipelines; (ii) ports, including port facilities for private use; (iii) energy, including co-generation anddistribution of electricity;(iv) water supply & sewage; (v) irrigation; and (vi) production and processingof natural gas14.4. REPENECThe Special Incentive Regime for the Development of the Oil Industry Infrastructure in the Northern,Northeast and Central West Regions (Regime Especial de Incentivos para o Desenvolvimento deInfraestrutura da Indústria Petrolífera nas Regiões Norte, Nordeste e Centro-Oeste - REPENEC) wasinstituted by Provisional Measure 472/09, converted into Law 12,249/10. This fiscal incentive is87

intended for corporate entities established and domiciled in the Northern, Northeast and Central Westregions that have approved projects for the implementation of infrastructure works in thepetrochemical, oil refinement and natural gas-based ammonia and urea production sectors.Corporate entities benefited by REPENEC will be entitled to the suspension of PIS/PASEP, COFINS,PIS/Import, COFINS/Import, Excise Tax (IPI), and Import Duty (II), at the time of the sale in thedomestic market or importation of new machines, apparatus, instruments and equipment, andconstruction materials for use or incorporation in infrastructure works intended for property, plant andequipment.14.5. REPETROThe Special Customs Regime for the Export and Import of Goods to be Used in the Research andExploitation of Oil and Natural Gas (Regime Aduaneiro Especial de Exportação e Importação de BensDestinados às Atividades de Pesquisa e Lavra de Jazidas de Petróleo e Gás Natural - REPETRO)grants Brazilian and foreign manufacturers tax incentives for the import of goods to be used directly inoil and natural gas activities, i.e., exemption of federal taxes.Such regime allows the use of the following special customs regimes, depending on the situation:(i)(ii)(iii)(iv)“Fictitious” export, when the good is not actually shipped abroad, but the temporaryadmission regime is applied in relation to goods manufactured domestically and soldto a person located abroad;“Fictitious” export, when the good is not actually shipped abroad, but the temporaryadmission regime is applied in relation to components and spare parts of goodspreviously admitted under the same temporary admission regime;Import under the drawback regime, concerning the suspension of duties in relation toraw material, semi-finished or finished goods and parts and components to be used inthe production of goods to be exported according to item (i) above; andTemporary admission of foreign or denationalized goods coming from abroad.By allowing the combination of these three regimes – i.e., fictitious export, temporary admission anddrawback – the REPETRO regime grants exemption of taxes levied on export revenues and suspendsall federal customs duties levied on import, namely: (ii) Import Duty; (ii) Excise Tax (IPI); (iii) PISImport; (iv) COFINS Import; and (v) Freight Surcharge for Renovation of Merchant Marine (AFRMM).At the state level, the REPETRO regime also grants tax incentives in relation to the Tax on theCirculation of Goods and Services (ICMS) levied on oil and natural gas extraction and productionactivities.88

14.6. RETAEROThe Special Tax Incentive Regime for the Brazilian Aeronautical Industry (Regime Especial deIncentivos Tributários para a Indústria Aeronáutica Brasileira - RETAERO) was instituted byProvisional Measure 472/09, which was then converted into Law 12,249/10. The RETAERO regime isdesigned to stimulate the expansion of the Country ’ s aeronautical sector and the greaternationalization of aircraft. In accordance with this special tax regime the collection of taxes levied onthe sale in the domestic market and importation of parts and equipment and other materials to beemployed in the maintenance and manufacture of aircraft are suspended.Within this scenario, in transactions conducted in the domestic market, the RETAERO regime includesthe suspension of PIS and COFINS levied on the revenue of corporate sellers and of the IPI levied onthe issue from the industrial establishment. In the case of imports, the suspension applies to the IPIand PIS Import and COFINS Import.14.7. RECOPAThe Special Tax Regime for Construction, Expansion, Renovation or Modernization of FootballStadiums (Regime Especial de Tributação para Construção, Ampliação, Reforma ou Modernização deEstádios de Futebol – RECOPA) was established by Law 12,350/10 to create tax incentivesspecifically related to the stadiums that will hold the games in the 2013 Confederations Cup and 2014World Cup.The RECOPA regime grants tax incentives related to construction work performed in connection withthe above-mentioned stadiums, suspending the collection of:a) Social contributions (PIS and COFINS) levied on the revenues of the corporate seller, arising from:(i) the sale of new machines, apparatus, instruments and equipment purchased by a legal entity that isa RECOPA beneficiary for use or incorporation into the construction work; (ii) the sale of buildingmaterials purchased by a legal entity that is a RECOPA beneficiary for use or incorporation into theconstruction work; (iii) the provision of services by a legal entity incorporated in Brazil to a legal entitythat is a RECOPA beneficiary, when the services are related to the construction work; and (iv) theleasing of machines, apparatus, instruments and equipment for use in the construction work, when thelessee is a legal entity that is a RECOPA beneficiary;b) Industrialized Products Tax (IPI) levied upon the exit from the industrial plant or other establishmenttreated for tax purposes as an industrial plant , when the products are purchased domestically;89

c) Social contributions (PIS Import and COFINS Import) levied on the import of: (i) new machines,apparatus, instruments and equipment for use or incorporation into the construction work, when theimporter is a legal entity that is a RECOPA beneficiary; (ii) building materials for use or incorporationinto the construction work, when the importer is a legal entity that is a RECOPA beneficiary; and (iii)services provided directly to a legal entity that is a RECOPA beneficiary in connection with theconstruction work;d) Industrialized Products Tax (IPI) levied on the import of goods, when the importer is a legal entitythat is a RECOPA beneficiary; ande) Import Duty, when the building materials or goods are imported by a legal entity that is a RECOPAbeneficiary.State governments also grant benefits regarding the Tax on the Circulation of Goods and Services(ICMS) levied on transactions related to construction work covered by the RECOPA regime.14.8. PROUCA and RECOMPEThe One Computer per Student Program (Programa Um Computador por Aluno - PROUCA) andSpecial Regime for the Acquisition of Computers for Educational Use (Regime Especial paraAquisição de Computadores para uso Educacional - RECOMPE) were also instituted by ProvisionalMeasure 472/09, which was then converted into Law 12,249/10.The objective of the PROUCA program is to promote the inclusion, in state schools, of computers,software and technical assistance in information technology. To help lay the groundwork for thisprogram, RECOMPE was created, with the purpose of granting fiscal benefits to those who wish tosupply the mentioned information technology products and services.Companies interested in obtaining the aforesaid benefits need to first qualify for the RECOMPE, whichguarantees the suspension of such taxes as IPI, PIS and COFINS on the sale of raw materials,intermediary products, equipment and services related to the information technology sector that aredesigned for the system of state schools. RECOMPE also includes the suspension of IPI, PIS ImportCOFINS Import, Import Duty and Cide Royalties, levied on the import operations of the respective rawmaterials, intermediary products, equipment and services.90

15. ACQUISITION OF COMPANIESThe total or partial acquisition of a Brazilian company by foreign capital may occur especially through:a) the acquisition of shares or quotas corresponding to the respective capital;b) the subscription of a capital increase in the company involved;c) the acquisition of an establishment;d) other means involving those listed above, but within a tax planning or corporate reorganization.An acquisition may be conducted directly by a company domiciled abroad or by its duly establishedsubsidiary in Brazil. The transaction may or may not involve the payment of a premium. The possibilityof setting off the premium paid by the acquirer with a view to its amortization and allocation asdeductible expense must be analyzed by a skilled professional, particularly when it comes toassessing the tax risks involved. For the purpose of setting off premiums, it is generally moreadvantageous for the acquisition to be made by the Brazilian subsidiary or by a company incorporatedin Brazil by the latter.Whatever method is adopted for the acquisition, special care should be taken by the foreign investor,with respect to the following:a) choice of a prospective local partner (in the case of a joint venture), based on an in-depth analysisof its financial conditions;b) analysis of the financial, market and legal status of the company involved;c) appraisal of the intended transaction, especially in relation to any premium to be paid;d) analysis of the company’s legal and accounting situation, particularly: tax registrations, licenses foropening and operating establishments, environmental licenses, possible special authorizations,depending on the company’s area of activity and its corporate, tax, labor and fixed asset status, andits situation in relation to judicial proceedings, contracts, environmental requirements, real estate(owned and leased), trademarks, patents, technology, the consumer protection code and sanitarysurveillance legislation;e) assessing whether it is necessary to submit the transaction to the Brazilian antitrust authorities.Among the issues listed above, the prior study of the financial situation of the company andprospective partner, and analysis of the company’s position in the market, and appraisal of the91

transaction are generally carried out by a local bank or specialized company with experience in thistype of transaction.The other conditions are analyzed by lawyers and auditors, through a due diligence to be conducted intheir respective sectors of expertise. In the environmental area, the work of the lawyers can beaccompanied by specialized technical consultants who will analyze the industrial practices of thetarget company, in order to determine the existence of any environmental liability of the company thatit is intended to acquire. Note that various cases recently verified in Brazil, relating to contaminationgenerated several decades ago and that have only now started to produce direct consequences,indicate the need for a rigorous environmental audit prior to an acquisition. These professionals willissue reports presenting the results of their respective interventions.With respect to due diligences in the field of competition law, special attention should be given to thestudy of any administrative proceedings involving the target company that are pending with theBrazilian Competition Defense System (Sistema Brasileiro de Defesa da Concorrência – SBDC), aswell as the existence of distribution contracts and any contracts or agreements entered into withcompetitors of the company, and other issues.Depending on the transaction, letters of intent, acquisition instruments, shareholder or associateagreements and other documents will have to be established between the parties to contract, possiblyinvolving the creation of new companies and/or the transformation of the existing company into adifferent type of company.It is customary in such operations to obtain guaranties from the sellers of the company for contingentliabilities and asset inconsistencies, among which the most common are: mortgage, bank, pledge ofshares, and personal guaranties and the retention of a portion of the price through an escrowagreement (depósito) with a bank with experience in the matter in question.All the foregoing precautions are important, especially in tax planning and corporate reorganizationoperations conducted by company sellers, in view of the tax succession and succession of operationsissues, with a view to avoiding the occurrence of capital gain by the sellers. These structures mayhave a negative impact on the acquirer.With regard to the acquisition of establishments, the Brazilian Civil Code contains the followingprovisions on the negotiation of a business establishment: a) the need for the publication of contracts,as well as the registration of their terms alongside the Commercial Registration of the transferorcompany, in order for them to produce effects against third parties; b) the requirement of the paymentof all creditors or the express or tacit consent thereof in case the seller is left with insufficient assets tosettle all of its liabilities; c) the responsibility of the acquirer for the debts prior to the transfer, with the92

joint and several liability of the transferor for one year, and d) the prohibition of competition on the partof the transferor for the period of five years, unless there is express authorization for such.Moreover, certain provisions of the new Bankruptcy and Company Reorganization Act (Law11,101/05) and Complementary Law 118/05, with respect to the acquisition of branches andproduction units and the joint or separate acquisition of assets, belonging to companies undergoingjudicial reorganization or even to the debtor companies, deserve mention.Indeed, in either of these cases, the subject of the transfer during the course of the judicial proceedingwill be free of any encumbrance and there will be no succession of the buyer to the obligations of thedebtor, including those of a tax, labor and occupational accident nature.16. FOREIGN INVESTMENT IN THE FINANCIAL MARKETForeign investments in the financial market include: (i) the use of the depository receipts mechanism;(ii) real estate investment fund; and (iii) Mutual Investment Fund in Emerging Companies. Theaforesaid operations depend on the prior authorization of the Brazilian Securities Commission(Comissão de Valores Mobiliários – CVM) and permit free migration from one type of investment tothe other.The foreign investor - corporate entities, natural persons, funds or other collective investment entities,resident, based or domiciled abroad – may invest in the same instruments and modalities of thefinancial and capital markets that are available to investors residing in Brazil. It is important to notethat financial movements with foreign countries, resulting from such investments, may only beconducted through the contracting of foreign exchange. Since 2005 the foreign exchange rules havesuffered considerable alterations, and as a result of the unification of the floating and free exchangerate markets, today there is one single market for foreign exchange operations.However, this investment system calls for the satisfaction of three prerequisites by the investor: (i) theestablishment of at least one representative in the Country, pursuant to the prevailing legislation; (ii)the completion of a form to be submitted to CVM and BACEN, and (iii) the obtainment of the investor’sregistration with CVM.All the foreign investments in question must be submitted to declaratory registration via electronicmeans at BACEN, which is obligatory for any financial movements with foreign countries, there beingno minimum time limit for the permanence of said investments in Brazil.93

The method of adaptation to the new system has not yet been defined for (i) Conversion Funds -Foreign Capital, (ii) Privatization Funds - Foreign Capital, (iii) Mutual Investment Funds in EmergingCompanies - Foreign Capital, and (iv) Capital investments made between the MERCOSUR signatorycountries.In addition, all natural persons and corporate entities domiciled, resident or based abroad that haveinvestments in the Brazilian financial and capital markets are required to register in the FederalRegister of Individual Taxpayers - CPF (in the case of individuals) or Federal Register of CorporateTaxpayers - CNPJ (when involving corporate entities).With respect to the taxation applicable to investments in the financial market please refer to paragraph6.1.1.3 above.17. REMITTANCE OF PROFITS AND DIVIDENDS TO INVESTORS DOMICILED ABROADOnce the foreign capital has been registered with Central Bank of Brazil (BACEN), profits may befreely remitted to the foreign investor abroad, in proportion to its holdings in the paid-up capital of theBrazilian company and always limited to the stake registered with SISBACEN, RDE-IED Module.Remittances must also have their movement registered with BACEN and will be exempt from anytaxation, except the rate of 0,38% corresponding to the IOF – Tax on Financial Operations levied onthe amount to be remitted abroad.18. REPATRIATION OF INVESTMENTCapital and reinvestments registered with BACEN may be repatriated to the investor's country withoutincurring income tax, up to the total foreign currency amount stipulated in the Consolidated InvestmentStatement available on the BACEN RDE-IED System.Therefore, with due observance of the ownership interest of the foreign investor in the capital stock ofthe Brazilian company, the allocation of resources determined in the sale of ownership interests,reduction of capital for the reinstatement of shareholders or liquidation of companies, shall beregistered with BACEN.The differences in excess of amounts registered as brought into the Country - such as the case of apremium verified on the sale of shares or quotas - will be considered “capital gain” and, as a rule, besubject to the levy of income tax at the rate of 15%.94

BACEN may, if it deems necessary, ask for the presentation of an appraisal report, as well as otherelements it considers relevant for the perfect characterization of the operation and verification of thereasonability of the amounts involved.19. INTERNATIONAL TREATIESAmong the most important international treaties signed by Brazil in the trade area we may mention:19.1. Latin American Integration Association (ALADI)a) Establishment: Montevideo Treaty, of 1980.b) Members: Argentina, Bolivia, Brazil, Colombia, Chile, Cuba, Ecuador, Mexico, Panama, Peru,Paraguay, Uruguay and Venezuela.c) Objective: formation of a Latin American common market, favoring the creation of an economicpreference area in the region, which is achieved through 3 mechanisms:(i) area of regional tariff preference in relation to non-member countries;(ii) agreements of a regional scope with the participation of all member countries;(iii) agreements of a partial scope with the participation of some countries from the area.The Aladi serves as an "umbrella" organization for various trade agreements between its members.Under the Aladi, goods manufactured in Brazil have a margin of preference between 8% to 20% whenexported to other members of the bloc.Among the agreements signed by Brazil under the Aladi, it is worth highlighting the Mercosuragreement, Auto Accords with Argentina and Mexico and Preferential Trade Agreements (PTAs) withall South American countries, Mexico and Cuba.It is interesting to note that the Aladi member countries are of strategic importance to Brazil's exports,as they are the countries to which the largest amount of manufactured goods are exported. Accordingto data of the Brazilian Foreign Trade Secretariat (Secex), in 2013 the Aladi member countriesaccounted for 46% of all Brazilian exports of manufactured goods, while the European Union and Asiaaccounted for 19% and 7%, respectively. For comparison purposes, only 6% of all Brazilian exports ofbasic goods that year were made to Aladi member countries, against 53% to Asia and 21% to the EU.Thus, the PTAs signed under Aladi are important trade instruments for Brazilian exports of industrialgoods.95

19.2. Southern Cone Common Market - MERCOSURa) Establishment: Asunción Treaty, of 1991.b) Members: Argentina, Brazil, Paraguay, Uruguay and Venezuela. Paraguay was suspended fromthe bloc until August 2013.c) Associates: Bolivia 1 , Chile, Peru, Colombia and Ecuador.d) Objective: eliminate all customs tariffs and other barriers that may hinder the free circulation ofgoods and services originating from their respective territories.Even though they are not associate States, in 2012 Guyana and Suriname began to enjoy forms ofparticipation in Mercosur meetings.e) Headquarters: Montevideo, Uruguayf) Characteristics:Mercosur represents one of the world's largest trade blocs, uniting more than 275 million people.In January 1995 the first stage of the integration process was carried to completion: the institution of afree trade area between the four countries. With respect to imports from non-member countries, theCommon External Tariff (CET) came into force, with a basic tariff ranging from zero to 20%, but withthe maintenance of a list of exceptions whereby the countries have the right to apply the national tariff.Nevertheless, there is a convergence mechanism up to the levels of the CET, in a linear andautomatic manner.Besides negotiations for the establishment of a customs union between the Mercosur Member States,the bloc also has extensive regulation covering many topics, including judicial cooperation, migration,foreign exchange swap agreements, industrial policy integration, government procurement,infrastructure, energy, non-tariff barriers and services. This vast regulatory framework may have asignificant impact on companies that wish to do business within intraregional boundaries.Mercosur signed various agreements with non-member countries, economic blocs and internationalorganizations with a view to laying the groundwork for investments and the establishment of freetrade, namely: the Andean Community, India, Southern African Customs Union (SACU), Egypt,Morocco, Gulf Cooperation Council (GCC), European Free Trade Association (EFTA) States (Island,1 On 7 December 2012, Bolivia signed an Accession Protocol to the Mercosur. Its approval is conditional todomestic approval by the other members of the Bloc.96

Liechtenstein, Norway and Switzerland), Trinidad, Tobago, Guyana, Singapore, Canada, RussianFederation, Mexico, Israel and Palestine.Today, Mercosur's negotiations are focused on deepening ties with other countries and economicgroups. The resumption of negotiations with the European Union is one example. In 2013, theEuropean bloc was the second most important destination for Brazilian exports, followed by LatinAmerica and the Caribbean. The recently resumed negotiations to expand the PTA between Mercosurand India are also worth noting.Within the ambit of Mercosur two treaties were also signed regarding the protection of investments:the Colony Protocol for the Reciprocal Promotion and Protection of Investments in Mercosur, and theBuenos Aires Protocol for the Promotion and Protection of Investments Originating from the NonmemberCountries of Mercosur. However, these Protocols have not yet completed the necessaryprocedures for their internalization into the Brazilian legal system.g) Dispute Resolution:The Olivos Protocol (signed in 2002), which introduced certain modifications in the original disputeresolution system in Mercosur established by the Brasília Protocol (signed in December 1991), cameinto force in 2004. These modifications included the creation of the aforementioned MercosurPermanent Review Tribunal, with its headquarters in Asunción, Paraguay.Private entities are allowed to use the dispute resolution system within Mercosur. However, first theymust make a claim with the Common Market Group (CMG) in their country of origin (MercosurMember State) and demonstrate the violation to the bloc's rules and the (potential or actual) harmincurred. Therefore, even though the system permits direct access by private entities, thegovernment's approval is still necessary in order to proceed with a claim.During the validity period of the Brasília Protocol (from 1992 to 2003), 10 arbitral awards were issued.As of 2004, with the advent of the Olivos Protocol, 6 awards were issued, 3 of which concerningretreaded tires. However, Mercosur's dispute resolution system has been avoided by Member Statesin the past years. Only one Award has been issued by the Permanent Review Tribunal since 2008.h) Latest Developments:In August 2010, The Mercosur Customs Code (Código Aduaneiro) was approved. The aforesaid codeaims to harmonize and standardize the methods and legislations in relation to the free circulation ofgoods through their territories. Its implementation was scheduled for January 2012, but has notoccurred yet. The code aims to ensure that the trade of finished products – those that have receivedno other components – will be taxed only at origin. Today, it is taxed at the time of the export and at97

the time of the sale in the country of destination (double charging of the Common External Tariff(CET)).In practice, this means that a product imported by Brazil, for example, pays a charge per operation. Ifthis same product is resold to Uruguay, it is taxed again. The code would put an end to this doubletaxation. Decision No. 10 of the Council of the Common Market (CCM), adopted in 2010 at the samemeeting that approved the Customs Code, established a schedule to eliminate the double charging ofthe CET. The decision, which complements prior decisions on the same topic (CCM No. 54/04 andCCM 37/05), provides for three stages that are yet to take place.The accession of Venezuela as a Mercosur Member State in 2013 offered the prospect of integratinga significant consumer market to the Customs Union and the expansion of intra-bloc trade. However,the serious economic crisis that the country has been facing – similarly to Argentina – has causeddifficulties to Brazilian exporters, placing – although in the short term – tough restrictions on thecommercial development of the bloc. Today, investors have been making unfavorable comparisonsbetween Mercosur and the recently created Pacific Alliance 2 trade bloc, which has been consideredmore dynamic and more commercially open than Mercosur.Venezuela's payment difficulties caused by the restrictions introduced by CADIVI and the importlicense requirements (DJAI) imposed by Argentina are examples of trade balance control policies thathurt Brazilian exports within the bloc.19.3. Union of South American Nations – UNASURUNASUR is formed by twelve countries of South America. The treaty that formed the organization wasapproved during the Extraordinary Meeting of Heads of State and Government, held in Brasília, on 23May 2008. Over nine countries have already deposited their ratification instruments (Argentina,Bolivia, Brazil, Chile, Ecuador, Guyana, Peru, Suriname, Uruguay and Venezuela), completing theminimum number of necessary ratifications for the entry into force of the Treaty on 11 March 2011.The main objectives of UNASUR are the political, economic and social coordination of the region.According to the language of the Treaty, its institutional structure comprises: a) Council of Heads ofState and Government; b) Council of Foreign Ministers; c) Council of Delegates; and d) GeneralSecretary. There is the possibility of the constitution of a Ministerial Council and of Working Groups.Every instance is already operational.2 Established in 2012, the bloc has Chile, Colombia, Mexico and Peru as Member Countries and seeks topromote trade integration between the region and Pacific countries.98

Currently, UNASUR has twelve ministerial councils and two working groups: a) Financial Integration;and b) Investment Disputes Resolution, in which the possibility of creating an arbitration mechanism isbeing considered, as well as a Legal Assistance Center and a code of conduct for arbitral tribunalmembers.The ministerial councils worth highlighting are the Infrastructure and Planning Council (COSIPLAN)and the Energy Council, with high levels of activity. A number of ambitious infrastructure integrationand regional energy production projects have been carried out through these councils, most of themwith the support of the Brazilian Development Bank (BNDES), creating business opportunitiesespecially for companies located in Brazil.19.4. World Trade Organization - WTOa) Establishment: the WTO was created in 1995, during the Uruguay Round, under the form of asecretariat to administer the General Agreement on Tariffs and Trade (GATT).b) Members: 159, including Brazil and other Mercosur member States.c) Headquarters: Geneva, Switzerland.d) Budget: approximately 197 million Swiss francs for year 2013.e) Objective: Regulating multilateral trade relations between the Members. The following are functionsof the WTO: managing the trade rules, discussing and negotiating them; settling trade disputes;monitoring the trading policy of each Member and providing technical assistance and cooperating withother international organizations. Special attention must be given to its role as an international tradecourt, function bestowed upon the Dispute Settlement Body. At a first level, disputes are settledthrough consultation between the Members and decisions are made by a panel of experts, and at asecond level, by the Appellate Body. The great importance of this body is that its decisions arebinding, under penalty of application of retaliatory measures, making the WTO the most efficient courtamong all international organizations.f) Agreements Covered: The WTO members assumed the commitments set forth in the followingmultilateral agreements: General Agreement on Tariffs and Trade – GATT, General Agreement onTrade and Services – GATS, Trade Related Aspects of Intellectual Property Rights – TRIPS, and alsoagreements on Agriculture, Sanitary and Phytosanitary Measures, Textiles and Wearing Apparel,Technical Trade Barriers, Trade-Related Investment Measures - TRIMs, Anti-dumping, CustomsValue, Pre-shipment Inspection, Rules of Origin, Import License, Subsidies and CountervailingMeasures, Safeguards, Understanding on Dispute Resolution and Trade Policy ReviewAgreement;Trade Facilitation Agreement.99

g) Characteristics: among the changes introduced by the WTO in relation to the GATT system of1947, we may highlight the inclusion of agriculture, the commitment regarding the elimination of allnon-tariff barriers, maintaining the import tariff as the only market defense instrument (which is alsoexpected to be gradually reduced), and the regulation (i) of trade-related intellectual property rights bymeans of the TRIPS, and (ii) trade in services by means of the GATS (for a wide range of sectors,including: merchant marine, telecommunications and labor).In late 2012, a trade facilitation agreement was signed in Bali with the purpose of eliminating thebureaucracy in trade exchange between WTO members.h) Dispute Resolution: To date, a total of 474 disputes have been taken to WTO’s Dispute ResolutionBody. The majority of the disputes are settled at the initial phase of the procedures (consultations),approximately 35% are finalized at the panel phase and roughly 25% reach the appeal phase.i) Trade liberalization talks: Unfortunately the WTO members have not managed to reach a consensusto finalize the Doha Round (launched in 2001, in which alterations in the agreements covered, andother subjects are discussed).j) Brazil’s Role: Brazil has worked in a broad and dedicated manner within the ambit of the WTO, notonly in multilateral negotiations, but also as a party in various disputes as claimant, respondent orinterested party before the Dispute Resolution Body. With the submission of various trade litigationsto the Dispute Resolution Body, Brazil aims, above all, to confer greater effectiveness on internationaltrade agreements, furthering and defending the interests of the national economy. Up to February2014, Brazil participated in a total of 120 disputes. In 26 it was the Claimant – the most recent isDS439, concerning South African Anti-Dumping Duties on Frozen Meat of Fowls from Brazil – in 15cases it was the Respondent ,- the most recent was initiated by the EU and challenges the Braziliangovernment's tax incentive policy – and in 79 it was a third interested party.Thus, taking into consideration Brazil’s strong participation in this forum, it has become increasinglymore important to be well informed about Brazil’s positions in the international trade area, not only atthe time of making investments in Brazil in specific sectors, but also to expand its trade flow,delegitimize barriers that affect its exports or even impose barriers that are admissible under the WTOrules for the protection of its domestic industry.In the end of 2012, Brazil nominated ambassador Roberto Azevedo as a candidate to run for Director-General of WTO. The election was held at the end of May 2013 and there were eight other candidatesin the dispute, representing South Korea, Costa Rica, Ghana, Indonesia, Jordan, Mexico, NewZealand and Kenya.100

Ambassador Roberto Azevedo was appointed Director-General of the WTO on September 1, 2013 fora four-year term.19.5. Multilateral Investment Guarantee Agency - MIGAThe purpose of this agency, which was created by a Convention within the sphere of the World Bank,is to encourage foreign investment and increase the flow of capital from the developed countries to thelesser-developed countries in a secure manner, complementing the activity developed by theInternational Bank for Reconstruction and Development and the International Finance Corporation.The aforesaid Convention was formalized in 1985, in Seoul, came into force in Brazil in 1992 andtoday has 178 member countries.MIGA promotes foreign direct investments in developing countries, guaranteeing investors againstpolitical risks, advising governments to attract investment, sharing information through on-lineinvestment information services, and the mediation of disputes between investors and governments.MIGA offers guarantees against noncommercial risks to protect the transborder investment of memberdeveloping countries. The organization aims to protect investors against the risks of currencyinconvertibility and transfer restrictions, and expropriation, war, civil commotion and terrorism.Among the guarantees granted by MIGA are those concerning coinsurance and re-insurance againstnoncommercial risks, related to investments made by one member country in another membercountry. To this effect, the investing country and the recipient country of the investment may jointlyrequest non-commercial risk coverage, with the exception of monetary devaluation or depreciation.This includes new investments, and the investments associated with expansion, modernization orfinancial restructuring of existing projects, or when the investor demonstrates the benefits ofdevelopment, and a long-term commitment to the project. Acquisitions of new investors, including theprivatization of state-owned companies can also be eligible. The projects that MIGA cannot guaranteeare described in the MIGA exclusion list.With due regard to certain requirements, both individuals and corporate entities may benefit from theguarantees granted by the Agency. It can be noted that the holder of a guarantee granted by MIGAshall, prior to seeking indemnification from the Agency, try other pertinent administrative remedies thatare permitted by the laws of the recipient country of the investment, though said entity cannotguarantee a sum in excess of 150% of its subscribed capital and available reserves.101

In addition to operating in the area of the mitigation of risks for investments in lesser-developedcountries, MIGA has a sector for the mediation of disputes, technical assistance and disclosure ofinformation.19.6. Agreements on the Reciprocal Promotion and Protection of InvestmentsBrazil signed 14 Bilateral Investment Treaties (BITs) 3 in the period of 1994-1999, but none of these isin force nowadays due to the lack of approval by the National Congress.In a recent change of attitude towards this type of treaty, Brazil has begun to conceive a type of BIT tobe signed with African and Latin American countries in which Brazilian companies – especially in theinfrastructure sector – have been making significant investments. These treaties are to be calledCooperation and Investment Facilitation Agreements and should be adapted to the reality of eachsignatory country. So far, the Brazilian government has not released any draft text, and concretedevelopments in the negotiation of such agreements remain to be seen.19.7. Treaty for International Legal Cooperation in Civil, Commercial, Labor and AdministrativeMattersBrazil has various Treaties for Legal Cooperation in Civil, Commercial, Labor and AdministrativeMatters with Mercosur countries, Spain, France, Italy, Japan Belgium and Portugal. Among them, wemay mention the treaty between Brazil and France, promulgated through Decree 3,598/00.The most important point of this treaty is the abolishment of the legalization or analogous formalities ofall public acts issued in the territory of either signatory State, defining such as documents thatemanate from judicial or notary entities, marital status certificates and official certificates, such asregistration transcriptions, visas with definite dates and the certification of signatures affixed on privatedocuments. The legalization of the respective documents with the diplomatic authorities of eachsignatory country is thus dispensed with in such cases.19.8 Treaty for Legal Cooperation in Criminal Matters3 The BITs signed by Brazil and filed to the National Congress are: Portugal (February 9, 1994), Chile (March 22,1994), United Kingdom (July 19, 1994), Switzerland (November 11, 1994), France (March 21, 1995), Germany(September 21, 1995). The following BITs have not been filed to the National Congress: Finland (March 28,1995), Italy (April 3, 1995), Denmark (May 4, 1995), Venezuela (July 4, 1995), Korean Republic (September 1,1995), Cuba (June 26, 1997), Netherlands (November 25, 1998) and Belgium-Luxemburg (January 6, 1999).102

Treaty for Legal Cooperation in Criminal Matters between Brazil and Switzerland on 12 May 2004. Itwas promulgated by the Decree 6,974 of 7 October 2009 with the objective of facilitating the exchangeof information about suspects of financial crimes and corruption. The treaty excluded the cases of taxevasion and provides for a rapid channel between the Courts of the two countries enabling them toexchange information and bank data about cases of fraud and corruption, in addition to therepatriation of resources.Treaty on International Legal Cooperation in Criminal Matters between Brazil and Mexico, of 6 August2007, concluded in Mexico City, promulgated by the Decree 606 of 2 September 2009. The objectiveof the Treaty is to promote cooperation between the countries with a view to facilitating criminalinvestigations and the conducting of judicial proceedings related to any offense under the domesticlaws of the States Parties.Treaty on Legal Cooperation in Criminal Matters between Brazil and Germany on 3 December 2009,concluded in Berlin, promulgated by the Decree 589 of 26 December 2012. It has the same object asthe aforementioned treaties.19.9 Multilateral International Treaties on Arbitration signed by BrazilThe main treaties/conventions in force in Brazil related to arbitration are the following:a) Inter-American Convention on International Commercial Arbitration of 30 January 1975, concludedin Panama City, approved in Brazil by the Decree 90 of 6 June 1995.It was signed by the Member States of the Organization of American States (OAS), which agreed tosubmit to arbitration any disputes arising between them related to a commercial transaction. Thearbitral awards are equivalent to a final judicial sentence, and as such any State can seek itsrecognition and enforcement against another State.b) Inter-American Convention on Extraterritorial Validity of Foreign Judgments and Arbitral Awards of8 May 1979, concluded in Montevideo, approved in Brazil by Decree 93 of 20 June 1995.It was signed by the Member States of the OAS. This Convention applies to both judicial sentencesand arbitral awards rendered in civil, commercial or labor proceedings in one of the States Parties,unless any of the States has made an express reservation to limit its application to certain mattersinvolving assets. With regards to the arbitral awards, the application of this Convention iscomplementary and subsidiary to the Panama Convention of 1975. Foreign sentences and awards areeffective in the territory of any Party in which recognition or enforcement is sought.103

c) Convention on the Recognition and Enforcement of Foreign Arbitral Awards of 10 June 1958,concluded in New York, approved in Brazil by the Decree 2 of 25 April 2002.It is very similar to the Montevideo Convention, the main difference being that it has a worldwide ratherthan a regional scope of application. Over 140 countries have enacted this Convention, and as suchhave reciprocal obligations regarding recognition and enforcement of arbitral awards within theirrespective territories. This Convention derogated the Geneva Protocol on Arbitration Agreements of1923 and the Geneva Convention on the Execution of Foreign Arbitral Awards of 1927.19.10 Multilateral International Treaties Signed by Brazil about Intellectual PropertyWe list below the main multilateral international treaties regarding Intellectual Property – outside thescope of the WIPO or the WTO – to which Brazil is a signatory, followed by their execution andratification dates by Brazil before the international order:a) Paris Union Convention for the protection of industrial property, of 1883, in effect in Brazil by theDecree 9,233, of 28 June 1884.b) Berne Convention for the protection of literary and artistic works, of 1886, in effect in Brazil by the n oDecree 15,530, of 21 June 1922.c) Madrid Agreement on the repression of false indications of the origin of merchandise, of 1891, ineffect in Brazil by the Decree 19,056, of 31 December 1929.19.11. United Nations Convention on Contracts for the International Sale of GoodsThe United Nations Convention on Contracts for the International Sale of Goods ("CISG") is not yet inforce in Brazil. On 8 May 2012, the Brazilian Chamber of Deputies approved the text of the CISG. TheFederal Senate approved it on 16 October 2012 and on the same day the National Congress enactedthe Legislative Decree 538/2012, which approved it. On 4 March 2013, Brazil deposited its instrumentof accession with the Secretary General of the United Nations, Ban Ki-moon.The CISG, for international purposes, will come into force in Brazil on 01 April 2014, in accordancewith Article 99 (2) of the Convention, which states that "(...) When a State ratifies, accepts, approvesor accedes to this Convention after the deposit of the tenth instrument of ratification, acceptance,approval or accession, this Convention, with the exception of the Part excluded, enters into force inrespect of that State, subject to the provisions of paragraph (6) of this article, on the first day of themonth following the expiration of twelve months after the date of the deposit of its instrument ofratification, acceptance, approval or accession".104

The Convention contains 101 articles, divided into four parts: Part I deals with its scope and generalprovisions; Part II provides rules on contract formation; Part III deals with the rights and obligations ofthe seller and buyer and Part IV refers to the reciprocal obligations between States.The Convention was adopted on 11 April 1980 and currently has 79 signatory states, including Brazil,representing over 80% of world trade. The most important trading partners of Brazil, China, UnitedStates and Argentina, are part of the Convention, as well as most members of the European Union.20. ENTRY OF FOREIGN WORKERS INTO BRAZILLaw 6,815/1980, regulated by Decree 86,715/1981, defines the legal status of the foreigner in Braziland creates the National Immigration Council.There are different types of visas for foreigners, their spouses and economically dependent children,the most common of which are:20.1. Visa for Business TravelersThe visa for business travelers, which can be obtained from any Brazilian Consulate, enables theforeigner to come to Brazil for acts of commerce, the dissemination of products and market research.This modality also permits participation in trade shows, events, meetings, seminars, conferences andthe like.The business visa is normally granted for up to five years, permitting multiple entries for citizens ofcountries that offer, on a reciprocity basis, similar conditions to Brazilian citizens. This period,however, refers to the validity of the visa.The first entry in the country should occur within up to 90 days of the issuance of the visa and themaximum permitted stay in the country is for up to 90 days, extendible for an equal period. However,the foreigner's total stay cannot exceed 180 days per year, as from the date of first entry into Brazil.Remuneration of the visitor is forbidden.Foreigners who are not required to take out a visa for a business trip may enter Brazil by presentingtheir passports and informing business purpose on the immigration card distributed duringinternational flights to the country.20.2. Temporary Work Visa105

Temporary work visas will be granted to foreigners who come to Brazil to work for a Brazilian companyin the capacity of employees, i.e., with an employment relationship, but without representation powersof the company. This visa will be granted for a maximum period of 2 years and may be extended foran equal period. After 4 years, the temporary visa may be transformed into a permanent visa, providedthat certain legal requirements are met.In accordance with Normative Resolution 80/1988, of the National Immigration Council (ConselhoNacional de Imigração), to apply for a temporary visa, the foreigner shall evidence professionalqualification and experience compatible with the activity he or she will be performing, by presentingdiplomas, certificates or declarations from entities in which the employee performed his or heractivities, evidencing the satisfaction of one of the following requirements:(a) 1 year experience in the practice of a high level profession, counted from the completion of the firstacademic degree that qualified the professional for this practice, or(b) 2 years experience in the practice of a mid level profession, with minimum schooling of 9 years; or(c) conclusion of graduate studies, with a minimum of 360 hours, or completion of a master's or higherdegree course that is compatible with the activity that the professional will be performing.Until 31 December 2012 the requirements set out in items (a) to (c) above shall not apply toapplications for work permits for nationals of countries of South America.As determined by labor legislation, the Brazilian company shall justify the use of foreign labor andobserve the required proportion of 2/3 of Brazilian employees both in relation to the total staff and thecorresponding payroll. This rule suffers criticism on the part of some legal scholars, who consider itunconstitutional due to violating the isonomy principle.The temporary visa will also be granted to foreigners who come to Brazil to render services to aBrazilian company, without an employment relationship, through a service contract or technicalcooperation contract between companies of the same group. In this case, the validity term of the visais one year, which may be extended for an equal period, provided that the need is evidenced. Itstransformation into a permanent visa is forbidden.20.3. Permanent Work VisaThe permanent work visa will be granted to the employee of a foreign company who is to betransferred to a company of the same Group, based in Brazil, to hold the position of officer or106

administrator of such company, with administration and representation powers, as long as the positionis provided for in the company's bylaws or charter documents.A Brazilian company wishing to indicate a foreigner to discharge the duties of administrator must, inaddition to the documents evidencing its regularity before the tax, labor and social security authorities,present the following to the Labor Ministry:a) Minimum investment: proof of foreign direct investment (in currency, transfer of technology or ofother capital goods), by the foreign company that wishes to indicate a foreigner for the position ofadministrator of the Brazilian company, in the minimum amount of:(i) US$ 200 thousand, for each foreign administrator, by means of a copy of theConsolidated Foreign Direct Investment Statement, obtained directly from SISBACEN (CentralBank of Brazil Information System) following registration of such investment, or of the ForeignExchange Contract and the respective contractual or bylaw amendment, duly registered at thecompetent agency, in order to evidence payment of the investment in the recipient company;or(ii) US$ 50 thousand for each foreign administrator, with due regard to the aforesaiddocumentation, whereas, in this case, evidence shall be produced of the generation of, atleast, 10 new jobs, during the two years subsequent to the administrator's entry into thecountry, observing, in both the aforesaid situations, such proportion of 2/3 of Brazilianemployees as set forth in Brazilian labor legislation;b) Salary structure: the present salary of the foreigner appointed to occupy the administrator positionin the Brazilian company shall be informed, and also the salary that this person will receive once he orshe has taken office. Finally, there must also be indication of whether the foreigner will continuereceiving any remuneration from abroad, in addition to receiving a salary in Brazil.The possible transfer of the foreigner to another company of the same business group shall becommunicated and justified with the Labor Ministry (MTE). For a change of job and/or addition of othernew functions to those already discharged by the foreigner, the local company shall presentjustification and an amendment to the contract to the General Immigration Coordination Department ofthe MTE. Concomitant jobs in two or more companies from the same business group must also beauthorized by the pertinent authority.The change of employment of the foreigner to another company that does not belong to the businessgroup where the foreigner was discharging his/her duties shall be the subject of prior authorizationfrom the competent authorities.107

20.4. Permanent Visa for the Foreign Investor – IndividualThe permanent visa will be granted to foreign individuals who wish to settle in Brazil by investing theirown resources, of foreign origin, in productive activities. In this case, the investor should work as apartner of the Brazilian company, being also authorized (after obtaining the visa) to occupy theposition of administrator of that same company.The requirements for obtaining this type of visa are:(i) Evidence of foreign direct investment (in currency, foreign), in the minimum amount equivalent toR$ 150,000 (equivalent to US$ 90,91 thousand American Dollars), through the presentation of a copyof the Consolidated Foreign Direct Investment Statement, obtained directly at SISBACEN (CentralBank Information System), and the respective contractual or bylaw amendment registered with thecompetent body, in order to evidence the payment of the investment in the Brazilian recipientcompany of the investment;(ii) Submission of the investment plan that attests the social interest.The permanent visa may be granted for the period of 3 years, which is renewable, and its granting willbe conditional on:(i)in Brazil;(ii)(iii)(iv)The verification of the social interest in accordance with the number of jobs generatedThe amount invested and the region of the country where it will be applied;The economic sector where the investment will occur; andContribution to the increase of productivity.The renewal of a permanent visa for the Foreign Investor – Individual will be subject to evidence of thefulfillment of the Investment Plan submitted.21. ARBITRATIONSince the effective date of Law 9,307/96 and declaration of its constitutionality by the Supreme Courtof Brazil (Supremo Tribunal Federal – STF) in 2001, and the ratification of the New York Convention in2002, foreign investors have been able to safely use arbitration to resolve their disputes. Arbitrationoffers the possibility of the resolution of disputes by experts, in a confidential manner, with greatercelerity, within a more flexible procedure and in a more cordial atmosphere, and also overcomeslanguage barriers and misgivings about the partiality of the state courts.108

If an arbitration seat is in Brazil, the arbitral award is in itself considered an enforcement order in theBrazilian territory, and is valid as a final and unappealable judgment or court decision. If the arbitrationseat is outside of Brazil, the acknowledgement and enforcement of the foreign arbitral awards willoccur before the Federal Court of Appeals (Superior Tribunal de Justiça – STJ), after the fashion ofthe New York Convention and Brazilian Law (based on the UNCITRAL Model Law).Arbitration has also been playing an important role in the Public Sector, being frequently elected as adispute resolution method in contracts signed between particulars and the Public Administration.Despite the inexistence, in Brazil, of a general law authorizing the use of arbitration within PublicAdministration, the majority of the recent legislation regarding public contracts provides for thepossibility of using private dispute resolution methods, which includes arbitration. Besides the severallegislations regulating specific sectors, the Concessions Law (Law n. 8.987/95, changed by Law n.11.196/2205) and the law of Public-private Partnership (Lei das PPPs) expressly provides for the useof arbitration.Arbitration has been confirmed by important rulings from the Country’s various Courts. Thecombination of a favorable law correctly interpreted by the Judiciary Power gives Brazil the status ofan important center for seating arbitrations, especially international trade arbitration procedures.Various Brazilian Arbitration Chambers have demonstrated competence to manage national andinternational arbitrations, such as the Chamber of Mediation and Arbitration of São Paulo (Câmara deMediação e Arbitragem de São Paulo), linked to the Center of Industries of the State of São Paulo(CIESP), the Arbitration Center of the Brazil-Canada Chamber of Commerce (Centro de Arbitragemda Câmara de Comércio Brasil-Canadá-CCBC), the Chamber of Mediation and Arbitration of theAmerican Chamber of Commerce AMCHAM, the EuroChambers' Mediation and Arbitration Chamber(Câmara de Mediação e Arbitragem das Eurocâmaras – CAE), and others. The Brazilian ArbitrationCommittee (Comitê Brasileiro de Arbitragem- CBAr) has also played an important role, uniting some ofthe greatest experts on the subject, in the scientific development of arbitration.Arbitration in Brazil has become even more recognized with the new regulations to corporate law.According to the Brazilian corporate law (Lei das S.A.), corporations can put arbitration agreements intheir by-laws, which is new for the Brazilian legal system. With the new regulations to be listed in theNovo Mercado (a listing level which makes high demands in terms of Corporate Governance in theBrazilian stock exchange), arbitration became compulsory to all of the conflicts related to theregulations of the Novo Mercado as well as with the contracts regulating the participation in the NovoMercado. Other regulatory measures, such as the CVM Instruction 391, consider arbitration a goodform of governance and create incentives to investments in corporations with such characteristic. Onecan say, therefore, that arbitration is becoming the preferred way to resolve corporate conflicts inBrazil.109

Finally, it is important to mention that Brazil has adhered to other important International Conventionson the subject, including: the Agreement on International Trade Arbitration of Mercosur (Buenos Aires,1998) and the Interamerican Convention on International Trade Arbitration (Panama, 1975).22. HEALTH UNDER BRAZILIAN LAWS22.1. Basic Principle – Health as a Right of All and a Duty of the GovernmentThe first law we need to mention when talking about this topic is without a doubt the BrazilianConstitution. Enacted in 1988, the Constitution guarantees the right to universal, equal access toactions for the promotion, protection and recovery of health (article 196) and states that this is a rightof all Brazilian citizens that must be guaranteed by the Government.Still based on the Constitution, health actions and public health services integrate a regionalized andhierarchical network and constitute a single system (SUS) financed by the Federal, State andMunicipal Governments and the Federal District, among other sources.In 1990, Law 8,080 was enacted to regulate article 196 of the Constitution. Law 8,080 determined theconditions under which health is to be promoted, protected and recovered and how related servicesare to be organized and run. Article 2 of this Law states that "health is a fundamental right of humanbeings, and the Government must provide the basic conditions for it to be fully enjoyed”.It is Law 8,080 that regulates the health actions and services throughout the country, whether suchactions and services are conducted individually or collectively, on a permanent or provisional basis, byindividuals or legal entities governed by public or private law, giving life to what we know today as theUnified Health System (Sistema Único de Saúde - SUS). The SUS comprises a set of health actionsand services conducted or provided by federal, state and local public institutions and entities in anyway belonging or related to the government.Although public health actions and services are to be conducted within the scope of the SUS, Law8,080/90 authorizes participation of the private sector on a complementary basis.The direction of the SUS is unified and must be conducted at each level by the following entities: (i) atthe federal level: Ministry of Health; (ii) at the state level and for the Federal District and (iii) at the locallevel: the relevant Department of Health (Secretaria de Saúde) or similar entity.The list of duties and purposes of the SUS is a very long one. Among the SUS’s duties is the duty tocarry out sanitary surveillance actions and to assist people by carrying out actions to promote, protectand recover health, both through assistance and preventive care. Another duty is the creation of110

policies concerning drugs, equipment and immunobiologicals and other products of interest to healthand the participation in their production.Law 8,080/90 determines what is to be known as and the scope of sanitary surveillance: a set ofactions capable of eliminating, reducing or preventing the risks to health. Sanitary surveillance mayalso intervene in sanitary issues concerning the environment, the circulation of goods and provision ofservices of relevance to health, including:I- To control any consumer goods directly or indirectly related to health, in all stages andprocesses, from manufacturing to consumption; andII- To control the provision of services directly or indirectly related to health.22.1.2 - Sanitary SurveillanceThis topic is generally regulated by Law 6,360 of 23 September 1976 as amended from time to time.Law 6,360 determines which products, inputs and services are subject to sanitary surveillance.A few months after the enactment of Law 6,360/76, on 25 January 1977 Decree 79,094 was enactedto regulate that Law, which was revoked in 2013 by Decree 8,077 of August 14 th .According to the laws mentioned above, when subject to sanitary surveillance, medicine,pharmaceutical inputs, drugs and the like, cosmetics, hygiene products, perfumes and the like,sanitizing products, products for use in aesthetic correction among others will only be extracted,produced, manufactured, packaged or repackaged, imported, exported, stored, shipped or distributedin accordance with such laws.It is important to point out that in order to conduct any business activity that is subject to sanitarysurveillance, companies must first be granted an operating permit by the federal sanitary surveillanceauthority and obtain all authorizations with the local sanitary surveillance authorities. Once thecompany has all such permits and authorizations, then it is in good standing for sanitary purposes andapt to do business.It is worth noting some concepts, amongst others, which help us understand the subject:Permit: Granted exclusively by the competent department of the Ministry of Health (Ministérioda Saúde - MS) (federal sanitary authority) to authorize companies to carry out such businessactivities that are subject to sanitary surveillance, upon evidence of fulfillment of specifictechnical and administrative requirements.111

Authorization: Granted exclusively by the health department of the relevant state or localgovernment or the Federal District to authorize establishments carrying out any businessactivities subject to sanitary surveillance to operate.Certificate of Compliance with Good Manufacturing and Control Practices: A documentissued by the federal sanitary authority attesting that the establishment is in compliance withgood manufacturing and control practices.Company: A legal entity that, according to the prevailing trade laws, is engaged in a businessactivity or industrializes a product that is subject to sanitary laws.Establishment: the Company’s unit where the activity subject to sanitary surveillance iscarried out.Any operating permit issued will be valid nationwide and will be renewed on an annual basis.Authorizations, in turn, must be issued to each establishment separately (an independent, specificauthorization), even when there is more than one establishment for the same company at the samelocation.In terms of operation, whenever an establishment industrializes or markets different types of productsor products for different uses, then such establishment must use different premises to manufactureand store materials, substances and finished products.In relation to the requirements that must be met in order for an establishment to carry out the businessactivities subject to the above laws, if an establishment wishes to manufacture, industrialize or importproducts subject to sanitary laws, it must operate under the assistance and responsibility of a legallyqualified technician (technically responsible professional).This is why companies engaged in the business activities subject to sanitary surveillance are requiredto have and keep, in each establishment, a sufficient number of technically responsible professionalswith proper skills, so that all different types of productions are covered for every establishment.Besides the operation permit and the relevant authorizations, the company must check if it is requiredto register its products with the competent authority. None of the products covered by the above laws– not even imported products – can be industrialized, offered for sale or provided for consumptionwithout proper registration.In particular, drugs, medicine and pharmaceuticals coming from abroad must first be registered in theircountry of origin in order to be registered in Brazil. It is important to point out that if a drug is not112

composed of effectively beneficial substances – from a clinical or therapeutic point of view – it cannotbe registered in Brazil.Technical specifications and requirements for the registration of products under the sanitary laws varyaccording to the type of product (drugs, inputs, cosmetics, etc).Sanitary authorities will control any and all products subject to sanitary surveillance, including thosewhose registration is not mandatory and related products, as well as the establishments used inmanufacturing, distributing, storing and marketing such products and the vehicles used to transportthem. Such control also covers product and brand advertising – by any means of communication –promotion and labeling.22.3 - Brazilian Sanitary Surveillance Agency - ANVISAThe Brazilian Sanitary Surveillance Agency (Agência Nacional de Vigilância Sanitária – ANVISA) wascreated by Law 9,782 of 26 January 1999. The Law also established the Brazilian SanitarySurveillance System (Sistema Nacional de Vigilância Sanitária).ANVISA is a government agency governed by a special regime. ANVISA is an administratively andfinancially independent agency linked to the Ministry of Health, with financial autonomy. It isheadquartered in Brasília and was incorporated for an indefinite period of time and with nationwidereach. ANVISA is managed by a Collegiate Board of Directors (Diretoria Colegiada) composed of fivemembers and chaired by a Director-President (Diretor Presidente).It is the duty of ANVISA to protect and promote public health through the health control of theproduction and marketing of products and services that are subject to sanitary surveillance, includingthe environments, processes, inputs and technology related to such products and services, and alsothrough the control of ports, airports and borders.ANVISA’s duties include:(i)(ii)(iii)(iv)(v)(vi)(vii)To coordinate the Brazilian Sanitary Surveillance System;To manage and collect the sanitary surveillance fee;To permit the operation of companies engaged in the manufacture, distribution and import ofthe products referred to below and in the marketing of drugs;To register products according to the rules applicable to each business activity;To grant and cancel the certificate of good manufacturing practices;To monitor the evolution of prices of drugs and health services, equipment, component andinputs;To control, supervise and follow up on the advertising and promotion of products that aresubject to sanitary surveillance, from a sanitary law perspective.113

The role played by ANVISA is an important one, as ANVISA has the power to control and monitor theproducts and services that may pose risks to health.For the purposes of Law 9,782/99, goods and products subject to ANVISA’s health control andsanitary surveillance include:(i)(ii)(iii)(iv)(v)(vi)(vii)Human drugs, active ingredients of human drugs and other inputs, processes andtechnologies;Food products, including beverages, bottled waters and related inputs, packagingmaterials, food additives, organic contaminant levels, veterinary drugs and pesticidewaste;Cosmetics, personal care products and perfumes;Sanitizing products to be used in the clearing, disinfection or pest management in homes,hospitals and collective environments;Sets, reagents and inputs to be used in diagnosis;Medical, hospital, dental, hemotherapeutic and diagnostic imaging equipment andmaterials;Immunobiologicals and the related active ingredients, blood and blood products.Services subject to ANVISA’s health control and sanitary surveillance are any services related toemergency or routine ambulatory care, inpatient laboratory testing, therapy and diagnosis supportservices and services involving the use of new technology.Facilities, equipment, technology, environments and procedures involved in all stages of theproduction process of goods and services subject to health control and sanitary surveillance are alsosubject to ANVISA's control.But ANVISA’s scope of action is not limited to the products and services described above. ANVISAalso has the power to regulate other products and services with the purpose of controlling any risks tohuman health under the Brazilian Sanitary Surveillance System.Some of ANVISA’s primary duties are to grant companies operating permits (autorização defuncionamento de empresa - AFE) and register products (drugs/cosmetics/healthcare products).Registration of such products must be made exclusively by ANVISA, who is also responsible formaking any change in or revalidating, suspending or cancelling such registrations (art. 7, IX,paragraph 1 of Law 9,782/99).As a general rule, all such products must be registered. However, some exceptions are made.Products that are easy to be compounded in pharmacy laboratories, for example, are exempt fromregistration.114

Experimental drugs to be used under medical supervision are exempt from registration as well, aslong as all specific legal requirements are met. Such drugs may even be imported, if expresslyauthorized by the relevant agency.Drug registrations with ANVISA are valid for five (5) years and are subject to revalidation for equal,successive periods, in which case the original registration will be renewed.According to the prevailing laws, a holder of a drug registration must necessarily be a legal entityholding the registration of the product, i.e., the rights in such product. Such legal entity will beresponsible for the product until it reaches the end consumerFor a drug registration to be granted, an assessment of legal, administrative, technical and scientificcompliance must first be made in relation to the efficacy, safety and quality of such products beforethey enter – and are marketed and consumed in – the Brazilian market.Another important point is that ANVISA’s registrations and revalidations will only start producingeffects on the date they are published in the federal gazette (Diário Oficial da União – DOU).Requests for revalidation must be filed with ANVISA within the period of time determined in the law;otherwise, such requests will be considered null. In addition, industrialization of the product in the firstvalidity period must be proved.It is important to mention that in case trademarks or product names are transferred betweencompanies, the assignee is not automatically entitled to the assignor's registration. In this case, theassignor must cancel the registration with ANVISA and the assignee must apply for a new registration.Both the cancellation of the old registration and the granting of the new registration will be published inthe DOU at the same time.22.4 - Violations of sanitary lawsThis subject is generally regulated by Law 6,437 of 20 August 1977, which contains provisionsconcerning the violation of federal sanitary laws and the relevant penalties, among other things.Under such law, violations of sanitary laws are subject to the following penalties – in addition to anyapplicable civil or criminal penalties that may be imposed on an alternative or cumulative basis:- Warning;- Fine;- Seizure of products;- Product destruction;- Product ban;115

- Suspension of sales and/or manufacture of products;- Cancellation of product registration;- Prohibition to advertise;- Cancellation of the company’s operating permit.When imposing fines, ANVISA will take into account the violator's financial capacity. In case ofrecurrent violations, fines will be doubled.When deciding the amount of the fine, ANVISA will also take into account any aggravating andmitigating factors. Examples of aggravating factors are: - The violator has committed more than oneviolation - The violator forced a third party to commit the violation.Violations are classified as minor, serious or very serious. The penalty for violating sanitary laws willbe imposed on the person who gave rise to or who helped committing such violation.Examples of violations of sanitary laws include:- To omit to provide information, provide false information, provide information not in accordance withsanitary rules or rules that govern corporate transactions, in which case ANVISA has the power tocancel the registration of products involved in the transfer of title;- To advertise products subject to sanitary surveillance, food and other products in violation of sanitarylaws;- To modify the manufacturing process of products subject to sanitary surveillance, modify suchproducts’ basic components, name or any other registered element without ANVISA’s authorization.23. MINING23.1. Legal and regulatory frameworkUnder the Brazilian Federal Constitution, all Brazilian mineral resources belong to the federalgovernment. In addition, the Constitution provides that mineral resources are separate from the soil forexploration and exploitation purposes and grants concession holders ownership of the extractedminerals.The federal government has exclusive power to legislate on mineral resources and mineralexploitation and to enact federal laws regulating mining activities.116

Nevertheless, the federal government and the states (including the Federal District) have concurrentpower to legislate on environmental matters involving mining activities. Cities can complement theselaws according to local needs, when applicable.Under the Brazilian Constitution, exploration and production of government assets can only be carriedout by Brazilians or companies incorporated under the Brazilian law with head office and managementin Brazil. However, these companies can be controlled by a foreign individual or company – except incase of border areas, as explained below.Mining activities are regulated principally by Decree-law 227, published on 28 February 1967 with thestatus of law (“Mining Code”); Decree 62,934, published on 2 July 1968 to regulate the Mining Code;and further regulations issued by the National Department of Mineral Production (DepartamentoNacional de Produção Mineral – DNPM).23. 2. DNPM / MMEUnder the Mining Code, mineral rights are granted either by the Ministry of Minesand Energy (Ministério de Minas e Energia - MME) or by the General Director ofthe DNPM – a federal department linked to the MME – depending on the type ofrights granted.In addition, the DNPM is responsible for supervising all activities related to mining, marketing andindustrialization of mineral raw materials and also for regulating mining activities, subject to the limitsof the applicable laws and with a view to promote environmental conservation and sustainabledevelopment.23. 3. PriorityIn Brazil, mineral rights are granted under a priority regime.Under the priority system, once a party files a legal and valid application with the DNPM claiming anarea that is free for exploration and free from any burden, the claimed area is blocked in relation toother interested parties. This ensures the applicant exclusive access to the owned area, for thepurpose of exploiting resources or mineral ores 4 .According to the priority system, anyone interested may submit an application for research claiming anarea that is free for exploration and free from any burden, ensuring the applicant exclusive access tothe area for research and eventual mining deposit.23. 4. Systems4 Marcelo Gomes de Souza (coordinator), Direito Minerário Aplicado, Ed. Mandamentos, Belo Horizonte - 2003117

The Mining Code provides for different mineral exploitation systems, namely: (i) Concession System,applicable in the cases where a concession issued by the Ministry of Mines and Energy is required; (ii)Authorization System, applicable in the cases where an authorization issued by the General Directorof the DNPM is required; (iii) Licensing System, applicable in the cases where a license issued by alocal administrative office and registered with the DNPM is required; (iv) Small-Scale MiningPermission System, applicable in the cases where a permit issued by the DNPM is required; and (v)Monopolization Regime, applicable in the cases where federal government intervention is required byvirtue of a special law.23. 5. Exploration PermitExploration activities (including but not limited to geological surveys, sample collection, physical andchemical analyses, etc.) can be carried out by Brazilian individuals or companies with head office andmanagement in Brazil upon the authorization of DNPM's General Director.The application for an exploration permit must be accompanied by, among other documents, adescription of the relevant area, a designation of the mineral substance intended to be explored and awork plan.If the DNPM verifies that the area is free – according to the priority system stated above – it will issuean Exploration Permit for a maximum period of 3 years, with the possibility of extension for the sameperiod.The mining company must pay DNPM a fee for each requested permit, in addition to the so-calledAnnual Fee per Hectare (Taxa Anual por Hectare - TAH), calculated according to the size of theexplored area.During the period of validity of Exploration Permit, the mining company must submit to the DNPM adetailed research report containing all studies, quantities and quality of the explored minerals andevidence of the technical and economic feasibility of mining the deposit ("Final Exploration Report").23. 6. Mining ConcessionAfter obtaining DNPM's approval of the Final Exploration Report, the mining company must submit theapplication for a Mining Concession to the MME along with the Economic Development Plan, within 1year after approval of the Final Exploration Report.Mining Concessions can be rejected if the federal government finds that it is contrary to public interest.In this case, the mining company is entitled to compensation for the costs incurred during theexploration stage.If a Mining Concession is granted, it will be valid until the mineral deposit is exhausted. The miningcompany will have the ownership of the extracted minerals, as long as it fulfills the duties and118

obligations set forth in the Mining Code.In addition, holders of mining rights are required to pay landowners a monthly share in the miningresults due to the occupation of the area, and a compensation for any damages caused by the mineralexploration and/or extraction activities. The obligation to pay for the land occupancy and tocompensate landowners for any damages caused exist in the exploration stage as well.It is worth noting that the mining company must obtain all environmental permits needed in order tocarry out mineral exploration activities.23. 7. Small-Scale Mining PermitThe Small-Scale Mining Permission System is applicable whenever a mineral deposit is – due to itsnature, size and location – capable of being exploited immediately (without prior exploration). In thiscase, requirements set by the DNPM, in charge of issuing the respective permit, must be met.Small-Scale Mining Permits are issued for up to 5 years, subject to extension at DNPM's discretion.Both Brazilian individuals and small-scale mining cooperatives are entitled to apply for small-scalemining permits.23. 8. Border Areas / Indigenous Peoples' LandBorder Areas are areas within the national territory that border other countries. They can be up to 150km wide. Therefore, they are essential for national security, and their occupation and use areregulated by law.The prospection, extraction, exploration and exploitation of mineral resources on border areas requirethe prior authorization of the National Defense Council.Only Brazilian individuals or companies controlled by Brazilians with management in Brazil andpredominantly Brazilian staff can be authorized to carry out activities on border areas.Mining activities on indigenous peoples' land require express authorization of the National Congress,pursuant to the Brazilian Constitution. However, the exploration and exploitation of mineral resourceson indigenous peoples' land are not yet regulated.23. 9. New Regulatory FrameworkThe currently discussed proposal for a new regulatory framework is a result of comprehensive studieson regulation in Brazil and other countries, feedback from entities from the mining industry and acontinuous search for new investments with a view to stimulate the industry's development. 5Among the proposed changes is the creation of the National Council for Mining Policy (Conselho5 www.mme.gov.br119

Nacional de Política Mineral) to advise the President on the creation and implementation of a miningpolicy. In addition, regulation and supervision activities, which are currently carried out by the DNPM,will be transferred to a Regulatory Agency.The new regulatory framework is expected to introduce bidding procedures for the acquisition ofmining rights through the public offering of areas. The bidding procedures will replace the current“availability of areas" procedure. In addition, the new regulatory framework will create special miningareas considered strategic for the country.Another innovation is the setting of a period of 30 years – with the possibility of extension forsuccessive periods of 15 years – for extraction as well as the extension of the exploration permit to 6years.Finally, the new regulatory framework is expected to establish a minimum investment in the areasubject to exploration. Also under discussion is the creation of a special participation – similar to theone due in the oil and gas industry – payable to the cities in case of highly productive mineraldeposits.The mining regulatory framework is still being analyzed by the National Congress.23. 10. OpportunitiesBrazil has some of the world's largest mineral deposits and exports high quality mineral resources.Therefore, the Brazilian mineral production occupies a privileged position in relation to the rest of theworld in regard to many types of minerals.In the last few years, the Brazilian mining industry experienced significant growth due to major social,economic and infrastructure changes in the country. As a result of the urbanization process andincreasing strength of global economies, the Brazilian mineral production is expected to continuegrowing from 2% to 5% during the next 2 years. 6Moreover, the Brazilian Mining Association (Instituto Brasileiro de Mineração - IBRAM) expectssignificant investments in the mining sector in the next 5 years. From 2012 to 2016, investments ofapproximately US$ 75 billion are expected, which would be a new record in the mining industry. 7Even though Brazil's mining potential is high, it is still under-explored. According to IBRAM, less than30% of the Brazilian territory has been subject to geological surveys on an adequate scale for thisactivity. Therefore, a lot of opportunities are open for mining companies interested in investing in thissector. 86 www.ibram.org.br7 www.ibram.org.br8 www.ibram.org.br120

A good opportunity for the exploration of uranium may arise in Brazil in the next few years with theGovernment relaxing its monopoly for the research, mining, enrichment, reprocessing, industrializationand trade of this mineral.If approved the the National Congress, the relaxation of the uranium monopoly will generateopportunity for private investments, which can make Brazil become a global player in producing andtrading uranium.24. OIL & GAS24.1. The MonopolyLaw 2,004/1953 created a monopoly in the oil industry by providing that no activities related to the oilsector could be carried out other than by the federal government or state-owned companies. Thegranting of concessions or permissions to private companies was not allowed. This law also providedthat the National Oil Council (Conselho Nacional de Petróleo - CNP), created in 1938, would beresponsible for directing and supervising oil and gas exploration and production activities, and that themonopoly over oil activities would be exercised by a company created specifically for this purpose –Petróleo Brasileiro S.A (Petrobras), a government-controlled company.Years later, with the 1973 and 1979 oil crises, Petrobras was allowed to sign "risk contracts" – serviceagreements containing a risk clause – with foreign companies. This was an effort to reduce Brazil'sdependence on foreign oil and maintain a regular supply of fuel in the domestic market.24.2. Relaxation of the Monopoly and the Petroleum ActIn 1995, Constitutional Amendment 09/95 "relaxed" the federal government's monopoly, allowingoil and natural gas activities to be carried out not only by state-owned but also by privately-heldcompanies incorporated under Brazilian laws, with head office and management in Brazil, underagreements with the federal government. This opened the way for investments by Brazilian andforeign private companies.To regulate this "relaxation", a law known as the "Petroleum Act" (Law 9,478/1997) was enacted.It ratified the federal government's ownership of oil and natural gas reserves and regulated thenew concession regime introduced in Brazil. In fact, the Petroleum Act regulated Brazil's energypolicy, among other things, and established the legal framework that governs concessions toexplore, develop and produce oil and natural gas under public tenders and the legal frameworkthat governs authorizations to refine, process, transport, import and export oil, oil products andnatural gas.121

The Petroleum Act also introduced the National Council for Energy Policy (Conselho Nacional dePolítica Energética) and the National Agency of Petroleum, Natural Gas and Biofuels (AgênciaNacional do Petróleo, Gás Natural e Biocombustível).24.3. The National Council for Energy Policy (Conselho Nacional de Política Energética -"CNPE")The CNPE is an advisory entity linked to the Presidency and presided by the Ministry of Minesand Energy (Ministério de Minas e Energia – MME). It is responsible for proposing to thePresident national policies and specific measures designed especially to encourage the rationaluse of Brazil's energy resources.The CNPE also has the power to lay down rules for the import and export of oil, natural gas andgas condensate and for the use and conservation of energy and natural resources and review ofBrazil's energy matrix.24.4 The Natural Agency of Petroleum, Natural Gas and Biofuels (Agência Nacional doPetróleo, Gás Natural e Biocombustíveis - ANP)The ANP is a federal government agency directly linked to the MME and in charge of regulatingthe oil industry. Its head office and jurisdiction are in the Federal District, but its central office isin Rio de Janeiro.As Brazil's oil industry regulator, ANP is in charge of regulating, engaging and supervising theeconomic activities involved in the oil, natural gas and biofuel industries based on the guidelinesissued by CNPE, on public interest and on the country's needs.Although it was created under the Petroleum Act, the ANP was actually implemented by Decree2,455/1998, which provides details on its structure and operation.24.5. The Concession Regime for the Exploration and Production of Oil and Natural GasToday, the exploration and production of oil and natural gas is done under concession contracts,always preceded by a bidding process. The blocks offered in the bidding rounds are selected bythe ANP and subject to the CNPE's approval. Any company that meets the technical, financialand legal requirements set out in the applicable laws may qualify to participate in the bid and tosubmit proposals for the concession of exploration blocks.Both Brazilian and foreign companies may qualify for the bid and submit their proposalsindividually or as a consortium. However, the concession contracts can only be signed bycompanies organized and existing according to the Brazilian law, with head office and122

management in Brazil. Therefore, if the qualified bidder is a foreign company, it must incorporatea Brazilian company in accordance with the applicable laws.In Brazil, the criteria used to determine the winning bidders in the Bidding Rounds conducted byANP are: (i) local content (concessionaire's commitment to purchase goods and services fromlocal suppliers); (ii) the minimum exploration program (investments in geology and geophysicalsurvey and drilling); and (iii) the signature bonus (minimum amount, set out in the tender notice,payable upon execution of the concession contract).When a concession is granted, the concessionaire must conduct exploration activities at its ownrisk and expense and, if successful, produce oil or natural gas in a certain block/field. Under aconcession agreement, the federal government grants the concessionaire the exclusive right tocontrol the entire process – from exploration to sales – within a fixed area and for a certain periodof time (usually 20 to 30 years). As a result, the concessionaire will have the ownership of the oilonce it passes through the measuring point, and will pay the respective government's takes.The last Bidding Rounds of Blocks for Exploration and Production of Oil and Natural Gas underconcession contracts were conducted by the ANP in May and November of 2013, the 11 th andthe 12 th Bidding Rounds, respectively. The 11 th Bidding Round offered 289 blocks (123 onshoreand 166 offshore), stretching over an area of 155.8 thousand km² and located in 11 sedimentarybasins, both mature and on new frontier areas, namely: Barreirinhas, Ceará, Espírito Santo, Fozdo Amazonas, Pará-Maranhão, Parnaíba, Pernambuco-Paraíba, Potiguar, Recôncavo, Sergipe-Alagoas and Tucano Sul. 71 companies expressed interest in this bidding round, 64 of whichwere enabled to participate in it and 30 were successful – 12 Brazilian and 18 foreign ones. Theyacquired 142 blocks in 22 sectors of the 11 sedimentary basins offered, totaling 100,372 km².The 12 th Bidding Round, in its turn, offered 240 onshore exploration blocks with potential forexploration of natural gas. 110 of these blocks are located in new frontier areas in the basins ofAcre, Parecis, São Francisco, Paraná and Parnaíba. 130 are located in the mature basins ofRecôncavo and Sergipe-Alagoas. 26 companies expressed interest in this bidding round, 21were enabled to participate in it and 12 were successful – 8 Brazilian and 4 foreign ones. Theyacquired 72 blocks, totaling 47,427.60 km².24.6. Government and Third Parties' TakesGovernment and third parties' takes include (i) a signature bonus; (ii) royalties; (iii) a specialparticipation; (iv) payment for area occupation and retention; and (v) payment to landowners.Royalties are a financial compensation payable by concessionaires per field, on a monthly basis,according to the amount of production. They range from 5% to 10%.123

Special participation is a special financial compensation payable by concessionaires only in caseof substantial production volumes or high profitability. It is payable per field of a given concessionarea as from the quarter on which the respective production begins.The payment for area occupation and retention is due on an annual basis. It is specified in theconcession contract and assessed per square kilometer of the block.Finally, if the awarded exploration block is located onshore, a payment must be made to thelandowners at a rate that may vary from 0.5% to 1% of the oil and natural gas production, atANP's discretion.24.7. New regulatory framework: The Pre-SaltRecently, Law 12,351/2010 (“Pre-Salt Act”) introduced a new regulatory framework for theexploration and production of oil, natural gas and other fluid hydrocarbons located in the pre-saltlayer and other areas designated as strategic. These areas are subject to a production sharingregime. The Pre-Salt Act assigned new duties to the ANP, MME and CNPE under this newregime. It also created a social fund to invest the federal government's revenues from the pre-saltfields.Two other laws further regulate the sector. Law 12,304/2010, which authorized the creation ofPré-Sal Petróleo S.A. (PPSA) and defined the roles of the state-owned company that will act onbehalf of the government to manage the production sharing agreements between the Ministry ofMines and Energy and oil companies and the contracts of sale of oil and natural gas from thepre-salt areas.Law 12,276/2010, in turn, authorized the onerous assignment by the federal government toPetrobras of the right to carry out oil exploration and extraction activities in pre-salt areas with upto 5 billion barrels of oil equivalent, in return for the government's right to buy additional shares inPetrobras.24.8. Pré-Sal Petróleo S.A. (PPSA)Decree 8,063 of August 1 st , 2013, created Empresa Brasileira de Administração de Petróleo eGás Natural S.A. (Pré-Sal Petróleo S.A. or PPSA, for its acronym in Portuguese), a state-ownedcompany in the form of a closed corporation (sociedade anônima de capital fechado) linked tothe Ministry of Mines and Energy.124

The purpose of PPSA is to manage the production sharing agreements executed by the Ministryof Mines and Energy and the contracts of sale of oil, natural gas and other hydrocarbon fluidsbelonging to the federal government, with the aim of maximizing the economic result of suchcontracts.According to the articles of incorporation of PPSA, as approved by Decree 8,063, thecorporation’s capital is 50 million reais, divided into fifty thousand registered common shareswithout par value, fully owned by the federal government.PPSA is managed by a Board of Directors, with decision-making functions, and by an ExecutiveBoard. The Executive Board is the collective body responsible for the general direction of thecorporation and is comprised of four officers appointed by the President of Brazil, uponrecommendation of the Minister of Mines and Energy. The officers are appointed for a three-yearterm. Reappointment is allowed.The Board of Directors is comprised of five members appointed by the President of Brazil for afour-year term. Reappointment is allowed.24.9. The Production Sharing RegimeOne of the main features of production sharing agreements (PSA) is the fact that the ownershipof the extracted mineral resources is retained by the government, whereas under the concessionregime, the ownership of the extracted minerals is held by the concessionaire.Under the production sharing regime, the oil company carries out exploration, appraisal,development and production activities in a certain block/field at its own risk and expense, inaddition to performing technical obligations, paying for the costs and allocating the investmentsand resources required for the activity.Therefore, in case of commercial discovery, the oil company is entitled to a share of theproduction as compensation for the investments and other costs incurred in connection with theoil production – the so-called "cost oil". The exceeding amount of the oil and/or natural gasproduction (i.e. after deduction of the "cost oil" and any amount of oil used in the operation itself)is shared with the federal government according to the provisions of the production sharingagreement (the so-called "profit oil").Under the production sharing regime, Petrobras acts as the sole operator of the blocks with aminimum 30% equity interest. Other companies are allowed to participate as non-operators.125

On September 3, 2013, in a special edition of the federal gazette, the ANP published the tendernotice and the draft production sharing agreement of the 1 st Pre-Salt Round, both approved bythe Ministry of Mines and Energy.The 1 st Production Sharing Bidding Round was held on October 21, 2013, offering the block ofLibra, located in Santos Basin. The contract was signed on December 2, 2013, by the winningbidder, a consortium formed by the following companies: Petrobras (10%), Shell (20%), Total(20%), CNPC (10%) e CNOOC (10%). The winning bidder offered 41.65% of the profit oil to thefederal government. Petrobrás, which will operate Libra, has a 10% stake in the consortium andalso a minimum stake of 30% in the block of Libra.24.10. The Gas ActUnder the Petroleum Act, activities related to the gas industry – except local distribution – weresubject to an authorization regime which allowed any interested company to request the right tobuild and explore infrastructure needed for the activity. From a regulatory point of view, ANP'srole was only to control the entrance of new players in the market.As the use of natural gas gained importance for electricity generation and the ways to use gasincreased, a specific regulatory framework for gas became necessary. As a result, in 2009, Law11,909/2009 (“Gas Act”), regulated by Decree 7,382/2010, established the new legal frameworkfor the natural gas industry.The Gas Act introduced rules governing the exploration of economic activities of transportation ofnatural gas through pipelines and the import and export of natural gas as referred to in art. 177,III and IV, of the Federal Constitution, and the exploration of the activities of treatment,processing, storage, liquefaction, regasification and marketing of natural gas. However, it mustbe noted that the exploration and production of natural gas are still regulated by the PetroleumAct.24. 11. Local Distribution of GasPursuant to article 25, paragraph 2, of the Federal Constitution, the states have the exclusivepower to explore local services of piped gas, whether directly or under concession. Therefore, itis up to each state to pass and implement a state law providing for the terms and conditions ofthis activity.126

24.12. OpportunitiesThe 1 st Bidding Round for the Transportation of Natural Gas.The Gas Act introduced a new regime for the concession of the natural gas transportationactivity, which must be preceded by a bidding process. The authorization regime must be usedonly in specific and exceptional circumstances.Thus, on September 13, 2013, the Ministry of Mines and Energy published Ordinance 317 in thefederal gazette. This ordinance provides for the construction of a gas pipeline from Itaboraí toGuaipimirim, both in the State of Rio de Janeiro. On December 13, Ordinance 450 waspublished, establishing the guidelines for the bidding of this pipeline.The bidding process for the concession of the activity of natural gas transportation will becoordinated by ANP’s Bidding Promotion Superintendency (Superintendência de Promoção deLicitações - SPL), while ANP′s Natural Gas Movement and Commercialization Superintendency(Superintendência de Comercialização e Movimentação de Gás Natural - SCM) will coordinatethe public call to hire the capacity.The Ministry of Mines and Energy released, on January 13, 2014, the preliminary version ofthe Ten-Year Plan for the Expansion of the Gas Pipeline Transportation Network (local acronymPEMAT), 2013-2022 cycle, for public consultation. The PEMAT is a result of studies carried outby the Energy Research Company (Empresa de Pesquisa Energética - EPE), based on theexpected demand for natural gas, on the forecasts for production and supply and on the existinginfrastructure conditions to meet the future demand in a 10-year period. The PEMAT alsopresents proposals for designs, compression systems, and the location of city gates, as well asan estimate of the investments in the pipelines.127

About L.O. Baptista, Schmidt, Valois, Miranda, Ferreira, AgelSince 1938, L. O. Baptista, Schmidt, Valois, Miranda, Ferreira, Agel has been acting in the main areasof Business Law, always based on values that became the firm’s brand: technical excellence withstrategic view, pragmatism, agility and commitment to the clients, who acknowledge the firm for beingcreative in approaching the legal issues and establishing lasting ties with those it works for.The quality of services offered by L. O. Baptista, Schmidt, Valois, Miranda, Ferreira, Agel is attestednot only by its clients, but also by major Brazilian and foreign publications, among which stand outChambers and Partners, Latin Lawyer 250, Who's Who Legal, Expert Guides (Euromoney), BestLawyers and Anuário Análise Advocacia 500.We have a team of more than 100 lawyers focused on the objectives and businesses of each client.Our professionals are specialized in the most diverse areas of law and economy, many of which alsoact as teachers, arbitrators or leaders of the most reputable domestic and international institutions intheir respective areas.Our clients in the private sector include large Brazilian and foreign companies of different segments,such as biofuels, energy, construction and infrastructure, banking, pharmaceutical, agriculture,petrochemical, media and electronics. In the public sphere, we serve government agencies such asthe Ministry of Foreign Affairs, as well as oil and gas companies with business in the country.São PauloAvenida Paulista, 12948th floorTel: + 55 11 3147 0800Rio de JaneiroRua da Assembleia, 6617th floorTel: +55 21 2114 1700www.lob-svmfa.com.brThis guide consists in a general review of legal issues and should not be considered as a legal opinion or legal advice.128

DOING BUSINESS INATLANTIC CANADA

EMBRACING EAST COASTPOTENTIALWelcome to the newest edition of Doing Business inAtlantic Canada. As a leading law firm with locationsthroughout Atlantic Canada, we have strong rootswithin this community and are proud to share our insightsinto its unique legal and economic landscape.It is an exciting and challenging time for Atlantic Canada. Irving Shipyard, based in Halifax,Nova Scotia, was awarded a $25 billion government contract to build new naval vessels. Utilitycompanies in Newfoundland and Labrador and Nova Scotia are investing in a multi-billion dollarproject to develop hydro-electric capacity, the Lower Churchill project, and an underwater link toship that electricity to markets all along the eastern seaboard. Newfoundland and Labrador andNova Scotia are reaping the benefits of a growing offshore oil and gas industry, while PrinceEdward Island and New Brunswick entrepreneurs in the technology, biotech, aerospace anddefence sectors continue to demonstrate the strength of our region’s start-up community.We face some interesting new challenges as well. A report released in early 2014 by the IvanyCommission, called Now or Never: An Urgent Call to Action for Nova Scotians brought aspotlight to these challenges – ones we believe all of Atlantic Canada shares. They includeimmigration (specifically, attracting new entrepreneurs to our provinces), developing a strongerexport culture, and diversifying beyond a traditional dependence on natural resources. Thanksto this report, these issues have re-emerged as priorities for both the public and private sectors.At Stewart McKelvey, our single objective is the best results for our clients. We have thecapacity, experience and size to assist, whether local clients aspire to expand in national andinternational markets, or national and international clients wish to explore Atlantic Canadianexpansion. More on our firm and our team is provided on the next page and see our website formore details, www.stewartmckelvey.com.We welcome your interest in Atlantic Canada. Should you wish to learn more, I am pleased toanswer your questions or put you in contact with our team.John Rogers, QCCEO, Stewart McKelveyjrogers@stewartmckelvey.comWelcome Message

Updated Oct 10, 201456

TABLE OF CONTENTSCHAPTER 1: INTRODUCING STEWART MCKELVEY ........................................................................ 1CHAPTER 2: FORMS OF BUSINESS ORGANIZATIONS ................................................................. 12CHAPTER 3: REGULATION OF FOREIGN INVESTMENT ............................................................... 21CHAPTER 4: BUSINESS TRAVEL TO CANADA, WORK PERMITS AND IMMIGRATION LAW ..... 26CHAPTER 5: TRADE AND BUSINESS CONDUCT REGULATION ................................................... 38CHAPTER 6: TAXATION LAW ............................................................................................................ 55CHAPTER 7: REAL ESTATE LAW ..................................................................................................... 64CHAPTER 8: SECURITIES LAW ........................................................................................................ 71CHAPTER 9: INTELLECTUAL PROPERTY ....................................................................................... 76CHAPYER 10: PRIVACY LAW ............................................................................................................ 83CHAPTER 11: EMPLOYMENT AND LABOUR LAW .......................................................................... 90CHAPTER 12: ENVIRONMENTAL LAW ........................................................................................... 107CHAPTER 13: COMMERCIAL REORGANIZATION AND INSOLVENCY LAW .............................. 123CHAPTER 14: ENFORCEMENT OF CREDITORS’ RIGHTS ........................................................... 131CHAPTER 15: MUNICIPAL LAW ...................................................................................................... 140CHAPTER 16: ABORIGINAL LAW .................................................................................................... 144CHAPTER 17: BIG LAND .................................................................................................................. 160APPENDIX: BUSINESS INCENTIVES .............................................................................................. 163Table of Contents

Chapter 1IntroducingStewart McKelvey

INTRODUCING STEWART MCKELVEYAt Stewart McKelvey, our single objective isto achieve “the best results for ourclients”.Since the last edition of Doing Business InAtlantic Canada prepared in 2009, thiscommitment to our clients has manifesteditself in many ways. Some of our workincludes acting as lead counsel for a largegrocery chain that recently cemented itsposition as the second largest groceryretailer in Canada; we helped to openinternational markets for a large aquaculturecompany that now distributes productsthroughout the world; and we advised alocal production company that has growninto a leading distributor and producer ofchildren’s entertainment.Since our 2009 edition, we recognize ourclients’ definition of the best result has alsoevolved. It means much more than asuccessful business outcome and hasgrown to encompass a new definition ofvalue.Value may also be seen in our commitmentto the communities in which we live andwork. Through sponsorships, donations ordirect staff and lawyer participation, we givegenerously to local events and charities thathelp to improve the quality of life andstrength of our communities. We fosterdiversity amongst our staff and we haveinitiated many green initiatives designed toreduce our environmental footprint.Our Doing Business In Atlantic Canadapublication is another way we add value andwe are pleased to share our insights intothis region.Within this publication, we are pleased toprovide you with specific detail with regardsto areas of practice, greater detail onbusiness and tax incentives designed toattract you to this region and some basicfacts about our communities and theeconomic outlook for the region.We knew we must invest in leading edgetechnologies and learn more about legalprocesses which foster efficiency, improveclients’ access to information and increaseresponsiveness. Therefore, we focused ourattention on client-facing tools that supportimproved service and greater value.Members of our team are recognized asleaders in the development of eDiscoveryprotocols, and are certified in Legal ProjectManagement. Where appropriate we applythis training and technology to deliver on ourcommitment of cost efficiency and thehighest quality of service.Introduction 1

CONNECT WITH US TO STAY CURRENTVisit www.stewartmckelvey.comKeep current with anRSS feed for our blogs,news or regular clientupdatesFollow@SM_Law, especially if youwould like to learn more aboutour CSR activities and firmcultureFollow ourLinkedIn Company Page formore news and client updatesfrom the firmIntroduction 2

WELCOME TO ATLANTIC CANADAQuick FactsATLANTIC CANADACanada, the world’s secondlargest country, occupies theupper portion of the NorthAmerican continent. Itsboundaries stretch from thePacific Ocean in the west tothe Atlantic Ocean in theeast, to the Arctic Ocean inthe north and to the UnitedStates in the south.Canada has a federation of10 provinces and threeterritories.It has a population ofapproximately 33 millionpeople.Canada has two officiallanguages, English andFrench, meaning that theyhave equal status in allfederal institutions and arethe languages used officiallyby the federal government.Canada’s four most easterly provinces form the region known as Atlantic Canada and has apopulation of approximately 2.3 million people. These provinces are (from west to east):New BrunswickPrince Edward IslandNova ScotiaNewfoundland and LabradorIntroduction 3

NEW BRUNSWICKQuick FactsNatural resources are an important part of the provincialeconomy. About 80% of the province is forested. Combinedwith fishing, agriculture and mining, these traditional naturalresource based industries have long been the cornerstone ofthe provincial economy.New Brunswick’s dependence on these traditional resources isevolving. The province is rich in natural gas deposits and itsproximity to markets in Quebec and the United States has helped to foster a growing naturalgas industry. A proposed east-west pipeline, a project that promises to ship oil from Calgary toNew Brunswick, would further bolster this province’s strong natural resources sector. Many ofthe lead manufacturing industries are derived from the production of these resources andinclude food processing, pulp and paper, sawmills, oil refining and metal processing.What is relatively new to the province is its strong start-up and entrepreneurial community. TheInformation and Communications Technologies sector contributes just under $900 million to theprovincial GDP. Success stories such as Radian6’s sale to tech giant Salesforce have helped toinspire further growth and investment, by both the government and angel investors from aroundthe world. The province continues to invest heavily in R&D, and in partnership with itsuniversities, has also helped to support a strong bio-med sector which benefits from thisgrowing start-up community.Population: 747,000 people.In the Atlantic Time Zoneand observes DaylightSaving Time.Bounded by Quebec to thenorth west, Nova Scotia tothe east and the state ofMaine to the south west.More than 5,500 km ofcoastline stretching betweenthe Gulf of St. Lawrence andthe Bay of Fundy, making upmore than 87% of the totalNew Brunswick boundary.The only province whereboth English and French areofficial languages, meaningthat all provincialgovernment services arerequired to be madeavailable to the public in bothlanguages.Introduction 4

PRINCE EDWARD ISLANDQuick FactsThe smallest province ofCanada, but with apopulation of 140,000 peopleit has the highest populationdensity of any Canadianprovince.Lies in the Gulf of St.Lawrence and is surroundedby the other three AtlanticProvinces and the provinceof Quebec.The Confederation Bridgestretches 13 km across theNorthumberland Strait,connecting Prince EdwardIsland to New Brunswick.No place in the province ismore than 16 km from thesea.Prince Edward Island is inthe Atlantic Time Zone andobserves Daylight SavingTime.The province is known as the “Garden of the Gulf” as 90% of the land is arable. It is a low levelisland and has red sandy clay which is excellent for agriculture. It is no surprise that theprovince is best known for its potatoes and that agriculture accounts for much of the provincialeconomy.The service industry, including a large tourism industry, is pivotal to the Island’s economy. Butlike many, the Island is looking for ways to diversify and government investment in the millionsof dollars has helped local companies in the aerospace and defence, information technologyand communications sectors.Introduction 5

NOVA SCOTIAQuick FactsIt has a population of938,000 people.Is almost completelysurrounded by the AtlanticOcean.It is comprised of a mainlandpeninsula and the island ofCape Breton.Its capital, Halifax, boaststhe world's second largestnatural ice-free harbour.In the Atlantic Time Zoneand observes DaylightSaving Time.In 2011, Irving Shipyard in Halifax, Nova Scotia won the $25 billion government contract to buildsupply and naval vessels, supporting the growth of a shipbuilding centre of excellence in thisregion. BP and Shell are involved in multi-million dollar offshore oil and gas exploration projectsoff the coast of the province and the hope for a new LNG shipment facility helps round outhealthy projections for the province’s future.In addition to a healthy natural resources based economy, which includes fisheries, forestry andmining, the province has gained a reputation for its financial sector. Approximately 3,300financial and insurance companies were operating in Nova Scotia in 2011.Finally, the province has also fostered a healthy start-up community, partially building on therobust university sector and with significant investment in big data analytics centres and mediaand gaming industries. The sector now accounts for 34% of all private sector R&D spending andemploys more than 21,000 people.Introduction 6

NEWFOUNDLAND & LABRADORQuick Facts It consists of the island ofNewfoundland and themainland of Labrador. It is the most easterly provincein Canada, where you can findthe most easterly point in NorthAmerica. The population is 508,000people, mostly concentrated onthe Avalon Peninsula where thecapital city of St. John’s islocated. It is in the unique position ofhaving two time zones.Labrador is in the Atlantic TimeZone, which is one hour aheadof the Eastern Time Zone.Newfoundland has its own timezone, which is one-half hourahead of the Atlantic TimeZone. So if it is 1 p.m. inToronto it will be 2 p.m. inLabrador and 2:30 p.m. inNewfoundland. BothNewfoundland and Labradorobserve Daylight Saving Time.Newfoundland and Labrador’s economy is currently one of the fastest growing in Canada. Oiland gas is leading this growth including well established projects at Hibernia, Terra Nova andWhite Rose, and new discoveries off the Flemish Pass Basin. The development of a multi-billiondollar hydro-electric project, the Lower Churchill project, further enhances the province’s strongposition in the energy markets.Labrador’s mineral development, particularly in iron ore, is also expected to rise. This remotearea of the country is rich in mineral deposits and large mining companies from around theworld have invested in its potential.The City of St. John’s, its capital, is also investing in its ocean technology. With 15 research andeducational institutions in the surrounding area, the City aims to attract over $1 billion in privatesector revenue by 2015. Private sector investment in R&D in this region is particularly strong,including the development of its manufacturing, oceans, technology and biotech sectors.Introduction 7

ECONOMIC EQUATION OFTHE ATLANTICADVANTAGEAtlantic Canada offers one of the mostcompetitive business cost environmentsamong the G7 countries.We have one of the lowest annual facilitycosts in Canada. (see chart)We boast a highly competitive taxenvironment. (see chart)To encourage innovation, our region hassome of the most favourable tax rates forR&D spending.R&D is growing faster in Atlantic Canadathan the rest of Canada.We benefit from low utility, insurance andlabour costs.We offer easy access to North Americanand European markets, thanks to aconvenient location, very strongtransportation infrastructure and anadvanced telecommunications network.What does this mean?When you add these up, it equals theAtlantic Advantage – a lower cost of doingbusiness. These are direct, material savings which can be reinvested back into growth anddevelopment, benefit shareholders and help you gain a competitive advantage.Introduction 8

WORKFORCEAtlantic Canada has one of the world’s best labour markets, with a skilled workforce of 1.2million people and among the lowest rates of turnover and absenteeism in North America.Atlantic Canada has more post secondary institutions per capita than anywhere else in Canada.As well, more than 200 different training programs are offered through Atlantic Canada’scommunity college network. The result is a highly skilled and educated workforce, aconsiderable portion of which is bilingual in English and French.QUALITY OF LIFEThe cost of living in Atlantic Canada is 25 to 65% lower than that of other major North Americanregions. It has the best Housing Affordability Index in Canada, and property taxes are 30%lower than the Canadian and United States average.Canadian residents enjoy lower direct health care costs as a result of the publicly funded healthinsurance system, which covers a wide range of health, hospital and physician services. Theexistence of this system provides employers with a competitive cost advantage over thosehaving to provide direct funding of private employee health insurance programs.Atlantic Canada is also a very safe environment in which to live and do business, with lowerrates of crime than most other industrialized nations. It offers safe, friendly, family-orientedcommunities, with an abundance of excellent schools, universities and colleges within theregion.INCENTIVESMany of the incentives available in Atlantic Canada take the form of forgivable loans, interestfreerepayable loans, equity participation, or combinations thereof. Training-related incentives,such as in the form of subsidized wages, are also commonly offered in the region.For a detailed survey of available incentive programs in Atlantic Canada, please see theAppendix: Business Incentives.Introduction 9

THE CANADIAN POLITICAL ANDJUDICIAL SYSTEMSCanada has a parliamentary system of democratic government. A formerdominion of Great Britain, Canada is a constitutional monarchy, its head ofstate being the Queen of Canada, Queen Elizabeth II, who is also Queen ofBritain, Australia, New Zealand and a number of other Commonwealthnations.Under the Constitution Act, 1867, powers and responsibilities are divided between the federalgovernment and the 10 provincial governments, with the federal government retainingjurisdiction over the three territories. The federal list of powers under the Constitution generallyrelates to national matters, such as the regulation of trade and commerce, criminal law andprocedure, direct and indirect taxation, banking, currency, defence, navigation and shipping,patents and copyrights. The provincial list of powers is generally concerned with local matters,such as municipal institutions, local works and undertakings, education, direct taxation, theadministration of justice, property and civil rights, and matters of a merely local and privatenature in the province (including internal trade issues). The Constitution also provides forconcurrent federal and provincial jurisdiction in a number of areas, including health, theenvironment, agriculture and immigration.An important element of the Constitution is the Canadian Charter of Rights and Freedoms,which was adopted in 1982. The Charter guarantees a series of rights and freedoms, subjectonly to such reasonable limits prescribed by law as can be demonstrably justified in a free anddemocratic society. Among the rights and freedoms contained in the Charter are:Fundamental freedoms, including freedom of conscience and religion; freedom ofthought, belief, opinion and expression, including freedom of the press and other mediaof communication; freedom of peaceful assembly; and, freedom of association;Democratic rights, such as the right of citizens to vote in elections for members of theHouse of Commons and legislative assemblies;Mobility rights, including the right to live and to seek employment anywhere in Canada;Equality rights;Legal rights, such as the right to be secure against unreasonable search or seizure;Language rights, such as the right to use either of Canada's official languages and theright of French and English linguistic minorities to an education in their language; andProtections for aboriginal peoples' pre-existing rights.Introduction 10

The Charter is particularly significant because unlike earlier Canadian human rights legislation,it is entrenched in the Constitution, which is the supreme law of Canada. Laws that are notconsistent with the Constitution (including the Charter) may be found to be invalid.Canada’s system of government has three branches: legislative, executive and judicial. At thefederal level, the legislative branch is represented by the Parliament, which consists of theHouse of Commons and the Senate. Members of the House of Commons are elected by direct,popular vote to serve for terms of up to five years. Members of the Senate are appointed by theGovernor General (the Queen’s representative in Canada), with the advice of the Prime Ministerand serve until reaching 75 years of age. At the provincial and territorial level, the legislativebranch is represented by a single chamber legislative assembly, whose members are elected bydirect, popular vote.The executive branch consists of the head of state (the Queen, as represented by the GovernorGeneral), the Prime Minister and the Cabinet. The Prime Minister is the leader of the party thatforms the government in the House of Commons. This is usually the party that has the highestnumber of members elected. The Cabinet is comprised of the federal ministers chosen by thePrime Minister from among the members of his or her own party sitting in Parliament. The sameexecutive structure exists at the provincial and territorial level, with the head of state (theQueen, as represented by the Lieutenant Governor), the Premier (being the leader of the partywhich forms the government in the legislature) and the Cabinet.In Canada, unlike the United States, some elements of the executive and legislative branchesare combined, in that the majority party in the legislature also controls the executive.The judicial branch consists of the Supreme Court of Canada, the Federal Court of Canada, theTax Court of Canada and the provincial courts. Each province has its own Court of Appeal,together with a number of lower level courts which function as the courts of first instance formost criminal and civil matters. In Canada, the judiciary enjoys complete independence from theother branches of government.With the exception of Quebec, the laws of Canada are derived from two sources: the statutelaws as enacted by the federal and provincial legislatures and the “common law”, being theprecedents established by the judiciary over time through court decisions. Unlike the rest ofCanada, Quebec operates primarily under a civil code system rather than a common lawsystem. The civil code is a written text defining civil laws in the province and has its basis inFrance’s Napoleonic Code.Introduction 11

Chapter 2Forms of BusinessOrganizations

CHAPTER 2FORMS OF BUSINESS ORGANIZATIONSBusinesses in AtlanticCanada can operate througha variety of legal entities,including companies, soleproprietorships, partnerships,limited partnerships, jointventures and co-operativeassociations.COMPANIESOverview of IncorporationA company is a legal entity that is separateand distinct from the shareholders whocontribute to the company’s capital. Theshareholders exercise ultimate control overthe management of the company throughthe election of directors. The directors areresponsible for the day-to-day managementof the business and affairs of the companyand have a duty to act honestly, in goodfaith and in the best interests of thecompany. Companies enjoy perpetualsuccession, meaning that the existence ofthe company continues despite the death ofany or all of its shareholders. Furthermore,companies are afforded all the rights of aForms of Business Organizations 12

natural person to own property and therights to carry on business.There are several advantages to using acorporate form of business organization asopposed to other available forms such assole proprietorships and partnerships:An incorporated company offersinvestors access to a wide range offinancing opportunities. The flexibilitythat exists with respect to acompany’s share structure undereither provincial or federalcorporations legislation providesinvestors with a number ofinvestment options: shares can bevoting or non-voting; can havelimited or unlimited participation inequity; and can be redeemable for afixed price at the option of thecompany or the holder. The effect ofthis flexibility is that various classesof shares and debt instruments maybe utilized to provide different levelsof shareholder and lenderparticipation in the capitalization ofthe company and to provide varyingdegrees of risk or opportunity forprofit.Generally speaking, the liability of ashareholder is limited to the amountof that shareholder’s contribution tothe company, although the NovaScotia Companies Act provides forthe incorporation of unlimited liabilitycompanies (discussed furtherbelow).The control of a company can easilybe transferred through a transfer ofshares.Federal or Provincial IncorporationEach province has its own companieslegislation, being the Business CorporationsAct (“NBBCA”) in New Brunswick, theCompanies Act (“PEICA”) in Prince EdwardIsland, the Companies Act (“NSCA”) inNova Scotia, and the Corporations Act(“NLCA”) in Newfoundland and Labrador.The federal companies legislation is theCanada Business Corporations Act(“CBCA”). Companies (referred to as“corporations” under the NBBCA and NLCA)may be incorporated either under one of theprovincial companies statutes or under thefederal CBCA. Currently there is littlepractical difference between the provincialand federal powers to incorporate abusiness. A company established under aprovincial companies statute is entitled tocarry on business in that province andgenerally will be required to register in allother jurisdictions in Canada in which itcarries on business. A companyincorporated under federal legislation isentitled to carry on business anywhere inCanada, but it may also be required to beregistered in any province in which it carrieson business.There are certain practical factors that mayaffect the decision on where to incorporate.One important factor is the requirement forat least 25% of the company’s directors tobe Canadian residents for incorporationunder the CBCA or the NLCA. To qualify asa resident, a person must be either aCanadian citizen or a permanent residentunder the federal Immigration and RefugeeProtection Act. Subject to some limitedexceptions, a person must already be livingin Canada in order to be considered to haveresident status. It is possible to avoid theseForms of Business Organizations 13

esidency requirements by incorporating inNew Brunswick, Prince Edward Island orNova Scotia, which have no residencyrequirements. Incorporation in theseprovinces can then be followed by extraprovincialregistration in other provinces inwhich the company intends to conductbusiness.Other factors to consider when determiningwhere to incorporate include:The PEICA requires disclosure of allshareholders having more than 5%of the issued and outstanding sharesof the company, both at the time ofincorporation and subsequently onan annual basis. However, theidentity of shareholders need not bedisclosed under the NSCA, NBBCA,NLCA and CBCA, either at the timeof incorporation or subsequently.Variations exist between thedifferent jurisdictions with respect tocorporate matters such as minorityshareholder rights and dissentingrights. For example, shareholdershaving a grievance against othershareholders or directors of afederally incorporated companyhave their right to recourse set out inthe CBCA, while shareholders underthe PEICA must generally rely onthe common law for protection oftheir rights.Directors of CBCA companies arepersonally liable for unpaid wages ofemployees of the company, to aspecified maximum. There is nocorresponding liability in any of theprovincial companies legislation inAtlantic Canada. However,Newfoundland and Labrador’sLabour Standards Act contemplatessuch liability in certaincircumstances, as do pendingamendments to the NewBrunswick’s Employment StandardsAct.The provincial criteria for nameclearance are generally lessstringent than under the CBCA, andconsequently an applicant is morelikely to obtain a preferred corporatename under provincial legislation.On the other hand, there is slightlymore name protection under afederal incorporation than under aprovincial incorporation.The “unlimited liability” form ofcompany continues to be in demandin recent years because of certainUnited States tax advantages thatare only available to companies withunlimited liability. If it is necessarythat the company have unlimitedliability, Nova Scotia is currently oneof only three jurisdictions in Canadathat permit incorporation of suchcompanies, the others being Albertaand British Columbia. Unlimitedliability companies are discussed inmore detail below.All of the Atlantic Provinces haveenacted provincial legislation to dealwith several important electroniccommerce issues, including theability to manage corporategovernance issues quickly andefficiently using electronic methodssuch as email. In New Brunswick,the Electronic Transactions Actgoverns electronic commerce. InNova Scotia, Prince Edward Islandand Newfoundland and Labrador therelevant legislation is known as theForms of Business Organizations 14

Electronic Commerce Act. Pleasesee Chapter 5 – Trade and BusinessConduct Regulation for furtherinformation.Provincial IncorporationThe process for incorporating a provincialcompany varies somewhat from province toprovince. In New Brunswick andNewfoundland and Labrador, companiesare incorporated through the delivery ofarticles of incorporation to the appropriatedirector and the issuance of a certificate ofincorporation. In Nova Scotia, incorporationtakes place through the delivery to theRegistrar of a memorandum of association,together with articles of association in mostcases. A certificate of registration is thenissued. In Prince Edward Island, charters ofincorporation are granted through theissuance of letters patent.While the mechanisms for creatingcompanies vary from province to province,they tend to follow the same generalpattern. The process for incorporating acompany under the NLCA is describedbelow for illustrative purposes.A company is registered under the NLCA byfiling articles of incorporation with theregistrar in the prescribed form. Theconstating documents of a Newfoundlandand Labrador company consist of theArticles of Incorporation and, in most cases,By-Laws. The Articles of Incorporationcontain the name of the company, therestrictions, if any, on the objects andpowers of the company, the address of theregistered office in the province, the classesand maximum number of shares which thecorporation is authorized to issue, astatement as to the nature of restrictions onshares and the number of directors.Companies are managed on a day-to-daybasis by the directors and officers of thecompany. The shareholder’s role isgenerally limited to matters prescribed bythe NLCA, including electing directors andfundamental corporate changes. Certainmatters, such as changes to the sharecapital or a change in the name of thecompany, are required to be dealt with byspecial resolution, which must be approvedby at least a two-thirds vote of theshareholders or a unanimous writtenresolution.Every Newfoundland and Labradorcompany must register with the Registrar ofCompanies pursuant to the NLCA. A namereservation is required prior to theregistration of a company name. A companyname is required to have both a descriptiveand distinctive element. For example, ABCInc. will not satisfy the Registrar ofCompanies, whereas ABC Software Inc. willlikely be acceptable as it provides anindication of the nature of the company’sbusiness. Companies are also required tohave a “registered office” in Newfoundlandand Labrador where certain corporate (butnot financial) records are required to bemaintained.Each year, the company must file an annualrenewal of its registration together with anupdated list of the directors of the companyand their civic addresses. If a company isnot in good standing under the NLCA it maynot bring or maintain an action in any courtin Newfoundland and Labrador. In addition,it is subject to a fine for non-compliance andForms of Business Organizations 15

is susceptible to being struck from theRegistry.Newfoundland and Labrador has an InnuBusiness Registry which maintains a listingof all Innu Businesses. An Innu Business isa business organization in which the Innu orFirst Nations have at least 51% ownershipor effective control. In addition, an InnuBusiness must commit to make best effortsto employ qualified Innu by providing either(i) a minimum of 20% of the full-timepositions; or (ii) a minimum of 25 full timepositions; and guarantee the Innu partner orpartnership the greater of 5% of the grossbusiness revenues or a net profit distributionin accordance with the partnershipownership percentages. All types ofbusiness organizations that meet theestablished criteria are eligible to beregistered at the Innu Business Registry.Registration is a requirement in order toavail of certain business opportunities andthere is no fee for registration.Nova Scotia Unlimited CompaniesAn unlimited company is a distinct form oflegal entity which may be formed under theNSCA. Like limited companies, unlimitedcompanies are registered under the NSCAby filing signed constating documents withthe Registrar of Joint Stock Companies.However, unlike a limited company, theshareholders of an unlimited company will,by definition, have unlimited joint andseveral liability for the obligations of thecompany upon its dissolution. Unlike thepartners of a partnership (which isdiscussed below), the shareholders of anunlimited company have no direct liability tocreditors of the company; theirresponsibilities only arise when the entity isliquidated with insufficient assets to satisfyits obligations.Unlimited companies are useful from aUnited States (“U.S.”) tax planningperspective. Under U.S. tax regulations, dueto the unlimited liability nature of unlimitedcompanies, they are eligible to electpartnership treatment (or elect to bedisregarded) and as a result for U.S. taxpurposes any income or losses of theunlimited company may thereby be taxed inthe hands of the shareholders. It isimportant to note that Canadian withholdingtax obligations on interest, dividends andother similar payment to the U.S.shareholders of an unlimited company maybe more onerous than for limitedcompanies. These complications shouldthus be carefully considered before using anunlimited company.Prior to 2005, Nova Scotia was the onlyCanadian jurisdiction that permitted theformation of unlimited liability companies(“ULCs”). However, since then amendmentsto Alberta’s Business Corporations Act in2005 and British Columbia’s BusinessCorporations Act in 2007 have permitted theformation of ULCs in Alberta and BritishColumbia as well.The legislative regimes governing ULCs inNova Scotia, Alberta and British Columbiahave some substantive differences. TheNSCA is derived from English partnershiplaw. Nova Scotia ULCs (“NSULCs”) arecreated under the NSCA and are governedby 150 years of case law in England andelsewhere. Alberta and British Columbia’sBusiness Corporations Acts are similar toother modern Canadian corporate statutes.Because the unlimited liability concept isForms of Business Organizations 16

novel in a statute of this kind, there arecompatibility issues to be resolved and littleapplicable judicial authority. On the otherhand, the Alberta and British Columbiastatutes are better able to address modernCanadian corporate concepts than theNSCA.One of the most significant differencesbetween ULCs in the different jurisdictionsis the nature of shareholder liability. Underthe Nova Scotia legislation, shareholdershave no direct liability to creditors of theULC; rather, liability arises on a winding-up.For the shareholders to be liable, thecreditors must establish a claim against theNSULC, and there must be the inability ofthe NSULC to pay. It is only at that pointthat the creditors may pursue shareholdersof the NSULC by winding up the NSULCand claiming a deficiency.Shareholders of an Alberta ULC (“AULC”)are liable for an unlimited amount, on a jointand several basis, for any liability, act ordefault of the AULC, including actionscommenced up to two years after thedissolution of the AULC. Liability alsoextends to non-monetary obligations (i.e.criminal liability).Shareholders of a British Columbia ULC(“BCULC”) are jointly and severally liable tosatisfy the debts and liabilities of theBCULC as follows: (i) if the BCULCliquidates, from the commencement of theliquidation to its dissolution, to contribute tothe assets of the BCULC for payment of theBCULC’s debts and liabilities; and (ii)whether or not the BCULC liquidates, afterdissolution, for payment to the BCULC’screditors of the BCULC’s debts andliabilities.Under the NSCA, “past members” of aNSULC may be liable upon winding-up incertain cases for one year after ceasing tobe a shareholder. Past members cannot beheld liable for obligations contracted afterthey ceased to be a member. UnderAlberta’s legislation, former shareholders ofan AULC are not liable for any liability, actor default of the AULC that arises after theshareholder ceases to be a shareholder andmay only be liable for other claims if anaction to enforce that claim is brought withintwo years from the date on which theshareholder ceases to be a shareholder.The shareholders of a BCULC will not beliable for debts of the company unless itappears to the court that the currentshareholders are unable to satisfy its debtsand liabilities. Even if that is case, theBCULC shareholders will not be liable forany debts or liabilities that arose after theyceased to be shareholder, and on aliquidation or dissolution they will not beheld liable if they ceased to be ashareholder one year or more prior to thecommencement of that liquidation ordissolution.Residency requirements for directors arealso different. NSULCs and BCULCs haveno residency requirements for theirdirectors. Alberta’s legislation requires thatat least one quarter of the directors of anAULC be residents of Canada. U.S. parentcorporations may find the lack of a directors’residency requirement for NSULCs andBCULCs to be an advantage, as iteliminates the need to find Canadianresidents to serve as directors. It alsoavoids the operational inconvenienceswhich result from having directors residentin different locations from that of the parentcorporation.Forms of Business Organizations 17

Extra-Provincial IncorporationsCorporations which are validly incorporatedand existing in one Canadian jurisdiction(including a federal incorporation) mayregister to carry on business in otherCanadian jurisdictions. The process forregistering as an extra-provincialcorporation varies from province toprovince, but is fairly similar. For illustrativepurposes, the process for registering as anextra-provincial corporation in Nova Scotiais described here. It is a relatively simpleprocedure, under which certain basicinformation, such as the name of thecorporation and the names and addressesof the officers and directors, must be filedwith the Registry of Joint Stock Companies.Furthermore, it is necessary for the extraprovincialcorporation to have a recognizedagent in the Province of Nova Scotia for thepurpose of service of documentation withinNova Scotia.OTHER BUSINESS STRUCTURESSole ProprietorshipA sole proprietorship is the simplest form ofbusiness enterprise. It consists of anindividual who owns and operates abusiness. Unlike an incorporated company,in the case of a sole proprietorship theowner/operator personally owns all of theassets, and all obligations of the businessare personal obligations of the soleproprietor. As such, all of the assets of thesole proprietor may be used to settle anyoutstanding debts of the business.A sole proprietor, as a self-employedperson, is not eligible for and does not payemployment insurance. Sole proprietorsmust report and pay tax on all proprietorshipincome in the calendar year in which theincome is earned, and the proprietorshipincome (or loss) will be added to othersources of income of the proprietor.One benefit of operating through aproprietorship is the low cost oforganization. If start-up losses areexpected, then proprietorship may offer theadditional advantage of allowing theproprietor to claim those losses as adeduction for income tax purposes againstother sources of income. To succeed inmaking such a deduction, the proprietormay be required to demonstrate that he orshe has a reasonable expectation ofearning a cumulative profit from thebusiness enterprise.Some, but not all, of the Atlantic provincesrequire sole proprietorships carrying onbusiness under a name other than that ofthe proprietor to register that businessname.PartnershipA partnership is the relationship that existsbetween two or more persons carrying on abusiness in common with a view to a profit.A partnership can be a simple form ofbusiness structure, although the parties tothe partnership can make it as simple or ascomplex as they desire. A partnership existswhen two or more persons agree to carry onbusiness together and share in the profitsand losses of that business. As is the casewith a sole proprietorship, a partnership isnot a separate legal person distinct from thepartners. The partners are personallyresponsible for all partnership obligationsand jointly own all partnership property.Forms of Business Organizations 18

Each province has its own Partnership Act,but with few exceptions the provisions ofthose acts are subject to any agreementmade between the partners. All the Atlanticprovinces other than Newfoundland andLabrador require partnerships to register thename under which they will be carrying onbusiness and to maintain an annualregistration. They also require that acomputerized name search be conductedprior to registering the name of apartnership.Partners should have a written partnershipagreement. If the partners do not enter intoa written partnership agreement, thecommon law implicitly provides one forthem, and it is unlikely that this unwrittenagreement will be on the same terms andconditions as the partners would haveagreed to if a written partnership agreementhad been entered into. A written partnershipagreement outlines the rights, interests andresponsibilities of each partner and sets outthe proportionate right to earnings or losses,whether or not a partner can be expelledfrom the partnership, and how thepartnership can be terminated.The primary disadvantage of a partnershipis that each partner is held liable for all ofthe debts and liabilities of the partnershipthat are incurred while that person was apartner, including liability for wrongful actsor omissions of any partner in thepartnership while that partner was carryingon business in the ordinary course.Limited PartnershipA limited partnership is very similar to that ofa general partnership described above, withthe major distinction being that in a limitedpartnership certain partners (the generalpartners) contribute management efforts tothe partnership while other partners (thelimited partners) contribute only capital,which contribution can be either cash orother property, but not services.Limited partnerships are governed byspecific provincial legislation knownvariously as the Limited Partnerships Act orthe Limited Partnership Act; however, theprovincial Partnership Act statutes and thecommon law also apply to limitedpartnerships to the extent that they are notinconsistent with the specific limitedpartnerships legislation. As in the case withgeneral partnerships, a computerized namesearch is required prior to registering thename of a limited partnership in NovaScotia, New Brunswick and Prince EdwardIsland.A limited partnership must have a minimumof one general partner and one limitedpartner, and each limited partner is liable forthe obligations of the limited partnershiponly to the extent of its capital contribution.This protection can, however, be lost if thelimited partner takes part in the control ofthe business, which can occur if the limitedpartner participates in the management ofthe business of the limited partnership.A limited partnership is formed when eithera certificate or declaration (depending onthe province) is filed with the applicableprovincial authority and recorded. Thisdocument contains the essential terms ofthe limited partnership, including the nameof the partnership, the nature of itsbusiness, the names of all partners and,with the exception of New Brunswick, theamount of capital contributed by the limitedForms of Business Organizations 19

partners. The parties to a limited partnershipshould also enter into a written limitedpartnership agreement, which governs therelationship between the parties and themanagement of the partnership itself.Joint VentureUnlike the corporate structures describedabove, joint ventures are not governed byprovincial or federal legislation. Instead, ajoint venture is an association of personsengaged in a common undertaking for jointprofit by combining capital, skill, experienceand other resources without forming apartnership. This form of organization iscommon in building or constructionundertakings.It is important that the parties to a jointventure enter into a written agreement, andthat the agreement explicitly states that theparties do not intend to be associated inpartnership and that neither party is anagent of the other. If this step is not taken,the parties could be deemed to be acting inpartnership, resulting in the application totheir relationship of the Partnership Act andthe common law principles regardingpartnerships.Co-operative AssociationsA co-operative is a body corporate, but is aseparate legal entity created under specificprovincial legislation known variously as theCo-operative Associations Act or the CooperativesAct. Co-operatives areassociations whose primary purpose is toprovide service to their members and whichbelong to the people who use the services,the control of which rests equally with all themembers, and the gains from which aredistributed among the members inproportion to the use they make of theservices. Each member of a co-operativehas one vote and no member is personallyliable for the debts, obligations or acts of theco-operative except for the amount, if any,unpaid on the shares for which he or shehas subscribed or the amount, if any,unpaid on the membership for which he orshe has applied. There are a number ofactive co-operatives in the AtlanticProvinces.Forms of Business Organizations 20

Chapter 3Regulation ofForeign Investment

CHAPTER 3REGULATION OF FOREIGNINVESTMENTBoth the establishment of a new Canadian business and theacquisition of an existing Canadian business by non-Canadiansare regulated by the federal government under the InvestmentCanada Act (“ICA”).Regulation of Foreign Investment 21

An individual who is neither a Canadiancitizen nor a permanent resident of Canadawill be considered a non-Canadian for thepurposes of the ICA, while a corporation isconsidered to be non-Canadian if more than50% of its shares are controlled or held by aperson or corporation that is non-Canadian.Additionally, with respect to a widely heldpublic company that is not controlledthrough the ownership of voting shares, thecorporation is deemed to be Canadian if atleast two-thirds of the board of directors isCanadian.The stated purpose of the ICA is to providefor the review of significant investments inCanada by non-Canadians in a manner thatencourages investment, economic growthand employment opportunities in Canadaand to provide for the review of investmentsin Canada by non-Canadians that could beinjurious to national security. Inadministering the ICA, the federalgovernment has the dual function ofpromoting investment in Canada by non-Canadians, while at the same timereviewing any investment where theMinister has reasonable grounds to believethat foreign ownership or involvement in aCanadian business could be injurious tonational security.While the majority of acquisitions andestablishments of Canadian businesses bynon-Canadians are subject only tonotification under the ICA, there are anumber of investments which are subject toreview by the relevant Minister. This reviewprocess is required when the acquisition bya non-Canadian entails:The direct acquisition of control (byway of acquisition of shares orassets) over a Canadian businesswith an enterprise value of $5 millionor more;The indirect acquisition of controlover a Canadian business (throughthe acquisition of its parent companyoutside Canada) with an enterprisevalue of $50 million or more, or $5million or more if the Canadianbusiness represents over 50% of theenterprise value of the foreignparent company being acquired;The acquisition of an existingbusiness, or the establishment of anew or related business in aculturally sensitive industry such aspublishing, film and music,regardless of its size; orAny investment which would beinjurious to national security.As a result of Canada’s membership in theWorld Trade Organization (“WTO”),investors from the United States and otherWTO member countries are subject to amore liberal set of rules under the ICA,including a higher threshold level for theacquisition of Canadian businesses.Under these rules, indirect acquisitions byWTO investors are not reviewable, anddirect acquisitions of Canadian businessesby WTO investors are only reviewable if thegross assets of the Canadian businesssurpass a certain threshold. Recentamendments to the ICA increased thethreshold to $600 million, increasing to $1billion over a four year period. Theseamendments come into force on a day to befixed by the Governor in Council. Theseincreased thresholds do not apply to culturalindustries.Regulation of Foreign Investment 22

With respect to cultural industries, such asthe creation or distribution of written, videoor audio works, the Minister of CanadianHeritage has authority for the review andapproval of foreign investments under theICA and related regulations and guidelines.Similar to undertakings required for nonculturalindustries, the Department ofCanadian Heritage may seek commitmentsfrom the foreign investor to report on anundertaking using both contextualinformation and statistics, includingbreakdowns which delineate Canadiancreatedproducts from foreign-createdproducts. In terms of operating in a culturalindustry, it is incumbent upon companies tocontribute to ongoing development ofCanadian cultural life, and commitments ofa behavioral nature will normally be of alengthy duration.Exemptions to the application of the ICA forcertain transactions are also specificallycarved out in the Bank Act (Canada).“NET BENEFIT TO CANADA”An application for approval may be filed atany time prior to the implementation of theinvestment or the acquisition. Generallyspeaking, the non-Canadian investor maynot implement an investment or acquisitionthat is reviewable under the ICA until theinvestment or acquisition has beenreviewed and the Minister responsibleconducts a review to determine the “netbenefit to Canada”. In conducting thereview, the ICA requires that the followingfactors be taken into account:on resource processing, on theutilization of parts, components andservices produced in Canada, andon exports from Canada;The degree and significance ofparticipation by Canadians in thebusiness;The effect on productivity, industrialefficiency, technologicaldevelopment, product innovation,and product variety in Canada;The effect on competition within anyindustry in Canada;Compatibility with national industrial,economic, and cultural policies; andThe contribution to Canada’s abilityto compete in world markets.Determination of the “net benefit toCanada” may be made based onundertakings made by the foreign investorin relation to the factors listed above.Undertakings are legally bindingcommitments made by the foreign investorthat usually remain in effect for three to fiveyears. The undertakings are also subject tocompliance reviews and audits during theperiod for which they are in force. Typicallyspeaking, the government is mostlyconcerned with maintaining specific levelsof Canadian employment, with particularattention to managerial positions, capitalinvestment in the Canadian business andfurther development of Canadian-sourcedtechnology. However, it should bementioned that the specific focus of theundertakings varies with the nature of thebusiness.The effect on the level and nature ofeconomic activity in Canada,including the effect on employment,Regulation of Foreign Investment 23

INVESTMENT REVIEW PROCESSFollowing the filing of the application, theInvestment Review Division of IndustryCanada has 45 days to conduct a review. Atthe end of this review period, the investor isnotified whether or not the Minister hasapproved the application. The Minister, aspart of this response, may suggest changesto the acquisition proposal which wouldallow the acquisition to become satisfactory.Alternatively, the investor may be notifiedthat the Minister requires an extra 30 daysto review the proposed investment. Whilethe ICA requires that all reviews occurwithin 105 days of the date the applicationwas completed, the review process isusually completed within six weeks.As part of the review process, the Ministergenerally consults with the province orprovinces that would be significantlyaffected by the investment, as well as theCompetition Bureau and other governmentdepartments with relevant expertise. TheICA preserves the confidentiality of allinformation filed as part of the reviewprocess, and government officialsadministering the ICA are subject to criminalprosecution if such information is illegallydisclosed to third parties.After the review process is complete, thegovernment may either reject or approvethe proposed investment. Most proposedinvestments are ultimately approved basedon undertakings negotiated between theinvestor and the government.There are several exemptions from theapplication of the ICA, including certaintypes of corporate reorganizations andsecurities transactions, certain financingtransactions, and certain transactions withinthe insurance industry.It is worth noting that since the inception ofthe ICA, no investment in Canada by a nonresidenthas been rejected under the reviewprocess, but in several instances applicantshave accepted recommended structuralchanges.OTHER RESTRICTIONS ON FOREIGNOWNERSHIPIn addition to the restrictions set out aboveunder the ICA, there is also other industryspecificlegislation which affects foreignownership in Canada.Both the federal Bank Act and the federalTrust and Loan Companies Act haveregulations which restrict the ability offoreign banks and other non-residents tohold more than 25% of the shares issued bybanks, trust companies and loancompanies.Under the federal Broadcasting Act,broadcasting licences may not be issued tocompanies that are owned or controlleddirectly or indirectly by non-Canadians, or toindividual non-Canadians. Also, the federalTelecommunications Act requires thatcompanies owning telecommunicationstransmission facilities used to offer serviceto the public must have at least 80% of theirvoting shares owned by Canadians, and notless than 80% of the members of theirboard of directors must be Canadians. Inaddition, these Canadian carriers must becontrolled in fact by Canadians at all times.The Insurance Companies Act limits foreignownership in an existing Canadian-ownedRegulation of Foreign Investment 24

life insurance company to 25% in theaggregate, and 10% for any individual nonresident.Provincial legislation also placesrestrictions on foreign investment in theinsurance industry.In addition to the more common restrictionsset out above, on a provincial level theremay be restrictions on the amount or type ofland which may be owned by non-residents,and there are also federal regulations withrespect to a number of other industriesincluding aviation, fisheries and securitiesdealers.Regulation of Foreign Investment 25

Chapter 4Business Travel toCanada, Work Permitsand Immigration Law

CHAPTER 4BUSINESS TRAVEL TO CANADA, WORKPERMITS AND IMMIGRATION LAWA foreign national’s entry intoCanada, whether temporaryor permanent, is governed byCanada’s Immigration andRefugee Protection Act andthe correspondingImmigration and RefugeeProtection Regulations. Thislegislative framework and thepolicies that underlie it createa complex system thatregulates eligibility andadmissibility criteria for thosewho seek to becometemporary or permanentresidents of Canada.TEMPORARY ENTRY TO CANADACanada has specialized immigrationstreams that facilitate the entry of someinternational business travelers and foreignworkers. Nonetheless, bringing foreignnationals into Canada still requires carefulplanning and preparation. If not, youremployees or key service providers can bedelayed at the border, or in some casesrefused entry altogether. Companies canalso be subject to fines and other penaltiesfor not following immigration rules.In recent years significant changes havebeen made to Canada’s immigrationrequirements such that employers are nowaudited more frequently and there are morerobust consequences for immigrationviolations. For these reasons, it is moreimportant than ever to be familiar with theBusiness Travel to Canada, Work Permits and Immigration Law 26

immigration rules applicable to the crossbordermovement of employees and otherinternational business travelers intoCanada, to avoid unfavourableconsequences that could interfere with theoperation of your business.A best practice for any organization thatregularly relies on the cross-bordermovement of personnel is to develop andimplement an immigration policy thatcontemplates the many different groupswho may need immigration support,including short- and long-term transferees,new hires, third-party contractors (bothconsultants and specialized servicetechnicians) and business travelers.International Business TravelersInternational business travel has become socommonplace that many people will boardan airplane or drive to the Canadian borderfor meetings, to provide services to a client,or to visit an affiliate office without carefullyconsidering the immigration consequencesof their cross-border business activities untilthey are questioned by an immigrationofficer. Whether a business travelerrequires an immigration document (such asa work permit or visitor record) to engage inbusiness activity in Canada should becarefully analyzed before an internationalbusiness trip or secondment is arranged.There are a lot of misconceptions about theapplication of Canada’s immigration rules toshort-term business travelers. For example,many foreign nationals and the companiesbringing them to Canada incorrectly assumethat specialized service providers andconsultants who are coming to Canada for ashort period of time do not require a workpermit since they are not employed by aCanadian organization. This mistakenbelief often comes from a traveler’s pastexperience of being admitted to Canada asa visitor without fully disclosing (or beingquestioned about) the purpose of their trip.The recent changes to Canada’simmigration regime have led to a moreenforcement-minded approach of ensuringthat foreign workers will not negatively affectthe Canadian labour market. As a result,there is much more scrutiny at the border bythe Canada Border Services Agency in theassessment of both business visitor andwork permit applications. This means thatthose international business travelers whomanaged to slip into Canada without theproper documentation in the past areunlikely to be as lucky in the future.Consequently, failure to assess theimmigration requirements of a particularsituation in advance and implement theappropriate strategy can translate into losttime and money.Business VisitorsForeign nationals who enter Canada toengage in international business activitiesdo not require a work permit and will beadmitted as business visitors provided theywill not enter the Canadian labour market.Business visitors may enter Canada to takepart in business activities which areinternational in scope if their place ofemployment and source of remunerationremain outside of Canada. Activities allowedunder the business visitor category includeattending board of directors meetings,negotiating contracts, looking for officespace and giving or receiving intra-companytraining. Where a Canadian company hasBusiness Travel to Canada, Work Permits and Immigration Law 27

etained a foreign company or individual toprovide services in Canada, the individualperforming the services will require a workpermit and will not qualify for admission toCanada as a business visitor.The business visitor category extends tothose individuals performing after-salesservice in Canada, provided the service tobe performed was negotiated in the originalor extended sales agreement, lease/rentalagreement, warranty, or service contract.After-sales service does not include “handsonwork” generally performed byconstruction or building trades.Work PermitsAs a general rule, foreign nationals cannotwork in Canada without first obtaining animmigration authorization called a workpermit. Depending on a foreign worker’snationality, a work permit application can bemade at a Canadian port of entry or aCanadian visa office abroad. Citizens ofcountries who require temporary residentvisas (“TRVs”) to enter Canada cannotapply for a work permit upon enteringCanada. TRV-requiring nationals 1 mustapply for their initial work permit in advanceat the Canadian visa office responsible fortheir country of residence or nationality.Work permits are valid for a specific periodof time, anywhere from a few days to threeyears, and can be renewed provided theforeign worker continues to be eligible forthe work permit category in question.1The list of countries and territories whosecitizens require a TRV can be found at:http://www.cic.gc.ca/english/visit/visas.asp.LMO-Based Work PermitsUnless an exemption is available, obtaininga work permit is a two-step process. First,the foreign or Canadian employer mustobtain Labour Market Opinion (“LMO”)confirmation from Service Canada. An LMOconfirms, among other things, thatemploying a foreign worker in Canada for aspecific time frame will have a neutral orpositive impact on the Canadian labourmarket. Subject to some exceptions forshort-term specialized service providers andother unique situations, employers arenormally required to demonstrate they havemade unsuccessful efforts to recruit aCanadian or permanent resident of Canadafor the job in question. Once an employersecures an LMO, the foreign worker mustapply for a work permit.LMO-Exempt Work PermitsThere are various specialized work permitcategories that are exempt from the LMOrequirement. Here is a brief description ofthe most commonly used LMO-exempt workpermit categories:Intra-Company TransfereesThis work permit category allowsinternational companies to temporarilytransfer qualified employees to Canada forthe purpose of improving managementeffectiveness, expanding Canadian exportsand enhancing the competitiveness ofCanadian entities in overseas markets.Intra-company transferees are eligible forwork permits without an LMO on the basisthat their employment in Canada willprovide significant economic benefit throughBusiness Travel to Canada, Work Permits and Immigration Law 28

the transfer of their expertise to Canadianbusinesses.To qualify as an intra-company transfereean employee must be: (1) employed fulltimeby a multi-national company outside ofCanada (for at least a year) in a role similarto the role to be performed in Canada; (2)seeking temporary admission to Canada towork in a parent, subsidiary, branch oraffiliate of that enterprise; and (3)transferred to a position in Canada wherethey will work in an executive, seniormanagerial or specialized knowledgecapacity.This work permit category can be used byinternational companies seeking to transferemployees to an established company inCanada, or specifically to start a company inCanada. In the case of a Canadian start-up,a company must show that physicalpremises in Canada have been secured,provide realistic plans to staff the newoperation, and demonstrate the financialability to commence business in Canadaand compensate employees.program criteria for specialized knowledgeworkers and is expected to introducechanges that will restrict the application ofthis work permit category, especially as itapplies to companies in the informationtechnology industry.Currently, immigration officers assess thefollowing factors to determine whether aforeign worker has the requisite level ofspecialized knowledge:KnowledgeThe knowledge possessed by theapplicant must be unusual anddifferent from that generally found ina particular industry. It should begained through extensive experiencewith the organization abroad.OccupationThe position must be critical to thewell-being of the operation, andshould generally be a skilledposition.Initial intra-company transferee workpermits can be issued for a period of up toone to three years, and may be extended toa maximum of seven years for seniorexecutives and managers, and five years forspecialized knowledge workers.While intra-company transferee work permitapplications for executives and seniormanagers are relatively straightforward,specialized knowledge worker applicationsare scrutinized much more closely at portsof entry and visa offices abroad. At the timeof writing this chapter (April 2014), theGovernment of Canada is reviewing theEducationThe foreign worker should have thelevel of education typically requiredfor the position in question.ExperienceThe foreign worker's experienceshould support the claim ofspecialized knowledge in that theemployee is expected to have held akey role abroad and in that capacityhave been involved in significantassignments related to theBusiness Travel to Canada, Work Permits and Immigration Law 29

employer's productivity,competitiveness, image or financialposition.SalaryThe salary should be similar to atypical Canadian salary for theoccupation in question (geographicallocation is a consideration) andshould support the claim ofspecialized knowledge in the contextof the employee's specificexperience.TrainingGenerally, the applicant shouldpossess training and experienceconsistent with his/her claim tospecialized knowledge. The requisitetraining would be difficult forsomeone else to complete in thetime available.Supporting DocumentsApplications should include theapplicant's résumé, educationalcredentials, reference letter andletters of support from the foreignand Canadian entities.Professionals (Under NAFTA and OtherInternational Trade Agreements)The North American Free Trade Agreement(“NAFTA”), other international free tradeagreements (which Canada has in placewith Chile, Peru and Colombia) and theGeneral Agreement on Trade in Service(“GATS”) all facilitate the temporary entry ofbusiness persons and certain professionalsfrom member nations into Canada withoutthe need for an LMO. The immigrationprovisions under NAFTA are the mostexpansive and apply to citizens of Mexicoand the United States. Under theseagreements, foreign nationals qualified inone of the professions named in therelevant agreement can obtain a workpermit for a specified period for prearrangedemployment in Canada.Depending on the agreement, professionalwork permits can be issued for 90 days(under GATS) and up to three years (underNAFTA). NAFTA professional work permitscan be renewed indefinitely provided thework permit holder can continue todemonstrate a temporary purpose for beingin Canada. After repeat renewals,immigration officers may begin to doubt thegenuineness of a foreign national’stemporary intention and look to theindividual to become a permanent residentof Canada.To qualify for this type of work permit,professionals must meet the statedminimum educational requirements andalternative credentials. Over 60 professionsare included in the NAFTA professionalcategory such as engineers, geologists,accountants, computer system analysts,management consultants and university,college and seminary teachers. Similar listsof professions are included in Canada’s freetrade agreements with Chile, Peru andColumbia, and a more limited number ofprofessions in GATS.On October 18, 2013, Canada signed, inprinciple, a Comprehensive EconomicTrade Agreement ("CETA") with theEuropean Union (“EU”). CETA, which isexpected to come into force inBusiness Travel to Canada, Work Permits and Immigration Law 30

approximately two years, will includeprovisions for facilitated entry to Canada forEU citizens. When these new LMOexemptions are available, employers willhave a whole host of new expeditedimmigration options for EU nationals.Emergency Repair PersonnelForeign workers entering Canadatemporarily to carry out emergency repairsto industrial or commercial equipment areeligible for LMO-exempt work permits, solong as it can reasonably be said that therewill be a negative effect on the local labourmarket (i.e. a disruption in employment) ifthe worker is not admitted to Canada. Thiswork permit category is normally used forcontracted service providers attending clientsites in Canada to conduct unscheduledemergency repair work. It can only be usedfor true emergencies, when there isinsufficient time to obtain an LMO. This typeof work permit is not available to foreignworkers seeking admission to Canada toconduct scheduled maintenance onequipment.Significant BenefitImmigration officers are permitted to issueLMO-exempt work permits to foreignworkers who are coming to Canada toperform work that will provide a significantsocial, cultural or economic benefit toCanada where an LMO cannot be obtainedin a timely manner. This type of work permitis highly discretionary, and the threshold fordemonstrating the necessary significantbenefit is high. Any foreign worker applyingfor a significant benefit work permit shouldbe armed with a well-documentedapplication package clearly showing thesignificant benefit their admission will haveon Canada. This work permit category canbe useful as a last resort or incircumstances where it is impossible toobtain an LMO in the time available, and noother LMO-exemptions are available.Reciprocal EmploymentReciprocal employment work permits canbe issued to foreign workers whoseemployment in Canada will create ormaintain reciprocal employmentopportunities for Canadian citizens orpermanent residents in other countries.Canada is willing to issue reciprocal workpermits to inbound foreign workers if it canbe shown that temporary opportunities alsoexist for Canadians overseas. This type ofpermit can offer flexibility to companies,especially those that send Canadiansabroad for business purposes. Strict job-tojobreciprocity is not necessary, butapplicants do need to show thatopportunities for Canadians and permanentresidents in similar positions exist in thereciprocal jurisdiction.Spouses and Dependent ChildrenSpouses of foreign workers who hold aCanadian work permit valid for at least sixmonths are eligible for an open work permitwhich allows them to work in Canada forany employer, in any occupation, subject toa few exceptions. Spousal work permits aretied to the principal foreign national’s workpermit and will expire on the same date,subject to an earlier passport expiry date.Dependent children of foreign nationals whohold work permits valid for at least sixmonths are eligible for a visitor record orBusiness Travel to Canada, Work Permits and Immigration Law 31

study permit that authorizes them to attendprimary or secondary school in Canada.Provincial Rules Governing theRecruitment and Hiring of ForeignWorkersAlthough immigration to Canada is largely amatter of federal jurisdiction, the provincesand territories are involved in immigration ina couple of ways. In addition to havingdelegated power to select a certain numberof foreign nationals to immigrate to theirprovince or territory each year throughprovincial and territorial nominationprograms, each province and territory alsohas the ability to pass laws governing therecruitment and hiring of foreign workers. Ahandful of Canadian provinces have doneso. At the time of writing (April 2014), NovaScotia is the only province in AtlanticCanada that has enacted this type oflegislation. Newfoundland and Labrador,New Brunswick and Prince Edward Islandwill likely follow suit eventually.Nova Scotia’s Foreign Worker RulesNova Scotia’s Labour Standards Codeincludes provisions designed to protectforeign workers from exploitation byrecruiters and employers. Theseprotections require third-party recruiters toobtain a licence from the province whenrecruiting “vulnerable” foreign workers.They also require employers to register withthe Labour Standards Division beforeemploying certain foreign workers. Therecruiter licensing process becamemandatory on May 1, 2013, and employersof foreign workers have been required toregister since August 1, 2013. Certain thirdpartyrecruiters and employers of foreignworkers are exempt from the licensing andregistration requirements.Foreign Worker Recruiter LicenceRecruiters do not require a licence toengage in the following types of foreignworker recruitment activities on behalf ofNova Scotia employers:1. Recruiting foreign workers for jobs withthe following types of entities:a. Provincial “GovernmentReporting Entities” (i.e.,provincial governmentdepartments, crowncorporations, health authorities,the Nova Scotia CommunityCollege and school boards);b. Municipalities; andc. Universities.2. Recruiting foreign workers formanagement and professional positions(occupations that fall within skill type 0and skill level A occupations on theNational Occupational Classification(“NOC”) Matrix developed by HumanResources and Skills DevelopmentCanada and Statistics Canada). Theoccupations include:a. Management Occupations (NOC0) – Management occupations ina variety of industries such asexecutive roles, seniormanagers, legislators, managersin health care, corporate salesmanagers, and managers inhuman resources, finance,construction, informationtechnology and retail.Business Travel to Canada, Work Permits and Immigration Law 32

. Professional occupations (NOCA) – Professional roles includingaccountants, physicians,lawyers, teachers, professors,dentists, librarians, translators,psychologists, engineers,mathematicians and scientists.Third-party recruiters, however, are onlyexempt from the licensing requirement iftheir recruitment of foreign workers foremployment in Nova Scotia is restricted toNOC 0 and A positions. Recruiters fillingNOC B (high-skilled), C (semi-skilled) or D(low-skilled) positions with foreign workersmust be licensed by Nova Scotia.Recruiters who conduct overseasrecruitment efforts to fill NOC 0 and A rolesare permitted to recruit domestically forNOC B, C and D positions without a licence.Only members in good standing with aprovincial or territorial bar society, theChambre des notaires du Québec or theImmigration Consultants of CanadaRegulatory Council are eligible to apply for alicense.Employer Registration ProcessCertain employers are also exempt from therequirement to hold a registration certificateto hire foreign workers in Nova Scotia.These exemptions mirror the exemptions tothe recruiter licensing regime. The followingtypes of employers do not requireregistration certificates:professional (NOC A) occupationslisted on the NOC Matrix.Employers who fit into one of theseexemptions and who use a third-partyrecruiter are also exempt from therequirement to use a licensed recruiter,provided the recruiter is also exempt fromthe licence requirement.Employers who require a registrationcertificate can apply on an annual basis.The application can be made online. Whenthe information upon which a registrationcertificate is issued changes significantly(e.g., working with a new third-partyrecruiter or recruiting foreign workers foremployment in a different skill level thanoriginally planned), employers are requiredto advise the Labour Standards Division.Nova Scotia employers (and their third-partyrecruiters) must demonstrate compliancewith the laws governing recruitment andemployment of foreign workers before anLMO will be issued from Service Canada.Similarly, Citizenship and ImmigrationCanada and the Canada Border ServicesAgency also have authority to request proofof compliance with these laws whenadjudicating LMO-exempt work permitapplications from foreign workers. Forthese reasons, it is important to adhere tothe employer registration and recruiterlicensing process.PERMANENT ENTRY INTO CANADAProvincial government reportingentities, municipalities anduniversities; andEmployers seeking to hire foreignworkers in management (NOC 0) orThere are several different classes underwhich a foreign national may qualify toimmigrate permanently to Canada. Eachclass is reviewed separately below:Business Travel to Canada, Work Permits and Immigration Law 33

Economic ClassesCanadian Experience ClassThe Canadian Experience Class (“CEC”)allows individuals with one year of properlyauthorized skilled work experience inCanada to become permanent residents. Inaddition to having 12 months of Canadianwork experience (in a NOC 0, A or Bposition) within the previous three years inCanada, applicants must also meetminimum language requirements and planto live outside of the province of Quebec.A maximum number of complete CECapplicants are accepted each year, withsub-caps for applications for certain NOC Boccupations. Work experience in thefollowing occupations does not qualify underCEC: cooks, food service supervisors,administrative officers/assistants,accounting technicians and bookkeepers,and retail sales supervisors.Federal Skilled Worker ClassSkilled workers are eligible to becomepermanent residents because they areconsidered able to become economicallyestablished in Canada. Applicants areassessed on language skills, education,work experience, and other factors thathave shown to help newcomers prosper inCanada. To be accepted as a skilledworker, applicants must have workexperience in an eligible occupation, have avalid offer of arranged employment, or be acurrent/previous student of a Canadian PhDprogram. Applicants must also score acertain number of points under six selectioncriteria.Federal Skilled Trades ClassCertain tradespeople are eligible to becomepermanent residents based on beingqualified in one of a prescribed number ofin-demand skilled trades. Applicants musthave at least two years of work experiencein a skilled trade, meet minimum languagerequirements, and have either an offer ofemployment or a certificate of qualificationin their skilled trade issued by aprovincial/territorial body. This programaccepts a maximum number of applicationsannually, with a sub-cap for certain tradeswith only moderate Canadian labour marketneed.Provincial Nominee ClassMost provinces and territories in Canadahave an agreement with the Government ofCanada that allows them to play a moredirect role in selecting immigrants who wishto settle in that province or territory. Peoplewishing to immigrate to one of Canada’sprovinces as a provincial nominee must firstapply to the province where they wish tosettle. The province will consider theirapplication based on its immigration needsand the applicant’s genuine intention tosettle there.Before applying to immigrate to Canada,provincial nominees must complete theprovincial nomination process. After beingnominated by a province, they must thenmake a separate application to Citizenshipand Immigration Canada (“CIC”) forpermanent residence. A CIC officerassesses their overall admissibility toCanada.Business Travel to Canada, Work Permits and Immigration Law 34

The following provincial nominee programsare available in Atlantic Canada:Nova Scotia Nominee Program (“NSNP”)At the time of writing the NSNP has threestreams:1. The Skilled Worker Stream acceptsapplications from individualssupported by a full-time permanentjob offer from an established NovaScotia employer. Applicants areassessed on education, language,work experience, adaptability andfinancial settlement support.2. The Family Business Worker Streamis designed for individuals who havea full-time permanent job offer froman established Nova Scotiacompany that is owned by a closerelative.3. The Regional Labour MarketDemand Stream does not requireapplicants to have a job offer from aNova Scotian employer; however,they must meet labour market needsby pursuing employment in an indemandoccupation in Nova Scotia.New Brunswick Provincial NomineeProgram (“NB PNP”)At the time of writing the NB PNP has onlyone active stream because applicants underthe Business Stream stopped beingaccepted as of September 6, 2013 untilfurther notice.1. The Skilled Worker Stream is forapplicants with either employer orfamily support. Both categoriesrequire applicants to have a full-timepermanent job offer from anestablished New Brunswickemployer. Applicants with employersupport must earn enough pointsunder five selection criteria to beeligible. Applicants with familysupport must have a job offer froman established New Brunswickbusiness operated by a close familyrelative.Newfoundland and Labrador ProvincialNominee Program (“NL PNP”)The NL PNP currently has two categories:2. The Skilled Worker category is forapplicants with a full-time permanentjob offer from an establishedNewfoundland and Labradoremployer. Applicants are assessedon various factors including workexperience, language, andsettlement ability.3. The International Graduate categoryis for international graduates of arecognized post-secondaryeducational institution in Canadawho have a full-time permanent joboffer from an establishedNewfoundland and Labradoremployer in their field of study.Applicants are eligible to apply forthis program within two years ofcompleting their studies.Prince Edward Island Provincial NomineeProgram (“PEI PNP”)The PEI PNP currently has two categories:1. The Labour Impact category isdivided into two streams, the SkilledBusiness Travel to Canada, Work Permits and Immigration Law 35

Worker Stream and Critical ImpactStream.a. Under the Skilled WorkerStream, applicants musthave a full-time long-term joboffer in a skilled occupationfrom an established PrinceEdward Island employer.b. Under the Critical ImpactStream, applicants musthave a full-time long-term joboffer from an establishedPrince Edward Islandemployer in one of thefollowing semi/low skilledoccupations: truck driver,customer servicerepresentative, labourer, food& beverage server orhousekeeping attendant.Under both streams,applicants are assessed onvarious factors includingwork experience, languageand settlement ability.2. The Business Impact category isdivided into three streams designedfor experienced business managersand entrepreneurs: the 100%Ownership Stream, PartialOwnership Stream, and Work PermitStream. To be eligible under thesestreams, applicants must have aminimum net worth and invest aminimum amount of money into thePrince Edward Island business.a. Under the 100% OwnershipStream, applicants mustinvest in and activelymanage a Prince EdwardIsland business and sign anescrow agreement.Family Classb. Under the Partial OwnershipStream, applicants mustinvest in a Prince EdwardIsland business and beinvolved in its day-to-dayoperations.c. Under the Work PermitStream, applicants obtain awork permit and become asole or partial owner of abusiness by investing in andactively managing an eligiblebusiness.Canadian citizens and permanent residentsliving in Canada, 18 years of age or older,may sponsor the immigration to Canada ofcertain family members. Spouses,common-law partners and conjugalpartners, and dependent children can besponsored most easily. It is also possible tosponsor a parent or grandparent, but morerestrictive rules apply and only a certainnumber of applications to sponsor parentsand grandparents are accepted annually.Sponsors must promise to support therelative or family member and theiraccompanying family members for a periodof three to 20 years depending on the typeof relative sponsored and the age of thesponsored person.Immigration applications from members ofthe family class are assessed to confirm thegenuineness of the relationship between thesponsor and the applicant.Business Travel to Canada, Work Permits and Immigration Law 36

OTHER CONSIDERATIONSTaxesThere are tax issues associated withrelocating to Canada. For example, aforeign national who moves to Canadatemporarily or permanently may have anobligation to file a tax return in Canada andelsewhere.There may also be tax considerations,including withholding and reportingobligations, for companies that transferforeign workers to Canada or retain theservices of non-resident service providers.Provincial Health InsuranceInternational business travelers, foreignworkers and prospective immigrants shouldconfirm whether provincially-funded healthinsurance will be available for them andtheir family members upon arrival inCanada. If not, private health insuranceshould be purchased in advance of arrival inCanada. Each province has different rules,and in some provinces there is a threemonthwaiting period for coverage.Business Travel to Canada, Work Permits and Immigration Law 37

Chapter 5Trade and BusinessConduct Regulation

CHAPTER 5TRADE AND BUSINESS CONDUCTREGULATIONINTERNATIONAL TRADEInternational trade is a vital component of Canada's economy —Canada’s exports account for approximately 30% of its total grossdomestic product.Trade and Business Conduct Regulation 38

Canada is a signatory to the NorthAmerican Free Trade Agreement ("NAFTA")with the United States and Mexico, underwhich the world's largest free trade areawas formed. Canada is also a participant inbilateral free trade agreements with severalother countries.North American Free Trade AgreementUnder NAFTA, tariffs and trade barriers ongoods which meet "rules of origin"requirements have virtually disappeared.The rules of origin basically stipulate that forgoods to be traded free of tariffs, thematerials and other components used in themanufacturing of the goods must originatein one of the member countries, and themanufacturing process itself must takeplace in a member country. The rulesprovide for the minimum amount of regionalcontent required to qualify for the tradeexemption, which varies depending on theparticular product.An important point to note is that ownershipof the manufacturer of goods does not affectthe application of NAFTA's rules, meaningthat foreign-owned Canadian businessesare fully eligible to take advantage of theelimination of tariffs under NAFTA, providedthat their goods satisfy the applicable rulesof origin requirements.NAFTA also contains rules governing thecross-border trade in services provided byenterprises located in member countries. Itstipulates that each member must treatservice providers from other membercountries no less favourably than its ownservice providers. Service providers are notrequired to establish a local office orotherwise be resident in a member countryas a condition for the cross-border provisionof a service. However, certain restrictionson cross-border services can be maintainedwhere such restrictions have been listed inan annex to NAFTA.Other Free Trade AgreementsCanada is a participant in bilateral free tradeagreements with Chile, Columbia, CostaRica, Honduras, Israel, Jordan, Panamaand Peru. Canada also has a free tradeagreement with the European Free TradeAssociation, comprised of Iceland,Liechtenstein, Norway and Switzerland.These agreements have eliminated variousbarriers to the trade of goods and servicesbetween the participating countries. As ofwriting, full negotiations with the EuropeanUnion have been completed in the form of aComprehensive Economic and TradeAgreement which was signed October 18,2013, but final ratification is still pending.Finally, Canada currently has on-going freetrade agreement negotiations with manyother countries, including India and Japan.Importing GoodsThe Customs Act establishes a selfassessmentsystem under which all goodsimported into Canada must be reported tothe nearest customs office. The applicableduties are calculated according to theprovisions of the Customs Tariff, which setsout a list of tariff provisions and establishesthe rates of customs duties applicable to thevarious tariff items. It is the importer'sresponsibility to determine and pay theduties on the goods being imported and toreport any errors within three years of theimportation of the goods.Trade and Business Conduct Regulation39

The penalties for infractions of customslegislation range from $100 to a maximumof $25,000 per infraction based on the type,frequency and severity of infraction. Thepenalties have largely replaced the use ofseizure and ascertained forfeitures asenforcement tools. However, a seizureaction may also be initiated in specificcircumstances such as where goods areprohibited or controlled. Penalties andseizures also do not preclude the possibilityof criminal prosecution, with maximum finesof up to $500,000 and maximum prisonterms of five years.The tariff treatment accorded to goodsunder the Customs Tariff varies accordingto the nature of the items and their countriesof origin. Special tariffs are applicable tocertain goods originating in CommonwealthCaribbean countries, Australia and NewZealand as well as those countriesparticipating in free trade agreements withCanada and certain developing countries.The customs value of imported goods is theprice actually paid or payable for the goodswhen sold for export to Canada. That priceis adjusted for a variety of factors includingtransportation costs, royalty fees, handlingfees and insurance costs, referred to as the“transaction value”. Other methods ofvaluation are available if the transactionvalue cannot be used. There are alsospecial rules that apply when the importerand exporter are related parties.In addition to duties which may be payableunder the Customs Act, the Excise Tax Actrequires importers to pay Harmonized SalesTax ("HST") on the value of imported goods,although some goods are exempted fromHST. Where goods are imported, the tax willgenerally be collected by customs officialsat the time the goods are imported. HSTmay be exigible on imported services. Animporter may be required to “self-assess”such HST where the services are notacquired for the purposes of “commercialactivities” as defined in the Excise Tax Act.Input tax credits on imported goods areavailable to HST registrants to the extentthat the goods are for use in the registrant'scommercial activities. HST rates varyacross provinces. Currently the HST rates inthe Atlantic Provinces are: 15% in NovaScotia, 14% in Prince Edward Island, 13%in New Brunswick and 13% inNewfoundland and Labrador. All importersand exporters must have an Import/Exportaccount number issued by the CanadaRevenue Agency.Import and Export ControlsThe Export and Import Permits Act requiresthat import permits be obtained for certaingoods, such as certain agricultural products,that are subject to import quotas. Otheritems are subject to import restrictionsbased on country of origin, in compliancewith UN Security Council sanctions orunilateral Canadian trade restrictions.Currently, for example, sanctions existagainst imports from North Korea, Iran andSyria, among other countries. The Exportand Import Permits Act also identifiescertain goods which may not be exported(such as goods that could have both acivilian and a military application), andcertain countries to which exports areprohibited, except under the authority ofexport permits. Currently, the only countriesto which exports are completely prohibitedwithout a permit are North Korea andBelarus. The Government of Canada canTrade and Business Conduct Regulation40

and does change the list of restrictedcountries periodically.Unlike the United States, there is noprohibition of trade with Cuba. Indeed,Canadian law prohibits Canadiansubsidiaries of American corporations fromcomplying with United States lawsrestricting trade with Cuba. American parentcompanies that try to prevent Canadiansubsidiaries from exporting Canadian goodsand services to Cuba could find themselvesin breach of Canada's ForeignExtraterritorial Measures Act, therebyexposing the Canadian subsidiaries topenalties under that Act. Canada doesapply American export controls on Americangoods bound for Cuba, in order to preventCanada from being used as a "goodslaunderer" by American exporters seekingto avoid export controls applicable in theUnited States. However, it is possible toobtain an Individual Export Permit in orderto sell goods of United States origin toCuba.Finally, trade in certain items may also berestricted pursuant to internationalagreements to which Canada is a party. Forexample, the Nuclear Non-ProliferationTreaty restricts the import and export ofuranium and nuclear-related materials.There may be provincial restrictions on theimport of certain goods into a province. Forexample, each of the Atlantic Provinces hasrestrictions on the importation of alcohol andtobacco products.Measures Act ("SIMA"), which allows themto file complaints and to request relief whendumped or subsidized imports cause, orthreaten to cause, material injury to aCanadian industry or material delay in theestablishment of a Canadian industry.Dumped imports are goods sold toCanadian importers at prices lower thantheir selling price in the exporter’s domesticmarket or at prices lower than the cost ofthe good. Canada's right to apply SIMA'sprovisions against imports from the UnitedStates and Mexico is not restricted byNAFTA but such decisions made underSIMA may be subject to a review underNAFTA.Initially, the President of the Canada BorderServices Agency determines whetherdumping or subsidizing is occurring. If eitheris taking place, provisional anti-dumping orcountervailing duties may be imposedpending the outcome of an inquiry by theCanadian International Trade Tribunal(“CITT”). The CITT’s role is to determine ifdumping or subsidizing has caused orthreatens to cause material injury.In limited circumstances, duties on fairlytraded goods may be exigible under theCanadian International Trade Tribunal Actand the Customs Tariff if the imports inquestion cause or threaten to cause seriousinjury to a Canadian industry. Safeguardactions, such as the imposition of surtaxesor temporary quotas, may be implementedby the federal Minister of Finance on therecommendation of the CITT.Trade RemediesCanadian producers are protected fromunfair trade under the Special ImportTrade and Business Conduct Regulation41

International Investment DisputeResolutionThe Settlement of International InvestmentDisputes Act (Canada) (the “SIID Act”) wasassented to March 13 th , 2008, and cameinto force on November 1, 2013. The SIIDAct applies to awards rendered, arbitrationagreements entered into and conciliationproceedings commenced under theConvention on the Settlement of InvestmentDisputes between States and Nationals ofOther States (the “Convention”). As ofNovember 1, 2013 the Convention hascome into force in 149 countries.The SIID Act establishes the InternationalCentre for Settlement of InvestmentDisputes (the “Centre”). The Centre has thecapacity of a natural person and is providedcertain immunities and privileges.Immunities are also extended to the chairand members of the Administrative Counciland to other persons such as parties toproceedings, counsel and witnesses.The Centre maintains a panel of conciliatorsand a panel of arbitrators. Each contractingstate designates four individuals to serve oneach of the panels.The jurisdiction of the Centre extends to alllegal disputes arising directly out of aninvestment between a contracting state anda national of another contracting state.Parties to a dispute must consent in writingto submit the dispute to the Centre. Once adispute has been submitted and consent isgiven by all parties involved, no party maythen withdraw its consent unilaterally.Consent of the parties to arbitration underthe Convention is deemed to be consent tosuch arbitration to the exclusion of any otherremedy. Awards are binding on the partiesand are not subject to any appeal or to anyother remedy.The SIID Act provides that a provincialsuperior court has the jurisdiction torecognize and enforce an award madepursuant to the SIID Act by a tribunalestablished under the Convention. Onapplication, such a court must recognizeand enforce an award as if it were the finaljudgment of that court.An arbitration tribunal will decide a disputein accordance with the rules of law agreedto by the parties, except that in the absenceof agreement, the tribunal shall apply thelaw of the contracting state party to thedispute (including its rules on the conflict oflaws) and such rules of international law asmay be applicable.A growth in the number and significance ofinternational investments has resulted in anincrease in the quantity and complexity ofinvestment disputes. The Centre offersContracting States an alternative to litigationwith the provision of a reputable andaccessible international dispute mechanism.Exchange ControlsCanada does not have any exchangecontrols, so there are no restrictions on therepatriation of profits to the foreign ownersof businesses operating in Canada.However, the Proceeds of Crime (MoneyLaundering) and Terrorist Financing Actdoes establish reporting requirements forthe export of currency or monetaryinstruments. The Act imposes three mainobligations on businesses: keeping recordsTrade and Business Conduct Regulation42

of certain types of transactions (e.g., largecash transactions); ascertaining the identityof clients; and making reports of suspicioustransactions to the Financial Transactionsand Reports Analysis Centre of Canada.Provincial LawsAs a result of the jurisdictional division ofpowers within Canada, internationalagreements entered into by the federalgovernment which affect matters underprovincial jurisdiction cannot come intoeffect until they have received provincialapproval. One of the areas of primaryprovincial jurisdiction is the regulation ofproperty and civil rights, which includes thelaw of contracts. Accordingly, internationalagreements only come into force afterprovincial implementation. Two examplesare the United Nations Convention onContracts for the International Sale ofGoods ("CCISG") and the UNCITRALModel Law on International CommercialArbitration ("MLICA"). The CCISG containsrules governing contract formation,breaches of contract and the obligations ofsellers and buyers of goods. The MLICAgoverns the conduct of arbitrations betweenparties that have their places of business indifferent countries. Both the CCISG andMLICA (and the related United NationsConvention on the Recognition andEnforcement of Foreign Arbitral Awards)have been enacted by all four AtlanticProvinces.As each of the Canadian provinces has thepower to regulate trade and commercewithin its boundaries, differences instandards and licensing regimes can createinterprovincial barriers to trade. Althoughmany of these barriers have come down inrecent years, when operating in the AtlanticCanadian market it is important to confirmthe standards and licensing requirements ineach of the four provinces.DOMESTIC TRADE/FEDERALREGULATIONMost business conduct in Canada isgoverned by the Competition Act which isintended to promote competition andefficiency in the Canadian marketplace.Under the Act, prohibited activities arecategorized as either criminal offences orcivilly reviewable conduct. Specific activitieswhich attract criminal sanctions include bidrigging,knowingly or recklessly makingfalse or misleading representations to thepublic, deceptive telemarketing, deceptiveprize winning notices, double ticketing (thecharging of the higher of two pricesindicated on a product), and pyramid sellingschemes.Predatory pricing, price discrimination anddiscrimination through promotionalallowances have all been decriminalized bythe recent amendments to the CompetitionAct which took effect in March 2010.However, the same behaviour has beenincluded as "anti-competitive acts" and maybe pursued by the Competition Bureau on acivil review basis. Although no criminalsanctions will be rendered, severeadministrative monetary penalties will apply.The amendments also introduced a twotrackreview for collaboration amongcompetitors (i.e. conspiracies) - a criminalreview for the most egregious acts, and acivil review for anti-competitive, but notcriminal, activity. Arrangements withcompetitors to fix prices, allocate customersTrade and Business Conduct Regulation43

or markets or control the production orsupply of a product are "per se" criminaloffences which do not require any actuallessening of competition to have resultedfrom the arrangement.Most complaints regarding breaches of theCompetition Act arise from businesscompetitors and consumers. Complaints arefiled with the Competition Bureau, whichthen examines them to determine if theyraise a concern under the Competition Act.If the Bureau determines that there isevidence of a possible contravention, aformal inquiry may be opened. Based on theBureau’s determination, suspected criminaloffences are referred to the AttorneyGeneral of Canada for possible prosecutionbefore the criminal courts. Civil law mattersare referred to the Competition Tribunal, aspecialized administrative tribunal which isindependent of government and is chairedby a judge. The Tribunal has the power toissue injunctions and remedial orderspreventing practices that are likely tosubstantially reduce competition.The Competition Act also establishes anumber of trade practices and activities thatcan be reviewed by the CompetitionTribunal. These activities include the refusalby a supplier to sell its product to anotherparty, consignment selling, exclusivedealing, market restrictions, tied selling,abuse of dominant position and deliveredpricing. Administrative monetary penalties ofup to $10 million for the first offence and upto $15 million for subsequent offences havebeen recently introduced for abuse ofdominant position offences. A civil actionmay also be commenced by a person whohas suffered damage as a result of anotherparty’s breach of the provisions of theCompetition Act.Merger RegulationThe Competition Act (under its civilreviewable conduct provisions discussedbelow) applies to mergers involving theacquisition of control over, or significantinterest in, the whole or part of an existingCanadian business (whether anincorporated or unincorporated business) ofa competitor, supplier, customer or otherperson, whether directly or indirectly andwhether by Canadian or non-Canadianentities, by share or asset purchase, or byamalgamation or otherwise (“Mergers”).Large proposed Mergers are subject toformal advance notification requirements(which must be accompanied by a $50,000filing fee) that must be satisfied before theMerger can be completed where the socalled“size of the parties” and “size of thetransaction” thresholds are both met. The“size of the parties” threshold is met if theparties to the transaction (together with theiraffiliates) have assets in Canada or anannual gross revenue from sales in Canadaexceeding $400 million. The “size of thetransaction” threshold is met if (1) the valueof the acquired assets (or where shares areacquired the value of the target’s assets inCanada) exceed $82 million, adjustedannually or (2) the annual gross revenue (inor from Canada) generated by those assetsexceed $82 million, adjusted annually. Aswell, in the case of share purchasetransactions, the proposed transaction mustresult in the acquiror holding at least 20% ofthe shares of a public corporation or 35% ofthe shares of a private corporation. ThereTrade and Business Conduct Regulation44

are additional rules that apply foramalgamations and joint ventures.A Merger meeting the above thresholdscannot be completed until the expiration of a30 day statutory waiting period (subject toextension by supplementary informationrequests known as “SIRs”), unless waivedby the Bureau. Failure to notify “withoutgood and sufficient cause” is a criminaloffence, liable on conviction to a fine of upto $50,000.In determining if a Merger or proposedMerger will substantially lessen competition,a number of factors are consideredincluding the extent to which foreignproducts or foreign competitors provide orare likely to provide effective competition tothe businesses of the parties to the Mergeror proposed Merger; whether the business,or a part of the business, of a party to theMerger or proposed merger has failed or islikely to fail; the extent to which acceptablesubstitutes for products supplied by theparties to the Merger or proposed Mergerare or are likely to be available; any barriersto entry into a market, including tariff andnon-tariff barriers to international trade andany effect of the Merger or proposed Mergeron such barriers; the extent to whicheffective competition remains or wouldremain in a market that is or would beaffected by the Merger or proposed Merger;any likelihood that the Merger or proposedMerger will or would result in the removal ofa vigorous and effective competitor; thenature and extent of change and innovationin a relevant market; and any other factorthat is relevant to competition in a marketthat is or would be affected by the Merger orproposed Merger.If the Commissioner refers a Merger to theCompetition Tribunal, and the Tribunaldetermines that a Merger or proposedmerger prevents or lessens competitionsubstantially, or is likely to do so, it mayorder that the Merger be dissolved or notproceeded with, or allow it to proceed undercertain conditions (such as requiring thesale of some or all of the assets acquired).Where there are no competition issuesrelated to a Merger, the parties may applyfor an Advance Ruling Certificate (“ARC”).The Commissioner may issue the ARCwhere he or she is satisfied that a proposedMerger will not prevent or lessencompetition substantially. This is the highestform of clearance for a proposed Mergerand if issued exempts the parties from thepre-notification requirements and precludesthe Commissioner from challenging theMerger. Typically, however, theCommissioner will instead issue a “noaction letter” stating that the Bureau will notcontest the completion of the Merger, butwill maintain its ability to do so up to oneyear post-completion.Marketing and AdvertisingThe Competition Act also applies to allforms of advertising (including contests andpromotions) and any claims made in them.Criminal or civil penalties may be imposedon the makers of false or misleadingadvertising.Knowingly or recklessly making false ormisleading representations to the public,deceptive telemarketing and deceptive prizewinning notices are all subject to criminalsanctions. If found guilty of a criminaloffence, the penalties are:Trade and Business Conduct Regulation45

On summary conviction, a maximumfine of up to $200,000 or a term ofimprisonment up to one year, orboth; andOn indictment, a maximum fine atthe discretion of the court or amaximum term of imprisonment of14 years, or both.Among the practices that are subject to civilpenalties are false and misleadingstatements to the public, misrepresentationsregarding the ordinary price of a product,misrepresentations as to product test resultsor public testimonials, bait and switch selling(where a product is advertised at a bargainprice but is not supplied in reasonablequantities), sales above advertised prices,and inadequate disclosure of the value ofprizes in promotional contests.If a civil offence is found to have beencommitted, possible remedies are: withdrawthe offending advertising; publish a notice ofcompliance; and/or pay an administrativemonetary penalty of up to $10 million (onfirst occurrence, individuals are subject topenalties of up to $750,000 andcorporations to penalties of up to $10million). For any subsequent offences, thepenalty increases to a maximum of $15million for corporations and $1 million forindividuals. In certain situations, an ordermay be made requiring compensation forconsumers who bought the advertisedproduct, but this would normally only occurwhen the consumers are identifiable.In addition to federal restrictions onmisleading advertising, certain products andservices are subject to provincial marketinglimitations under consumer protectionlegislation, such as the costs of borrowingdisclosure requirements imposed onlenders.Confidential Information and TradeSecretsBusinesses in possession of confidentialinformation can generally impose a legalobligation of confidentiality on other partieswho are given access to that information.This may include employees and/or otherbusinesses that obtained the information inthe course of negotiating a businessrelationship, such as a joint venture.However, this legal right can only beenforced where there is a contractualobligation or other legally-recognizedrelationship imposing obligations ofconfidentiality. In order to protect acompany’s interests, it is prudent to ensurethat parties who are given access to acompany’s confidential information sign anon-disclosure or confidentiality agreementbefore the information is disclosed.The Canadian common law also providesbusinesses with protection againstunauthorized acquisition and/or use of tradesecrets. Trade secrets are defined asinformation that is used, or may be used, inbusiness for any commercial advantage.For such information to qualify for legalprotection as a trade secret, it must not begenerally known to the public or to otherpersons who can derive economic benefitfrom its use or disclosure. Reasonableefforts must also be made by the possessorto prevent the information from beingdisclosed.A trade secret is only protected as long ascompetitors are unable to duplicate it bylegitimate and independent means, such asTrade and Business Conduct Regulation46

examination of the product. If a competitoris able to discover the secret throughlegitimate means, they acquire the full rightto use it. Unlike patents, trade secrets donot provide the right to prevent others frommaking use of the secret, if it is successfullydiscovered through means that are notwrongful. As with confidential information,non-disclosure or confidentiality agreementsare an important tool that should be used toprotect a company’s trade secrets.In some circumstances, businesses may fallvictim to the disclosure of trade secretsdespite taking appropriate precautions. Thismay be caused through unauthorizeddisclosure by a former employee or formerdirector or officer of the business. As longas the possessor of the secret tookreasonable steps to ensure that theinformation remained confidential, thecourts will usually treat the disclosure of thesecret as wrongful and may award damagesagainst the offending party, injunctive relief,or both.Advertising Standards CanadaAdvertising Standards Canada isresponsible for regulating advertising inCanada in accordance with the CanadianCode of Advertising Standards (the “Code”).The Code covers all forms of advertisingexcept foreign advertising (unless made bya Canadian advertiser), election advertisingand packaging and labelling. The Codestates advertisements “must not, unfairly,discredit, disparage or attack otherproducts, services, advertisements orcompanies, or exaggerate the nature orimportance of competitive differences.” TheCode further prohibits advertisers fromimitating the slogans or illustrations ofanother advertiser in a manner that wouldmislead the consumer. Advertising thatcompares the product or servicecharacteristics, value, performance,consumer preference, market share, salesorigin or availability of one advertiser’sproducts or services with those of anotheridentifiable organization is considered to becomparative advertising under the Code.Product Standards and CodesProducts and services in Canada aresubject to numerous technical standardswhich set minimum requirements for safetyor performance. Many of these standardshave been developed by industryassociations on a voluntary basis. Federaland provincial governments have alsoestablished many mandatory standards,often by incorporating into law standardsdeveloped by industry organizations. One ofthe key federal statutes to be aware of is theHazardous Products Act, which applies tothe advertising, sale and importation intoCanada of hazardous products andsubstances, and which sets out nationalsafety standards for numerous consumerproducts, including toys, furniture,household and garden products.The Standards Council of Canada is afederal Crown corporation with the mandateto promote efficient and effectivestandardization. It coordinates and overseesthe efforts of the National StandardsSystem, which includes organizations andindividuals involved in voluntary standardsdevelopment, promotion andimplementation in Canada. Some of themore prominent standards developingorganizations in Canada include theCanadian Standards Association (whichTrade and Business Conduct Regulation47

deals with electrical products, fire and safetyequipment, plumbing fixtures, toys andother consumer goods), the CanadianGeneral Standards Board (textiles) and theUnderwriters Laboratories of Canada (firehazards and detection).Given the large number of standards inforce, developers and importers of productsshould seek expert advice to ensure theirproducts comply with applicable standards.Companies should also determine if theirproducts are eligible to receive certificationmarks from accredited certificationorganizations.Packaging and Labelling RequirementsThe federal Consumer Packaging andLabelling Act applies to most products thatare the subject of trade or commerce inCanada, including both food and non-foodproducts. The Act provides that noprepackaged goods can be sold, importedto Canada or advertised without a labelprominently displaying the net quantity ofthe product. Labels are required to identifythe product’s identity in both English andFrench, and quantities must normally bedescribed using the metric system ofmeasurement. The Act also regulatesstandard container shapes and sizes.In addition to the Consumer Packaging andLabelling Act, there are a number of federalstatutes that mandate additional packagingand labelling requirements, including theFood and Drugs Act (which deals with foodproducts, drugs, cosmetics and medicaldevices), the Canada Agricultural ProductsAct (which regulates specific food andbeverage products), the Textile LabellingAct, the Hazardous Products Act, the PestControl Products Act, the Precious MetalsMarking Act, the Trade-marks Act, theCustoms Tariff (which mandates that thecountry of origin be indicated on certainimports) and the Weights and MeasuresAct.Internet RegulationThe ability to regulate internet activities isshared by the federal government and theprovinces. Regulation of the internet itself isstrictly a matter of federal jurisdiction,overseen by the Canadian Radio-televisionand Telecommunications Commission(“CRTC”). Businesses that meet thedefinition of a “telecommunications commoncarrier” under the Telecommunications Actare subject to federal regulations whichcover items such as rates and services,facilities, ownership and operations.Generally speaking, internet activities arenot extensively regulated in Canada,reflecting a 1999 announcement made bythe CRTC that it did not intend to regulateinternet content. However, a number ofdevelopments in the area of internet andwireless data regulation are on the horizon.The 2014 federal budget, introduced onFebruary 11, 2014, disclosed the federalgovernment’s intention to implement anumber of measures designed to increasecompetition in the telecommunicationsindustry and increase regulatoryenforcement in the wireless sector. Notably,the budget announced that amendments tothe Telecommunications Act andRadiocommunications Act will be proposed.The proposed amendments, if enacted, willprovide the CRTC and Industry Canada withthe authority to impose “administrativeTrade and Business Conduct Regulation48

monetary penalties” on companies thatviolate regulatory requirements, includingviolations of Canada’s new Anti-Spam Actand the recently in-force Wireless Code. Inaddition to the proposed amendments, thebudget also announced plans to allocate$305 million for the expansion of broadbandservices into rural and northerncommunities.Anti-Spam LegislationFederal legislation aimed at preventingmalicious email communications (i.e. spam)comes into force on July 1, 2014. Onceimplemented, the legislation, commonlyreferred to as Canada’s Anti-SpamLegislation (“CASL”), will prohibit thesending of a commercial electronicmessage (“CEM”) to an electronic addressunless certain form and consentrequirements are satisfied (with certainlimited exceptions). Under CASL, an opt-insystem is created whereby consent must beobtained from the recipient prior to the CEMbeing sent. This is different than theapproach taken in the United States, whichuses an opt-out system whereby an emailcan be sent without prior consent subject tothe recipient opting out from receivingfurther emails. There are also prohibitionsrelating to installation of computer programsand altering transmission data withoutconsent.Consent can be either implied or express.Consent is implied where there is an“existing business” or “non-businessrelationship” (as defined in CASL) betweenthe sender and recipient within a two year orsix month period (depending on thecircumstances) prior to sending the CEM.Certain types of messages in specificcircumstances are fully exempt from CASL(meaning there are no consent or formrequirements), including some kinds ofbusiness to business communications,fundraising communications by registeredcharities, messages to family members, andother communications as set out in theregulations. Furthermore, for the first threeyears following implementation of CASL,there is an implied consent for sendingCEMs to recipients where, as of July 1,2014, there was an existing businessrelationship or non-business relationshipregardless of when that relationship mayhave last been active (i.e. without referenceto the two year or six month time periods),provided that the recipient does notwithdraw consent and the relationshipincluded the exchange of commercialelectronic messages.Also, unless subject to an exemption, allCEMs will need to contain certaininformation identifying the sender (or personon whose behalf the CEM is sent), includingname, mailing address and either telephoneor email address. As well, an unsubscribemechanism must be included to allow therecipient to unsubscribe from future emails.Unsubscribes must be effected within 10days after an unsubscribe request is made.Potential penalties for contraventions ofCASL are high, with a maximum penalty of$10 million for corporations and $1 millionfor individuals. There is also vicariousliability for violations by employees. Aprivate right of action comes into force inJuly 2017 for recipients who have receivednon-compliant CEMs. A due diligencedefence will be available where the senderhas implemented polices aimed atcompliance with CASL obligations.Trade and Business Conduct Regulation49

DOMESTIC TRADE / PROVINCIALREGULATIONE-CommerceThe basic legal framework governing e-commerce in Canada is outlined in theUniform Electronic Commerce Act(“UECA”). The UECA was designed toimplement the principles developed by theUnited Nations Commission on InternationalTrade Law, a global initiative that has beenhighly influential in Canada and otherinternational jurisdictions. The UECA ismodeled after the United Nation’s ModelLaw on e-commerce, which has developeda set of internationally acceptable rules andprinciples for e-commerce legislation.A central tenet of the UECA is the principleof “Electronic Equivalence,” which providesthat on-line transactions and electroniccontracts are given the same legal effect astheir traditional paper-based equivalents,provided that certain requirements are met.Although the UECA sets out the modelframework for e-commerce in Canada,enforcement of e-commerce laws andregulations is a matter of provincialjurisdiction.All of the Atlantic Canadian provinces haveenacted provincial legislation to facilitateelectronic contracts and e-commerce. InNew Brunswick, the Electronic TransactionsAct governs electronic commerce. In NovaScotia, Prince Edward Island andNewfoundland and Labrador the relevantlegislation is known as the ElectronicCommerce Act. Provincial e-commercestatutes across Canada are modeled afterthe UECA, ensuring relative consistency ine-commerce law across the provinces andfederally. Some of the shared centralfeatures of Atlantic Canadian e-commercelegislation include:Electronic information anddocuments, including contracts, arelegally recognized and are notinvalid or legally unenforceablesimply by virtue of beingcommunicated electronically.Where there is a legal requirementthat information be in writing, thisrequirement is satisfied by electronicinformation so long as theinformation is accessible andcapable of being retained forsubsequent reference.Where there is a legal requirementthat information be in a specifiednon-electronic form, this requirementis satisfied by electronic informationif it is provided in the same orsubstantially the same form as thenon-electronic form and isaccessible and capable of beingretained for subsequent reference.In other words, the electronicinformation should be recognizableas the form required by law.A legal requirement for a signaturewill generally be satisfied by anelectronic signature, with someexceptions.Electronic information is notconsidered to be capable of beingretained where the person providingthe electronic information prohibitsthe printing or storage of theinformation by the recipient.Trade and Business Conduct Regulation50

Electronic Contracts and SignaturesIn Canada, electronic contracts arerecognized under both the common law andprovincial e-commerce legislation. Inaddition to the enactment of provincial e-commerce statutes, more than 300 federalstatutes have been amended toaccommodate electronic documents,contracts and signatures and to removebarriers to e-commerce.The federal and provincial statutesgoverning electronic transactions and e-commerce are essentially uniform in theirtreatment of the enforceability of electroniccontracts. Most contracts made throughelectronic media are treated in the sameway as traditional contracts, provided theymeet the requirements set out in theapplicable statutes and regulations.However, there are a number of documentsincluding wills, powers of attorney and mostnegotiable instruments, which requireoriginal signatures and cannot be finalizedin electronic format.The validity and enforceability of electroniccontracts are governed by the same basicprinciples of Canadian contract law thatapply to traditional paper-based contracts(e.g., offer, acceptance, consideration). It isnecessary that the terms of the contract areclear and unambiguous, and that the partiesintend to be legally bound when they enterinto the contract. E-contracts that areentered into between individuals andelectronic agents (automated computerprograms) are considered valid andenforceable unless the individual makes amaterial error.Acceptance of the terms of electroniccontracts can be communicated throughelectronic signatures. Electronic signaturesare defined in the federal PersonalInformation Protection and ElectronicDocuments Act as a signature that consistsof one or more letters, characters, numbersor other symbols in digital form incorporatedin, attached to or associated with anelectronic document. Provincial e-commerce statutes define electronicsignatures similarly, and provide thatelectronic signatures are functionallyequivalent to their paper counterparts.Electronic documents and signatures areconsidered to be sent when they enter aninformation system outside of the sender’scontrol. Once the sent information iscapable of being retrieved and possessedby the addressee, it is presumed to bereceived.Legally valid e-contracts can also beexecuted through clicking or touching acomputer icon. Additional forms ofelectronic contracts that have beenrecognized by the common law include“clickwrap” agreements (agreements whereacceptance is expressed by clicking ortouching a computer icon), “shrink-wrap”agreements (where licences are placedinside the packaging of consumer softwareproducts) and “browse-wrap” agreements(where use of a website constitutesagreement to the terms and conditions of itsuse). However, the enforceability of suchagreements depends on the specific factsand circumstances and is determined by thecourts using the common law principles ofCanadian contract law.Trade and Business Conduct Regulation51

Franchising RegulationIn Atlantic Canada, both New Brunswickand Prince Edward Island have legislationnamed the Franchises Act that substantiallydetermines the rights and obligations of theparties to a franchise agreement in thoseprovinces. For example, both pieces oflegislation impose a “duty of fair dealing” onall parties to a franchise agreement, andplace fairly onerous disclosure requirementsupon franchisors. Failing to supply adisclosure document according to the law orinadvertently including a misrepresentationin the disclosure document will expose afranchisor to statutory liability in theseprovinces.Although Nova Scotia and Newfoundlandand Labrador do not currently havefranchise legislation, courts in Canada havestated that, even in provinces where there isno legislation pertaining to franchises, afranchisor still has a duty to “act in utmostgood faith towards a franchisee.”Furthermore, in all of the Atlantic Provinces,many laws of general application will applyto franchise operations, including statutesthat deal with commercial tenancies,employment standards and personalproperty security.Regulation of Gift CardsAll of the Atlantic Provinces have enactedlegislation to regulate gift cards. NovaScotia and Newfoundland and Labradorenacted Gift Card Regulations under theirrespective consumer protection legislation,while New Brunswick and Prince EdwardIsland enacted a Gift Cards Act. All of theprovinces define “gift cards” as electroniccards, written certificates, or other vouchersor devices with a monetary value that areissued or sold in exchange for the futurepurchase or delivery of goods or services.Under the respective provincial legislation,gift cards cannot have an expiry date unlessthey are sold for a charitable purpose orissued for a marketing, advertising orpromotional purpose. Also, a person whoissues or sells a gift card must clearlydisclose, at the time the card is issued orsold, all restrictions, limitations, terms andconditions imposed in respect of the use,redemption or replacement of the gift card,as well as information about the way inwhich the purchaser or holder of the giftcard can obtain details about the gift card,including the remaining balance. Thisinformation must be provided in writing.Warranties and Consumer ProtectionAll of the Atlantic Provinces have a Sale ofGoods Act (“SGA”), and there exists a highdegree of uniformity between thejurisdictions. The SGA sets out a completeand uniform set of rules which govern allsituations where goods are bought and sold.The SGA contains implied terms as to thequality of goods, including impliedwarranties (e.g., of quiet possession and offree and clear title) and implied conditions(e.g., that the goods will be of merchantablequality, will correspond to the descriptionand will be reasonably fit for the particularpurpose for which they are acquired,provided that that purpose is made knownto the seller). Its provisions do not supplantthose of the contract, they merelysupplement them, and the legislationspecifically allows parties to explicitlycontract out of some or all of its provisions,should they wish to do so. As well, the SGAonly has application to sales of goods, andTrade and Business Conduct Regulation52

does not cover an agreement to supplyservices, even if goods are incidentallyinvolved.In addition to the SGA, the AtlanticProvinces have passed a variety of otheracts geared towards consumer protection.For example, Newfoundland and Labradorconsolidated its consumer protectionlegislation into a single enactment, theConsumer Protection and BusinessPractices Act, which prohibits unfair andunconscionable business practices andprovides a right of action against a supplierwhere a consumer has suffered damage asa result of an unfair trade practice. PrinceEdward Island’s Business Practices Act alsoprohibits unfair practices and allows theconsumer to rescind an unfair agreementand seek damages, or to recover thedifference between the amount paid and thefair market value of the goods or serviceswhere rescission is no longer possible orwould deprive a third party of a rightacquired in good faith and for value. NovaScotia and Prince Edward Island both havea Consumer Protection Act which containsmore implied terms and warranties forcontracts of goods and services, and affectsthe rights of creditors and debtors.In New Brunswick, the Consumer ProductWarranty and Liability Act (“CPWLA”)provides that any statement made by asupplier, whether written, oral or inadvertising, becomes an express warranty ifthe buyer reasonably relies upon it inpurchasing a product. The CPWLA alsoestablishes a number of implied warrantiescovering title, quality and fitness, andcontains a product liability section whichimposes strict liability on a supplier forlosses suffered by consumers as a result ofdefective consumer products, irrespective ofany contract or negligence.The other Atlantic Canadian provinces donot have legislation dealing with productliability. However, product liability claimsmay be maintained by parties under thecommon law principles of negligence andunder the law of contract for breaches ofcontractual warranties or conditions. Thenormal measure of damages in negligenceis for reasonably foreseeable losses.Personal injury and property damageawards are intended to be compensatory.On rare occasions, punitive damages mayalso be awarded. A recent developmentwhich may have an impact on productliability award levels is the emergence ofclass action lawsuits. In 2001,Newfoundland and Labrador passed itsClass Actions Act, in 2006 New Brunswickpassed its Class Proceedings Act and in2007 Nova Scotia passed its ClassProceedings Act. To date, Prince EdwardIsland has not introduced similar legislation.Like other Canadian provinces, class actionlawsuits in Newfoundland and Labradorhave become more frequent over time. Asimilar experience is expected in NewBrunswick and Nova Scotia. By makingaccess to such lawsuits more affordable forindividual claimants, it seems likely thatoverall awards for product liability claims willincrease in the coming years.Other consumer protection legislation canbe found in provincial acts which specifyborrowing cost disclosure requirements thatmust be complied with by businesses thatextend credit. As well, all the AtlanticProvinces have enacted comparableUnconscionable Transactions Relief Acts,which provides relief to debtors inTrade and Business Conduct Regulation53

circumstances where a court finds the costof the loan to be “excessive” and thetransaction to be harsh and unconscionable.Still other forms of consumer protection arefound in provincial statutes that regulatespecific industries. Examples of suchstatutes (which often include licensing orpermit requirements) include NewBrunswick’s Real Estate Agents Act andAuctioneers Licence Act; Nova Scotia’sCollection Agencies Act and PaydayLenders Regulations; Prince EdwardIsland’s Collection Agencies Act; andNewfoundland and Labrador’s Flea MarketsRegulation Act. Also of note is NovaScotia’s Consumer Creditors’ Conduct Act,which protects consumers from certainkinds of inappropriate behaviour on the partof creditors.Trade and Business Conduct Regulation54

Chapter 6Taxation Law

CHAPTER 6TAXATION LAWSince 2000, the government of Canada has steadily reducedcorporate and personal income tax rates at all income levels, andhas also introduced various tax measures to create a favourabletax environment to encourage investment and entrepreneurship inCanada. The current status of these initiatives is reflected below.Taxation Law 55

The primary basis for taxation in Canada isresidence of the taxpayer; Canada does notimpose tax on the basis of citizenship. Anyresident of Canada, whether individual orcorporate, pays tax on its worldwideincome. The federal Income Tax Act (“ITA”)does not define the term resident.Generally, residency is determined usingcommon law principles, taking intoconsideration factors such as the dwellingplace of individuals and the location of acorporation’s central management andcontrol. Certain deeming provisions in theITA may also apply.Non-residents pay tax on their Canadiansource income, which will typically includeincome from employment or businesscarried on in Canada and the disposition oftaxable Canadian property. Taxes on nonresidentsare subject to relief by way of ratereduction or, to a limited extent, eliminationof Canadian tax, under a tax treaty. Canadahas an extensive network of treaties, withapproximately 90 treaties currently in force.CORPORATE TAXATIONThe entity chosen by a taxpayer to conductits business activities will determine how thebusiness will be taxed. For instance, a soleproprietor adds the business income earnedfrom the business to his or her personalincome. A partnership must compute itsincome as though it were a separatetaxpayer and then a partner’s share of thepartnership income is taxed at the samerates applicable to other income earned bysuch partner. Hence, partnerships aregenerally flow-throughs for tax purposes.Special rules apply to limited partners thatmay, in certain circumstances, restrict theirability to claim losses of a limitedpartnership allocated to them.Unlike partnerships, trusts resident inCanada are taxable entities under the ITA.However, certain trusts, including personaltrusts and mutual fund trusts, may beeligible for an offsetting deduction in respectof amounts distributed to beneficiaries. Theeffect of such rules is to reduce (oreliminate) tax at the trust level. Suchdistributions are generally taxable in thehands of the beneficiaries.An incorporated company is also taxed as aseparate legal entity. Any corporationresident in Canada is liable for Canadianincome tax on its worldwide income (subjectto relief from applicable tax treaties to whichCanada is a party). A corporation canestablish Canadian residency byincorporating in Canada (or a province orterritory within Canada) or by having itsdirecting mind reside in Canada. Theapplicable federal corporate tax rate willvary, according to the nature of acorporation’s business, its residency statusand its affiliations.Foreign Investment in CanadaForeign corporations planning to invest inCanada may establish their Canadianoperations either through a branch or aCanadian subsidiary company. The taxtreatment of a branch versus a subsidiaryvaries significantly, so foreign investorsshould carefully consider which option willminimize their tax burdens before investingin Canada.Taxation Law 56

Carrying on Business Through a BranchThe Canadian operations of a branch will besubject to Canadian corporate income taxon the net income of the branch. It will alsobe subject to withholding taxes on propertyincome earned by the branch. In addition,the foreign entity will be subject to a branchtax at a rate of 25% of the net profits notreinvested in Canada, unless such rate isreduced by an applicable tax treaty.Carrying on Business Through a SubsidiarySmall Business Rate (onActive Business Incomeor income in excess of$500,000)Manufacturing &Processing Rate15%15%The Canadian government ceased levying acapital tax on large corporations as ofJanuary 1, 2006. In addition, the Canadiangovernment maintains several federal taxincentives to encourage investment inCanada. These include:The operations of a Canadian subsidiary willbe taxed on its net income as a Canadiancompany. In addition, the subsidiary will berequired to pay a withholding tax on interest,royalties and dividends paid to its parent.The rate of such withholding tax will varyaccording to the nature of the income andwhether a tax treaty between Canada andthe country of residence of the parentcompany is applicable.Federal Corporate TaxesThe federal corporate tax rates as ofJanuary 1, 2014 are set out below. Acorporation must meet the requirements ofspecific provisions contained in the ITA toqualify for these rates.General Rate (ActiveBusiness Income orInvestment BusinessIncome)Small Business Rate (onSmall Business Income,up to income threshold)Small Business DeductionLimit15%11%$500,000Scientific Research andExperimental DevelopmentProgram: Businesses involved inscientific research and experimentaldevelopment can apply for taxcredits applicable to expendituressuch as wages, materials andequipment.Film Tax Credit Programs: TheCanada Revenue Agencyadministers two film tax creditprograms to help the film industry inCanada.Natural Resources Tax Incentives:Businesses involved in drilling,exploration, development andproduction of minerals, or oil andgas, may qualify for industry-specifictax incentives. Investors should alsobe aware that each of the fourAtlantic provinces has establishedcertain tax and royalty regimestargeted specifically at the naturalresource sector.Taxation Law 57

Provincial Corporate TaxesIn addition to federal corporate income tax,corporations are subject to provincialcorporate income tax. Where a corporationoperates in more than one provincialjurisdiction, its taxable income must beallocated between the provinces based onfederally-defined formulae. These formulaeare proxy measures of the actual businessactivity generated and are intended toreflect the level of business conducted in ajurisdiction. The formulae are based on theexistence of a “permanent establishment”,which is determined by considering whetherthere is a body or activity in place within aparticular province with an ability andauthority to generate or contribute towardrevenues or the business purpose of thecorporation.New BrunswickNew Brunswick corporate income tax ratesand bracket structures are applied tofederally-defined New Brunswick taxableincome. Applicable rates for 2013 includethe following:Business TypeTaxRate(onJanuary1, 2014)General 12%Manufacturing &Processing12%Small Business 2 4.5%The Province of New Brunswick eliminatedthe Large Corporations Capital Tax as ofJanuary 1, 2009.Financial institutions are still subject to theFinancial Corporations Capital Tax("FCCT") at a rate of 4% on taxable capitalin excess of $10 million as defined in theNew Brunswick Financial CorporationCapital Tax Act. The FCCT rate increasedfrom 3% to 4% effective April 1, 2012. TheFCCT is deductible from taxable income forfederal and provincial corporate income taxpurposes.Businesses subject to tax in New Brunswickmay be eligible for (or individually benefitfrom) one or more tax credits, tax incentivesor benefits offered by the New Brunswickgovernment. These include:Dividend Tax Credit;New Brunswick PoliticalContributions Tax Credit;New Brunswick Labour-sponsoredVenture Capital Tax Credit;Research and Development TaxCredit; andSmall Business Investor Tax Credit.Of significance for entrepreneurs, the NewBrunswick Small Business Investor TaxCredit provides a 30% non-refundablepersonal income tax credit of up to $75,000per year (for investments of up to $250,000per investor) to individuals, and a 15% non-2 The New Brunswick Small Business DeductionLimit is $500,000 as of January 1, 2014.Taxation Law 58

efundable income tax credit of up to$75,000 per year (minimum investment of$50,000 to a maximum of $500,000) toeligible corporate and trust investors whoinvest in eligible small businesses in theprovince.Prince Edward IslandThe applicable corporate tax rate for acorporation operating in Prince EdwardIsland is dependent on the type of businessundertaken by a corporation. Applicablerates for 2014 include the following:Business TypeTax Rate(onJanuary1, 2014)General 16%Manufacturing &16%Processing (certaincorporations may beeligible for amanufacturing andprocessing profitsdeduction)Small Business 3 4.5%Financial Institutions must pay a FinancialCorporations Capital Tax at a rate of 5% ontaxable capital in excess of $2 million asdefined in the Prince Edward IslandFinancial Corporation Capital Tax Act. TheFinancial Corporations Capital Tax isdeductible from taxable income for federaland provincial corporate income taxpurposes.In order to stimulate economicdevelopment, the government of PrinceEdward Island has instituted a number oftax incentives for corporations in specificindustries. Invest PEI oversees an array offiscal measures to attract investment fromcorporations involved in industries such asaerospace, bio-sciences, renewable energyand information and communicationtechnologies. Further assistance may beavailable from the development arm of theprovincial government, Innovation PEI.For those businesses subject to corporateincome tax in Prince Edward Island, variousinvestment tax credits or rebates may beavailable. These include:Nova ScotiaInnovation and Development LabourRebate;Enriched Investment Tax Credit;Specialized Labour Tax Credit; andShare Purchase Tax Credit.The applicable corporate tax rates forcorporations operating in Nova Scotiainclude the following for 2014:3 The Prince Edward Island Small BusinessDeduction Limit is $500,000 as of January 1,2014.Taxation Law 59

Business TypeTax RateGeneral 16%Manufacturing & Processing 16%Small Business 4 3%As in New Brunswick and Prince EdwardIsland, financial institutions are subject to aprovincial capital tax at a rate of 4% ontaxable capital in excess of $2 million asdefined in the Nova Scotia CorporationCapital Tax Act. The tax payable under thislegislation is deductible from taxable incomefor federal and provincial corporate incometax purposes.Businesses subject to tax in Nova Scotiamay be eligible for (or individually benefitfrom) one or more tax credits, incentivesand benefits programs offered by theprovincial government. These include:Equity Tax Credit;New Small Business Tax Deduction;Film Industry Tax Credit;Digital Media Tax Credit;Labour-Sponsored Venture-CapitalTax Credit; andResearch and Development TaxCredit.Newfoundland and LabradorThe applicable corporate tax rates forcorporations operating in Newfoundland andLabrador depend on the type of businessundertaken by a corporation and include thefollowing for 2014:Business TypeTax Rate(as ofJanuary1, 2014)TaxRate(as ofJuly 1,2014)General 14% 14%Manufacturing &5% 5%ProcessingSmall Business 5 4% 3%In addition to corporate income tax,businesses operating in Newfoundland andLabrador are also liable for a payroll tax,known as the Health and Post SecondaryEducation Tax. This tax is payable at a rateof 2% by employers whose annualemployee remuneration payable in theprovince exceeds $1.2 million.Further, unlike many Canadian provinces,Newfoundland and Labrador does notimpose a general capital tax on largecorporations.Financial institutions with permanentestablishments in Newfoundland andLabrador are subject to a 4% capital taxpayable on an entity’s taxable capital in theprovince. Financial institutions with taxable4 The Nova Scotia Small Business DeductionLimit is $350,000 as of January 1, 2014.5The Newfoundland and Labrador SmallBusiness Deduction Limit is $500,000 as ofJanuary 1, 2014.Taxation Law 60

capital of less than $5 million are exemptfrom the tax, and financial institutions withless than $10 million of taxable capital aresubject to capital tax to the extent that thetaxable capital exceeds $5 million.Businesses subject to tax in Newfoundlandand Labrador may be eligible for (orindividually benefit from) one or more taxcredits, incentives and benefits programsoffered by the provincial government. Theseinclude:Direct Equity Tax Credit;Manufacturing and Processing TaxCredit;Small Business Tax Credit;Small Business Corporate IncomeTax Holiday;Labour-Sponsored Venture CapitalTax Credit;Film Tax Credit;Resort Property Investment TaxCredit;Scientific Research andExperimental Development TaxCredit; andEconomic Diversification and GrowthEnterprises (“EDGE”) Program.Most significantly, corporations that qualifyfor the EDGE Program may receive a 10 or15 year tax holiday from provincialcorporate income and payroll taxes and a50% tax rebate of federal taxes for thesame period, followed by a five year phaseinof these taxes.SALES AND SERVICES TAXThe federal government levies a 5% Goodsand Services Tax (“GST”) on the supply ofmost goods and services.The Atlantic Provinces are parties to anagreement with the federal governmentunder which separate GST and provincialsales taxes have been replaced by a singleHarmonized Sales Tax (“HST”). The HSTrate varies between provinces as follows:ProvinceHST RateNew Brunswick 13%Prince Edward Island 14%Nova Scotia 15%Newfoundland and Labrador 13%Regardless of the province, the federalportion of the HST is 5%, with the provincialportion comprising the difference, which isapplied to the same goods and services asthe GST.The GST/HST which is paid or payable onpurchases, expenses and property used forcommercial activities may be recoverable byclaiming input tax credits. As well, there area variety of rebates available which mayallow businesses and individuals to recoverthe GST/HST paid on certain goods andservices.Imports and exports are subject to variousexceptions from GST/HST. For example,certain goods and services ordinarilytaxable at 5% GST or 13% HST may beTaxation Law 61

taxed at zero percent if they are exportedfrom Canada and certain other conditionsare satisfied.PROPERTY AND BUSINESS TAXESDetails on property and business taxes arecontained in Chapter 16 – Municipal Law.PROPERTY TRANSFER TAXESThe transfer of an interest in land may besubject to provincial transfer or registrationfees, as well as to GST/HST. Provincialtaxes and fees vary from province toprovince (and within the particularprovinces), and there are varyingexemptions available in each province.PERSONAL INCOME TAXIndividual Canadian residents are taxed ona progressive basis – the higher the income,the higher the tax rate. For 2014, the federaltax rates payable are:In addition to federal tax, each of theAtlantic Provinces levies personal incometax directly on taxable income earned byresidents of the particular province.Provincial taxable income is calculatedusing the same definition as federal taxableincome. However, a separate set of taxbrackets and tax rates are used to calculateprovincial tax, and the tax credits availableto an individual also vary from province toprovince. For 2013, the provincial tax ratespayable are:New BrunswickTaxable IncomeTax Rate$0 - $39,305 9.68%$39,306 - $78,609 14.82%$78,610 - $127,802 16.52%$127,803 and over 17.84%Taxable IncomeTax RatePrince Edward Island$0 - $43,953 15%Taxable IncomeTax Rate$43,954 - $87,907 22%$87,908 - $136,270 26%$136,271 and over 29%$0 - $31,984 9.8%$31,985 - $63,969 13.8%$63,970 and over 6 16.7%6 A surtax of 10% is applied on Prince EdwardIsland tax exceeding $12,500.Taxation Law 62

Nova ScotiaTaxable IncomeTax Rate$0 - $29,590 8.79%$29,591 - $59,180 14.95%$59,181 - $93,000 16.67%$93,001 - $150,000 17.5%$150,001 and over 21%Newfoundland & LabradorTaxable IncomeTax Rate$0 - $34,254 7.7%$34,255 - $68,508 12.5%$68,509 and over 13.3%The provincial tax rates are added to thefederal tax rate to compute the effective taxrate.Taxation Law 63

Chapter 7Real Estate Law

CHAPTER 7REAL ESTATE LAWGENERAL CONCEPTSCanadian real estate law hasroots that stretch back as faras the eleventh centuryEnglish feudal system. As aresult, the principles andconcepts of land rights whichapply in Canada areconsistent with those thatexist in many other countries,including the United Statesand England.Fundamental to the property law system isthe concept that land can be subject todifferent interests held by different people,some simultaneously.The highest interest in land that can be heldis a freehold estate. There are severalcategories of freehold estate, the uppermostbeing the fee simple, which looselytranslated means an outright ownership ofpotentially infinite duration. Lesser interestsare a life interest, which as the namesuggests, is an interest which expires uponthe death of the person holding it, and aremainder interest, which is an interest inland which will become a fee simple interestafter the death of the life interest holder. Noperson can sell a greater interest in landthen that which he holds. If, therefore, onewants to buy a fee simple interest in landsfrom someone who holds only a life interest,one must be sure to include in thetransaction those holding the remainderinterest. Furthermore, if one buys the lifeinterest from the life interest holder, thepurchaser has an interest only for the life ofthe person to whom the life interest wasoriginally granted.Real Estate Law 64

The next highest interest in land is aleasehold estate, which is a temporary rightof possession enjoyed by one party (thetenant), to land owned by another (thelandlord) pursuant to the terms of a writtenlease.In addition to freehold and leasehold estatesin lands, there are several lesser categoriesof interests including easements, licences,profits à prendre and restrictive covenants.An easement is a burden which attaches toone piece of land for the benefit of anotherand which stays with the land even thoughthe land changes ownership. Commoneasements are rights-of-way for access orutilities and the right to drain water onto theland of another (drainage easements).Except where permitted by statute, valideasements require a clear description of theright to be enjoyed, the lands burdened andthe lands directly benefitted.Licences are likewise rights to use the landsof another but in this case the right is infavour of a person rather than land. Thus, aparticular business may have a licence tocross the land of a neighbour for thepurpose of accessing a public road in aparticular place. Generally speaking,licences expire when the ownership of theproperty over which the right is enjoyedchanges or when the licence holder sells itsland. If the licence is intended to outlive thecurrent parties to it, it is very important thatappropriate wording be included in theoriginal grant of licence to accommodatethis intention.Profits à prendre are rights to go onto thelands of another to take something of valuein the land itself (for example, crops, trees,gravel) and remove it.Restrictive covenants come in three forms,two of which run with the land and one ofwhich is contractual. Restrictive covenantsset up under a building scheme attach to allof the lots within the particular subdivisioncreated by the developer. Restrictivecovenants in residential subdivisions havebeen common for many years and now theyare appearing more frequently incommercial subdivisions also.Municipalities, for example, generallyimpose restrictive covenants on newindustrial parks. The intention of therestrictions is to protect the value of thelands within the subdivision by imposingrules as to how the lands may be used.Similarly, one land owner may subdivide hisland in two and sell one portion of landsubject to a restrictive covenant which is forthe benefit of the land remaining with theland owner. An example of this type ofrestrictive covenant would be a restrictionon building within a certain portion of thenew lot so that the view from the remainingland is not affected. Because this restrictionis for the benefit of the remaining land, thisrestriction will run with the two lots when thelands are sold.The contractual restrictive covenant is arestriction on the use which may be made ofland which is advantageous to the businessof the party selling it. Thus for example,Company A may sell a piece of land toCompany B with the restriction thatCompany B may not use the land for thepurpose of carrying on a business similar tothat of Company A. The lands to bebenefited by the restriction must beReal Estate Law 65

identified with the intention that if CompanyA ceases to carry on business at thatlocation, the purpose for the restrictivecovenant disappears. When challenged,courts have often held that these restrictivecovenants can only be imposed for a certain“reasonable” period of time on lands withina “reasonable” distance from the businessbeing benefitted, as determined by the factsof the particular case.Title to land can be held by one or morepeople or entities for themselves or for thebenefit of others.Generally, persons and companies hold titleto their own land. If two or more people taketitle, they can own as joint tenants or astenants in common. joint tenants, who musthold equal interests obtained from the samegrantor(s), have a right of survivorship, i.e.:if one dies then the other(s) automaticallyobtain the interest of the deceased, entirelyif there is one joint tenant and in equalshares if there are more. Tenants incommon can hold unequal shares ofproperty, which shares can come fromdifferent people. When a tenant in commondies, his or her share goes into his or herestate and is distributed in accordance withthe terms of the will or, if no will exists,according to the intestacy laws of theprovince where the land lies.Executors and personal representatives areexamples of people who hold title to land forthe benefit of others, as of course, dotrustees who take title pursuant to a trustinstrument. These people have the “legal”title because the land is held in their namebut the “beneficial” title lies with those whoare supposed to benefit from the land, theso called beneficiaries. The powers of thosewho hold land in trust are determined by theinstrument which set up the trust andsometimes by statute.FEDERAL LAWWhile jurisdiction over property and civilrights is allocated to the provinces under theconstitution, some federal laws may affectproperty transactions. Statutes whichcommonly come into play are the ExciseTax Act (Harmonized Sales Tax/Goods andServices Tax in commercial transactions),the Income Tax Act (capital gains taxpayable on the proceeds of lands sold bynon-residents of Canada) and theBankruptcy and Insolvency Act. Lessfrequently, but very important whenrelevant, one has to pay attention to federallaws relating to environmental standards,the regulation of lending institutions,navigable waters, railways and airports.PROVINCIAL LAWEach province has its own laws andprocedures relating to the creation,protection and disposition of interests inland and one is therefore wise to consult alawyer in the province where the land lieswhen legal advice is required.OwnershipGenerally speaking, there are no restrictionson the ownership of land in New Brunswick,Nova Scotia or Newfoundland andLabrador. However, New Brunswick andNewfoundland and Labrador require thatcorporations holding certain interests in landmust be registered as extra-provincialcorporations under their provincialcorporation legislation.Real Estate Law 66

The situation is different in Prince EdwardIsland. The Land Protection Act restrictsland ownership by limiting the aggregateamount of land a person (resident or nonresident)may own to 1,000 acres and acorporation to 3,000 acres. In certaincircumstances the Lieutenant Governor inCouncil (“Executive Council”) controls theamount of land a non-resident orcorporation may acquire. A non-resident orcorporation must make an application to theIsland Regulatory and Appeals Commission(“IRAC”) for approval of a land acquisition ifthey have an aggregate land holding inexcess of 5 acres or have shore frontage inexcess of 165 feet. IRAC reviews theapplication and makes a recommendation toExecutive Council. Executive Council maydecide to approve, approve withidentification, approve with conditions ordeny an application for land acquisition.Land Registration systemsAll provinces have a public system of landregistration administered by provincialauthorities through which title to land can beinvestigated and transferred. Generallythere are two systems of land registration:the “registry” system and the “land titles”system.Registry SystemsUnder the registry system the emphasis ison the names of the people owning lands.Grantor/Grantee indices list the names ofthe entities/persons named as parties to thedocuments filed in the registry. There is nolisting of the lands themselves. Title isconfirmed by searching back to a “good rootof title”, the characteristics of which differaccording to the province the land is in, toensure that there is an unbroken chain ofvalid conveyances from the “earliest” one tothe current owner and to determine whatvalid encumbrances (easements,restrictions, mortgages, etc) may still affectthe title. The title search determineswhether the lawyer can certify the title.Unfortunately, there are many differentkinds of problems to be found. Afundamental problem is a gap in the title,either because no document exists (e.g., Aconveyed to B and C conveyed to D but Bdid not convey to C), or because there is aproblem with the document on record (e.g.,B purported to convey to C but the legaldescription was defective or B did not havethe interest which he purported to convey orB was legally incapable of executing thedeed himself, to cite a few examples). Theremay be a restriction on the use of the landor an easement which affects the enjoymentof the land. A common problem is oldunreleased mortgages.Very often there are solutions to theproblems. Sometimes the problem existsbut the risk of it leading to an issue in thepresent is so small that it is simply acceptedand not allowed to affect the currenttransaction. Sometimes title insurance willcover the risk, though it should be notedthat if the underwriters think that there is areal possibility that the problem will lead tolosses, then coverage will be denied.Land Titles SystemsOne of the advantages of the land titlessystems is that the ownership of the landsand, to some extent, the benefits andburdens on title are warranted by theprovince. Under this system, the lands inReal Estate Law 67

the province are mapped and assigned anidentification number. Title andencumbrances are confirmed by looking upthat number and reviewing the parcelregister/information page, which typicallylists the owner and any instruments whichmay affect the title: easements (bothbenefitting and burdening the land),restrictions and financial charges such asmortgages, debentures and liens.Judgments may or may not be found in theparcel register. Because of their naturethere is usually a special judgment rollwhich lists the names of people who arejudgment debtors.When land titles systems replace registrysystems a process has to be in place for thetransfer, (sometimes referred to as“migration”) of the information from onesystem to the other.The land titles system is clearly moreefficient and particularly suited to thecomputer age. The transfer of records is atime consuming process, however, and untilthe process is complete a province mayhave both a registry system and a land titlessystem operating in parallel from the samephysical office space (the “LRO”).Again mixing the old and the new, someLROs have only electronic records for publicviewing which may be accessed byauthorized users from computers anywhere,while other LROs have only paper recordsand one needs to attend physically at theLRO to review them.Recording CostsRecording fees differ from province toprovince, not only in amount, which is to beexpected, but also in character. In NovaScotia, for example, there is a standard feeacross the board for each document to befiled. In Newfoundland and Labrador, on theother hand, the fee for recording a mortgagedepends on the amount of the mortgageand can be as high as $5,000.Deed transfer taxes also differ fromprovince to province and sometimesbetween municipalities within eachprovince.DocumentsThe form and content of documents whichmay be filed at the LROs, whether under theregistry system or the land titles system,differ from province to province. Forexample, agreements of purchase and saleand caveats (documents intended to givenotice that someone believes/claims he hasan interest in someone else’s land, but notsufficient to establish that interest) are notrecordable in Nova Scotia though they arein other provinces. In New Brunswick andNewfoundland and Labrador amortgage/notice of mortgage may set outthe financial particulars but not all of theterms of the mortgage, which in NewBrunswick are incorporated by reference toa set of standard terms recorded separately.In Nova Scotia and Prince Edward Islandthe complete mortgage is always recorded.In New Brunswick, registrable documentsare restricted to certain forms prescribed byregulation under the Land Titles Act, whichmust be used for land titles registrations.The differences noted above underline theimportance of having someone who isfamiliar with a given jurisdiction’srequirements prepare your documents toReal Estate Law 68

ensure they will be acceptable to the localregistry.Statutory InterestsIn each province there are interests createdby statute which do not have to be recordedin order to bind a property. Statutory liensinclude liens for unpaid property taxes,business occupancy taxes, workers’compensation levies and utilities. Again, theliens are not uniform across the provinces.Other statutory interests include short-termleases, certain unrecorded easements,certain rights of access, some rights of theCrown and municipal by-laws.SALESThe sale of land between arms lengthparties is generally governed by the termsof a written agreement of purchase andsale. Verbal agreements for the sale oflands are generally unenforceable underprovincial legislation. Sometimes the armslength parties enter into a letter of intentwhich sets out the major terms of the sale tobe incorporated in the formal agreement butmore frequently the parties simply enter intoan agreement of purchase and salenegotiated between them, either with theassistance of a real estate agent or alawyer. The more complex the transaction,the more advisable it is to have a lawyerinvolved at some point before theagreement of purchase and sale isexecuted by the parties.The agreement of purchase and saleidentifies the lands, sets out the purchaseprice, the due diligence investigations andinspections to be undertaken by thepurchaser, any preconditions to the sale tobe fulfilled by the purchaser or the sellerprior to closing, the representations andwarranties to be given by the seller withrespect to the lands, the closing date andvarious standard terms which direct how thesale will be completed. Generally thepurchaser is required to make a deposit toconfirm his interest in the property. Theamount of the deposit varies according tothe amount of the purchase price, thenature of the lands being sold and the termsof the agreement itself. The greater thevalue of the land or the further away theclosing date, for example, the greater theamount of the deposit. As a deposit (whichis generally held either by the listing agentor the seller’s lawyer) will be forfeited if thepurchaser defaults under the terms of theagreement of purchase and sale, it is veryimportant that the purchaser pay attention tothe deadlines set out in the agreement withrespect to due diligence and satisfaction ofpreconditions, or seek extensions, asrequired.The onus is on the purchaser to make surethat the lands and any buildings on thelands are satisfactory to the purchaser inevery respect (survey, zoning, title, value,suitability for the purpose intended, andphysical condition - both structuralsoundness of buildings and environmentalcondition of the lands overall). It is,therefore, very important that the purchaserpay close attention to the due diligence andpreconditions in the agreement andcoordinate with the experts required toassist in the process. Apart from a lawyer,the purchaser may need a surveyor, abuilding inspector, a contractor, a soilsengineer and/or an appraiser, depending onthe complexity of the transaction and theavailability of pre-existing information.Real Estate Law 69

The lawyer’s role in the transaction is toassist with the due diligence process byobtaining information and, if necessary,raising objections if acting for the purchaseror by providing information and answeringobjections if acting for the seller. The lawyerwill also prepare documents for executionby the party for whom he is acting, reviewdocuments being prepared for execution bythe other party, deal with any mortgagecompany involved in the transaction, assistwith the calculation of adjustments, coordinatethe closing itself and ensure anypost-closing requirements are fulfilled in atimely manner (e.g., registration ofdocuments, payouts of mortgages, provisionof title reports, and registration of releases).Real Estate Law 70

Chapter 8Securities Law

CHAPTER 8SECURITIES LAWREGULATORY OVERVIEWEvery province and territory in Canada hasits own securities regulatory system,including separate securities legislation andgoverning authorities. As a result, nationalsecurities transactions require compliancewith several regulatory schemesadministered by different authorities. Inrecent years, the substantive requirementsof these different regulatory schemes havelargely been harmonized under a system ofnational instruments adopted as rules by theregulatory authorities in most or all of thejurisdictions. The federal government hasproposed a single national securitiesregulatory system which provinces canvoluntarily join, following a Supreme Courtof Canada ruling that the federalgovernment could not unilaterally impose anational securities regime.Each of the four Atlantic Provinces has itsown Securities Act which, while notidentical, share many common features.Provincial securities legislation creates a“closed system” for the trading of securitiesand regulates both the issuance anddistribution of securities by the issuingcompany, as well as secondary trading bysecurity holders in the respective provinces.The purpose of securities legislation is toprotect investors, which is accomplished intwo basic ways. First, securities legislationstrives to ensure that all investors andsecurity holders have as much informationas possible concerning the securities thatthey are acquiring or selling. This isaccomplished by both initial and continuousdisclosure requirements. Second, industryprofessionals must meet appropriatecompetency requirements and are requiredto be registered under the legislation. Thisensures that investors can be advised byknowledgeable persons prior to making aninvestment.DISCLOSURE OF MATERIALINFORMATIONCompanies that issue securities to thepublic (“reporting issuers”) must provideboth initial and continuous disclosure. Thekey to initial disclosure is the “prospectus” -a detailed document which describes thecompany’s business, financial position andsecurities. Provincial securities legislationalso requires that continuously updatedinformation on the reporting issuer be madepublicly available, including details on anymaterial changes to the business of thecompany, insider trading information, earlywarnings for take-overs, and up-to-dateSecurities Law 71

financial information. These disclosurerequirements are generally consistentacross the provinces.PROSPECTUS PROCESSIssuers filing a prospectus must do soelectronically through licensed softwareknown as “SEDAR”. The issuer must file apreliminary prospectus in each of theprovinces in which securities will be offered.There is a review and comment processthat is led by the securities regulator in the“principal” jurisdiction with the mostsignificant connection to the issuer. After thesecurities regulators have cleared theprospectus for final filing, the issuer thenfiles the final prospectus. A registered agentor underwriter is generally required toparticipate in this process and sign acertificate on the prospectus along with twoofficers and two directors of the issuerverifying that there is no misrepresentationin the prospectus.LISTING REQUIREMENTSIssuers who wish to list their securities fortrading on stock exchanges must satisfyminimum listing requirements set by thestock exchange relating to their business,management, issued capital, distribution ofsecurities and financial resources. Issuersmust sign a listing contract with the stockexchange and agree to comply with therules of the stock exchange.Listed issuers must notify, and in somecases obtain the consent of, the stockexchange before making corporate changesor entering certain transactions, such as (i)changes in capital structure, (ii) materialtransactions such as businesscombinations, and (iii) issues of shares oroptions. Listed issuers must also makeregular filings with the exchanges, payannual fees and satisfy timely disclosurerequirements in addition to the continuousdisclosure requirements under provincialsecurities laws.EXEMPT TRANSACTIONSThe general rule under securities legislationis that a company may not issue securitiesunless it files a prospectus. However, it isrecognized that not all investors requiresuch protection for all securities, so thelegislation and rules adopted under thenational instruments contain a number ofexemptions from the prospectusrequirements. Additional exemptions maybe granted at the discretion of the variousprovincial securities regulatory authorities.It is important to note that although one ofthe advantages of issuing securities underthe exemptions noted below is that theissuer is not required to issue a prospectus,in some circumstances it is necessary toprovide purchasers with certain disclosuredocuments when a company is attemptingto sell its securities. Even if not mandated, itmay be commercially necessary to have adisclosure document to give to prospectivepurchasers in order for them to have theinformation required to make an investmentdecision.The following are a few of the more usefulprospectus exemptions set out in provincialsecurities legislation, local rules, policiesand/or national instruments adopted by thevarious provincial securities regulatoryauthorities.Securities Law 72

Accredited Investor ExemptionEach of the Atlantic provinces has anexemption that allows a person or companyto purchase the security of an issuer if thepurchaser purchases the security asprincipal (i.e. not on behalf of someoneelse) and is an “accredited investor”. Toqualify as an accredited investor, the personor company must meet one of severalsophistication or financial tests, includingamong others:An individual who, either alone orwith a spouse, beneficially owns,directly or indirectly, financial assetshaving an aggregate realizable valuethat before taxes, but net of anyrelated liabilities, exceeds $1 million;An individual whose net incomebefore taxes exceeded $200,000 ineach of the two most recent years orwhose net income before taxescombined with that of a spouseexceeded $300,000 in each of thetwo most recent years and who, ineither case, reasonably expects toexceed that net income level in thecurrent year;An individual who, either alone orwith a spouse, has net assets of atleast $5 million; andAn entity, other than an individual orinvestment fund, that has net assetsof at least $5 million, as shown on itsmost recently prepared financialstatements.There are no limits on the number ofaccredited investor purchasers or theaggregate proceeds raised. Regulatoryfilings may be required post-transaction.Private Issuer ExemptionClearing a prospectus involves costs thatrarely can be justified or borne by a small,private company. Accordingly, exemptionsare provided for private issuers to sellsecurities to a specified category ofpurchasers. To qualify for this exemption, acompany must:Have a restriction on the transfer ofits securities in the company’sconstating documents or in ashareholders’ agreement;Not be a reporting issuer or aninvestment fund;Not have more than 50 shareholders(not counting current or formeremployees); andOnly sell (and have only ever sold)its securities to persons who eitherare within listed categories (includingaccredited investors, employees,directors, officers and certainrelatives, close friends or businessassociates of directors and officers)or are not the “public”.Whether a person falls into the “public”category can be a difficult question toanswer, and involves a mixture of fact andlaw. Generally speaking, the approachtaken is based on the view that the publiccomprises those members of a communitywho need the protection of securitieslegislation and require the informationcontained in a prospectus to make aninformed investment decision. A number offactors are relevant in determining whethera person is part of the “public” in respect ofthe trading of a particular security, includingthe number of offerees and purchasers in atransaction, the relationship of theSecurities Law 73

purchasers to the issuer, the sophisticationor investment expertise of purchasers ortheir access to advice, the net worth orability of the purchasers to risk a completeloss of their investment, the manner inwhich the offering is made, the purpose ofthe offering, and the circumstances relatingto the issuer.Because a private issuer is, by definition,not a reporting issuer, there is no public orliquid market for its equity securities, andthere may be limited access to informationabout the company’s business or finances.Investors generally must be prepared to bein for the long term. As a result, it can bedifficult for the owners of the business toraise money using the private issuerexemption.Family, Friends and BusinessAssociates ExemptionAll of the Atlantic provinces have adoptedan exemption which allows for trades in thesecurity of an issuer if the purchaserpurchases the security as principal and isone of the following:a. A director, executive officer orcontrol person of the issuer, or of anaffiliate of the issuer;b. A spouse, parent, grandparent,brother, sister or child of a director,executive officer or control person ofthe issuer, or of an affiliate of theissuer;c. A parent, grandparent, brother,sister or child of the spouse of adirector, executive officer or controlperson of the issuer, or of an affiliateof the issuer;d. Aa close personal friend of adirector, executive officer or controlperson of the issuer, or of an affiliateof the issuer;e. A close business associate of adirector, executive officer or controlperson of the issuer, or of an affiliateof the issuer;f. A founder of the issuer or a spouse,parent, grandparent, brother, sister,child, close personal friend or closebusiness associate of a founder ofthe issuer;g. A parent, grandparent, brother,sister or child of the spouse of afounder of the issuer;h. A person or company of which amajority of the voting securities arebeneficially owned by, or a majorityof the directors are, personsdescribed in paragraphs (a) to (g); ori. A trust or estate of which all of thebeneficiaries or a majority of thetrustees or executors are personsdescribed in paragraphs (a) to (g).There are no specified limits on the numberof purchasers or the aggregate proceedsunder this exemption. Regulatory filingsmay be required post-transaction.Offering Memorandum ExemptionEach of the Atlantic provinces has adoptedan exemption for trades by an issuer in asecurity of its own issue if the purchaserpurchases the security as principal and, atthe same time or before the purchaser signsthe agreement to purchase the security, theissuer delivers an offering memorandum ina specified form to the purchaser, andobtains a signed risk acknowledgement.The offering memorandum must containSecurities Law 74

certain information about the issuer andother disclosures that are specified in thesecurities legislation and rules. The requireddisclosures are similar to, but generallysomewhat less onerous than, theprospectus disclosure requirements. InPrince Edward Island, the purchaser mustbe an “eligible investor” or be investing lessthan $10,000. The eligible investor is similarto the accredited investor definition forindividuals, but with lower thresholds. Unlikeother exemptions, purchasers under anoffering memorandum must also be grantedrights to rescind purchase commitments andrights of action for misstatements in theoffering memorandum comparable to thoseavailable to purchasers under a prospectus.There are no limits on the number ofpurchasers. Regulatory filings may berequired post-transaction.Minimum Purchase Amount ExemptionA transaction is exempt from the prospectusrequirements of provincial securitieslegislation where the purchaser purchases,as principal, securities that have anaggregate acquisition cost of at least$150,000. There are no limits on thenumber of purchasers, but purchasers mustnot have been formed for the purpose ofmaking the investment (i.e. investors maynot pool their resources in a new entity totake advantage of this exemption).Regulatory filings may be required posttransaction.Securities Law 75

Chapter 9IntellectualProperty

CHAPTER 9INTELLECTUAL PROPERTYINTELLECTUAL PROPERTY RIGHTSIntellectual property rights are intangible,exclusivity rights which provide their ownerslegal remedies to stop others from exploitingthe fruits of their intellectual labour withoutpermission inside a particular jurisdiction.They were created by governmentlegislation to advance societal interests incultural knowledge and science whilecompensating creators for their creativityand productivity. Unlike land or physicalproperty, they cannot be seen or held inone’s hands. However, they are often a veryvaluable asset and care must be taken toensure that their value is both maximizedand protected.Most intellectual property rights (includingpatents, registered trade-marks andcopyright) are created by statute; they existas a result of legislation which both definesand limits the scope of protection affordedto the intellectual property right. Copyright,Intellectual Property 76

patents and trade-marks are all governed byfederal legislation and thus the rightsassociated with them do not vary betweenprovinces and territories of Canada.Other intellectual property rights (includingtrade secrets and unregistered trade-marks)are known as “common law rights”, becausethey have evolved over time as a result ofcommon law court decisions but have notbeen codified in a statute like the Patent Actor the Copyright Act.TRADE-MARKSA trade-mark may be a word, symbol,slogan, design, sound or combination ofwords, designs, symbols, colours, or the“get-up” or unique shape of a package orproduct (or a combination of thesefeatures), used to distinguish the wares orservices of one person or organization fromthose of others in the marketplace.Trade-marks are important to any industrywhere products or services are significantlypromoted or advertised. Once peoplebecome familiar with a particular trademark,they associate a certain standard withproducts or services that are marketedunder that trade-mark. Trade-marks are anindication of source and represent not onlyactual wares and services, but also thereputation and goodwill of the producerswho own them.Trade Name vs. Trade-markA trade name is the name under which abusiness is conducted, whether it be one’sown name or the name of a corporation or apartnership or a name adopted for asegment of that business, such as a divisionof a company. A trade name can beregistered under the federal Trade-marksAct only if it is also used as a trade-mark,namely if it is used to identify wares orservices.Provincial legislation in Nova Scotia andNew Brunswick requires that any companythat operates its business under a tradename rather than under the name of theincorporated entity must register its tradename. In Prince Edward Island, companiesare not required to register their tradenames, but may do so if they wish. Before aname can be registered, a computerizedname search must be conducted. Namesthat closely resemble existing businessnames may not be registrable.Unlike the other three Atlantic provinces,Newfoundland and Labrador does not havea trade names registry. The only registry forbusiness names is the corporate registrymaintained by the Registry of CompaniesDivision of the Government ofNewfoundland and Labrador. A company’sregistered corporate name is notnecessarily the same as its trade name.Accordingly, in Newfoundland and Labradorthere is no way to know whether or not atrade name is being used by another party.It is advisable that businesses using a tradename register the name as a registeredtrade-mark if possible, as they otherwise runthe risk of a dispute arising over the rights tothe use of that trade name.Registered Trade-mark vs. UnregisteredTrade-markThere are two ways to obtain and maintaintrade-mark rights:Intellectual Property 77

By registering a trade-mark in theTrade-mark Registry in accordancewith the Trade-marks Act (registeredtrade-mark rights); orBy using a trade-mark in themarketplace (unregistered orcommon law trade-mark rights).Common law trade-mark rights are createdover time by the continued use of a trademarkin association with goods or servicesin a geographic area. The strength of theserights will depend on the public recognitionof the association between the trade-markand the goods or services being sold.Common law trade-mark rights are onlyprotected within the geographical areaswhere the goods or services are marketed.Notwithstanding the existence of basiccommon law trade-mark rights acquiredthrough use, securing registered trade-markstatus is always recommended. Registrationis primary evidence of ownership andbecomes very useful in the event of aninfringement dispute. In such a dispute, theregistered owner does not have to proveownership; the onus is on the partychallenging the owner’s rights to prove thatthe registered owner does not have the rightto register or use the trade-mark. Use of anunregistered trade-mark can lead to alengthy and expensive legal dispute overwho has the right to use it.Registered trade-mark rights give the ownerthe exclusive right to the use of the trademarkin Canada, in respect of the goodsand services associated with it, and the rightto prevent others from using the same orconfusingly similar marks for a period of 15years, which can be renewed indefinitely.The registration process takesapproximately 18 to 24 months providedthat no objections are raised by the Registryand that no third party opposition to thetrade-mark registration application arises.However, using a trade-mark prior toobtaining registration is very common andacceptable provided that adequatesearching has been done to ensure that thetrade-mark is not already being used bysomeone else and can be eventuallyregistered.Losing Trade-mark RightsTrade-mark registrations may be renewedindefinitely subject to the continued use ofthe mark. A failure to use a trade-mark mayexpose a trade-mark owner to anexpungement proceeding which, ifsuccessful, would result in the removal ofthe mark from the Registry. A failure to usea common law trade-mark erodes thestrength and goodwill of the trade-mark andmakes it more difficult to enforce againstothers.It is also possible to lose a trade-mark rightif the distinctiveness of the mark is lost andit becomes “generic”. Examples of trademarksthat have become generic in somejurisdictions include “Thermos”, “Aspirin”and “Margarine”. It is incumbent upon atrade-mark owner to watch out for andprevent infringements of its trade-markrights and enforce those rights to avoidlosing distinctiveness of the mark.Infringing Trade-markUsing another party’s trade-mark or using amark that is confusingly similar to anotherparty’s trade-mark (e.g. “Appled Computers”vs. “Apple Computers”) constitutes trade-Intellectual Property 78

mark infringement. Passing off one’s owngoods or services so that they appear to besomeone else’s (e.g. labelling footwear“Nike” if it was not produced by Nike) is alsoan unlawful activity and can be enforcedeither at common law, as a tort, or pursuantto the specific rights and remediescontained in the Trade-marks Act.COPYRIGHTCopyright in Canada is governedexclusively by the federal Copyright Act.Copyright gives its owner, among otherthings, the sole right to produce, reproduce,copy or rent the protected work. It does notprevent other persons from viewing thecopyrighted material. For example,copyright does not prevent you from readinga book you have purchased, or giving yourcopy of the book to another person.However, it would prevent you fromphotocopying the book and selling thecopies to other parties.Copyright protects many different kinds of“works”. Copyright can subsist in anyoriginal literary, artistic, musical or dramaticwork, or any substantial part thereof, in anymaterial form whatsoever. It also protectssoftware programs, broadcast signals, liveperformances, sound recordings andtechnological protections measures. Theword “original” is key to defining a work thatqualifies for copyright protection. Originalitycan be tricky to determine and many courtcases revolve around the question ofwhether a work has been copied, even inpart, from someone else’s work. In order tobe protected by copyright, the work also hasto have some degree of fixation orpermanency.Copyright arises automatically upon thecreation of the work and no registration isrequired, although, like trade-marks, theregistration of copyright is useful andbeneficial. A certificate of registration isprimary, albeit rebuttable, evidence that thework is protected by copyright and that theregistered party is the lawful owner. In theevent of a legal dispute, the registeredcopyright holder does not have to proveownership - it is presumed; the onus is onthe opponent to disprove ownership.Copyright protects the expression of an ideabut not the underlying idea itself. As long asthere is no actual copying involved, anyonecan produce a similar work even if they areusing the same underlying idea. Forexample, you may have a brilliant idea for amystery plot but until the script is actuallywritten, or the motion picture produced,there is no copyright protection. Copyright isrestricted to the expression in a fixedmanner (for example: text, recording, ordrawing) of an idea; it does not extend tothe idea itself. Facts, ideas, scientificformulae, titles and news are all consideredpart of the public domain; in other words,they are everyone’s property to use withoutlimitation or restriction.Independent of the usual reproductionrights, authors also have moral rights inrespect of their works. Moral rights includethe right to be associated with a work eitherby name or by pseudonym; the right toremain anonymous; and most importantlythe right to the integrity of the work,meaning that no one can, to the prejudice ofthe author’s reputation or honour, distort,mutilate, modify or use the work forpromotional purposes. Moral rights cannotbe assigned because they are personal toIntellectual Property 79

the author. They can, however, be waivedirrevocably.In Canada, the term of copyright protectiongenerally subsists for the life of the authorplus 50 years but there are exceptionsdepending on the type of work and whetherit was authored by one or more persons.The general rule is that the author of thework is its first owner. However, when awork is created by an employee in thecourse of his or her employment, thecopyright relating to that work isautomatically owned by the employer unlessthere is an agreement to the contrary. Awork created by an independent contractoris owned by the independent contractorunless there is an agreement to thecontrary, despite the fact that the work inquestion may have been commissioned andpaid for by someone else.Exceptions to InfringementThere are certain uses that can be made ofcopyrighted material that do not constituteinfringement and, as such, are legaldefences to claims of infringement.Historically, such defences have beencalled “fair dealing” (in contrast to “fair use”in the US legislation, although thesubstantive differences are minor).However, as a result of a recent line oflandmark decisions of the Supreme Court ofCanada, fair dealing is now moreappropriately described as “user rights” inCanada. User rights must be exercisedfairly and must fall within one or more of theseven enumerated statutory purposes: (i)research; (ii) private study; (iii) education;(iv) parody; (v) satire; (vi) criticism or review;and (vii) news reporting. There are also anumber of other specific exceptions toinfringement contained in the Copyright Act,however they are extremely detailed,relatively narrow and beyond the scope ofthis summary.PATENTSPatent law in Canada is governedexclusively by the federal Patent Act. Apatent gives the owner of the patent theexclusive right to manufacture, use and sellthe invention claimed in the patent, and theability to prevent others from doing thesame. A patent protects the claimedinvention only, and not just the expressionof the inventive idea, like copyright. Thus,even if you independently developinventions on your own, without anyknowledge of an existing patent, you maystill be barred from making, using or sellingthe invention until the patent that previouslyclaimed the invention has expired.Patents offer inventors monopolies on theircreations for specific periods, and thusprovide incentives for research anddevelopment. The length of time duringwhich a patentee is able to exercise itsexclusive rights is currently 20 years fromthe Canadian application date. Without thepossibility of patent protection, many peoplemight not take the risks or invest the timeand money involved in devising andperfecting new products.Patents are also a means of advancingtechnology. The patent discloses in clearand specific terms how the invention beingpatented works although no one else canuse the information until the patent hasexpired. Because of the rigid tests andjurisprudence governing the patentability ofinventions, patents are more difficult toIntellectual Property 80

obtain than other forms of intellectualproperty rights and their applications cantake many years and carry significant costs.RequirementsIn order to be issued a patent, the inventionmust meet all four of the followingrequirements:Patentable subject matter: Any newand useful art, process, machine,manufacture or composition ofmatter, or improvement, can be thesubject of a patent. Scientificprinciples, mathematical equationsand other like “inventions” are notpatentable subject matter.Novelty: The invention must nothave been disclosed in a mannersuch that it had become available tothe public prior to the filing date ofthe application (if the disclosure wasby a third party), or prior to one yearbefore the filing date of theapplication (if the disclosure was bythe inventor).Non-Obviousness: The inventionmust reflect some amount ofinventive ingenuity; in other words, itmust not be obvious to a skilledprofessional in the industry, havingregard to all of the other informationand knowledge of the industry that isavailable to him or her.Utility: The invention must servesome functional purpose and it mustdeliver the results promised in thepatent, if any.patent expires, there is nothing to preventothers from making the inventionthemselves. Accordingly, inventorssometimes choose to maintain the inventionas a trade secret instead.TRADE SECRETSA trade secret is information that is actuallysecret in an objective sense. For example,secret chemical formulae and proprietaryrecipes for are not patented or otherwiseregistered under some statute – they aretrade secrets, unknown to anyone otherthan the companies that own the productsand their employees who need to know. Ifthe recipes were patented, anyone coulduse them after the patent expired in 20years but as a trade secret, the rights arepotentially perpetual.However, there are inherent problems withattempting to protect an invention as a tradesecret. There is no protection for theinventor if another person independentlyinvents or discovers the subject matter ofthe trade secret and there is nothing toprevent that person from using or exploitingthe information, applying for a patent orpublishing the information. Furthermore,once the information becomes public, thetrade secret loses all of its value. Althoughthe owner of a trade secret may have a rightof recourse against a third party who,through wrongful actions, discloses thetrade secret, this may not compensate theowner for the loss in value or preventinnocent parties who receive the informationfrom exploiting it.Because patent applications become publicdocuments, the world at large is then able toknow the details of an invention. After theIntellectual Property 81

INTEGRATED CIRCUIT TOPOGRAPHIESTopographies are innovative, threedimensionalcircuit designs used in manydifferent products. The federal IntegratedCircuit Topography Act (“ICTA”) providesprotection against the copying of registeredtopographies, but does not prevent othersfrom developing integrated circuit productsthat use other topographies to provide thesame electronic functions. Topography willqualify as original and receive protectionunder the ICTA if it is developed through theapplication of intellectual effort, and if it isnot produced by the mere reproduction ofall, or a substantial part, of anothertopography. The registration of thetopography gives the creator an exclusiveright in the topography for a period of 10years. The ICTA does not protect preexistingtopographies that are commonplaceamong topography designers or integratedcircuit product manufacturers.INDUSTRIAL DESIGNSAn industrial design is a feature of anobject, whether a shape, configuration,pattern or ornament or any combination ofthose features, that, in the finished article,are assessed by appearance as opposed toutility and functionality. Industrial designsthat are original and not similar to existingdesigns may be registered under the federalIndustrial Design Act and receive amonopoly on the design for a period of 10years.new plant varieties. The PBRA gives plantbreeders the exclusive right to sell andproduce the protected variety in Canada, tosell the variety’s propagating material, touse the variety in commercially producinganother variety, to use the variety inproducing ornamental plants, and to licenseothers to do any of the above, for a periodof 18 years.LICENCES AND ASSIGNMENTSFrequently, the technology protected byintellectual property rights is licensed orassigned to others for use. An assignmentis a transfer of ownership rights from oneparty to another; whereas a license doesnot transfer any property interest or title tothe work to the licensee. A licence is acontract that allows someone to use thework on the terms and conditions set out inthe licence. A licence can be structured sothat it is non-exclusive allowing the licensorto grant as many licenses as it chooses todifferent parties. Limited time frames, usagerights, territorial restrictions and other termsand conditions can be placed on thelicence. With an assignment, the originalrights of the owner are generally lost.Federal registries such as the TrademarksRegistry and the Copyrights Registry shouldbe notified of transfers of ownership ofregistered intellectual property rights.Certain transfers must be documented inwriting in order to be valid.PLANT BREEDERS’ RIGHTSThe federal Plant Breeders’ Rights Act(“PBRA”) gives plant breeders in Canadacertain rights relating to the production ofIntellectual Property 82

Chapter 10Privacy Law

CHAPTER 10PRIVACY LAWFEDERAL LAWSPersonal Information Protection andElectronic Documents ActThe Personal Information Protection andElectronic Documents Act (“PIPEDA”) isfederal legislation that imposes statutoryobligations and restrictions on private sectororganizations for the collection, use anddisclosure of personal information of othersand applies in all provinces and territories,except Alberta, British Columbia andQuebec, which have enacted their own“substantially similar” legislation. InNewfoundland and Labrador, NewBrunswick and Ontario, legislation dealingwith health information has been deemed tobe “substantially similar” to PIPEDA. Assuch, PIPEDA does not apply in thoseprovinces to health information.Private sector organizations in AtlanticCanada that collect, use or disclosepersonal information in the course of theircommercial activities are required to complywith PIPEDA. Personal information meansinformation about an identifiable individual,but does not include the name, title orbusiness address or telephone number ofPrivacy Law 83

an employee of an organization. UnderPIPEDA, organizations are required tocomply with the key principles set out in theModel Code for the Protection of PersonalInformation, which include the following:Accountability: Organizations areresponsible for personal informationunder their control and mustdesignate an individual or individualswho are accountable for theorganization’s compliance with theprinciples set out in PIPEDA.Identifying Purposes: The purposesfor which personal information iscollected must be identified by theorganization at or before the time theinformation is collected.Consent: The knowledge andconsent of the individual arerequired for the collection, use, ordisclosure of personal information,except where inappropriate.Limiting Collection: The collection ofpersonal information must be limitedto that which is necessary for thepurposes identified by theorganization. Information must becollected by fair and lawful means.Limiting Use, Disclosure, andRetention: Personal informationmust not be used or disclosed forpurposes other than those for whichit was collected, except with theconsent of the individual or asrequired by law. Personalinformation must be retained only aslong as necessary for the fulfilmentof those purposes.Accuracy: Personal information mustbe as accurate, complete and up-todateas is necessary for thepurposes for which it is to be used.Safeguards: Personal informationmust be protected by securitysafeguards appropriate to thesensitivity of the information.Openness: Organizations mustmake readily available to individualsspecific information about theirpolicies and practices relating to themanagement of personalinformation.Individual Access: Upon request, anindividual must be informed of theexistence, use, and disclosure of hisor her personal information and mustbe given access to that information.An individual must be able tochallenge the accuracy andcompleteness of the information andhave it amended as appropriate.Challenging Compliance: Anindividual must be able to address achallenge concerning theorganization’s compliance with theabove principles to the designatedindividual or individuals accountablefor the organization’s compliance.The Privacy Commissioner of Canada isresponsible for overseeing theadministration of the legislation andinvestigating and adjudicating complaints.Complaints regarding an organization’scompliance can be filed by any person or bythe Privacy Commissioner. The PrivacyCommissioner has broad powers, includingthe right to conduct audits, undertakeinvestigations, issue subpoenas, compelpersons to give evidence, and enter thepremises of an organization and examine orobtain copies of records relevant to aninvestigation. There is an offence provisionunder PIPEDA with fines for obstructing thePrivacy Commissioner in an investigation orPrivacy Law 84

audit, destroying personal information afteran access request has been made, anddisciplining an employee for lodging acomplaint against his or her employer forPIPEDA violations.PIPEDA governs only personal informationcollected, used or disclosed in the course ofan organization’s “commercial activities”and does not otherwise apply to theemployer-employee relationship, unless theorganization is a federal work, undertakingor business. Provincial laws govern thetreatment of employee information.Employers should, however, follow thegeneral rules applicable in the collection ofpersonal information - namely, obtainconsent and limit collection and disclosureto only what is reasonably necessary.What’s on the HorizonBill S-4, known as the Digital Privacy Act,was introduced in federal Parliament onApril 8, 2014. If passed, the legislationwould result in numerous changes toPIPEDA with the stated goal of ensuringthat Canadian businesses and consumersare more secure when transacting online.The Digital Privacy Act seeks to increasecompliance with PIPEDA by establishingmandatory privacy breach notification withcorresponding penalties.The proposed Act would also increaseprotections for consumers by requiring morethorough record keeping by businesses. Inaddition, PIPEDA’s consent requirementswould be changed for some businesstransactions, thereby aiming to simplify therules currently imposed. The Office of thePrivacy Commissioner would be grantednew powers to engage in complianceagreements with organizations in an attemptto foster cooperation. Thorough debateabout the proposed changes is anticipatedas the Digital Privacy Act proceeds throughthe legislative process and such debatecould also provide a review of PIPEDA.Access to Information ActThe federal Access to Information Act(“ATIA”) provides a right of access toinformation in records under the control of afederal government institution and applies toany federal government institution that is aCrown corporation and any of its whollyownedsubsidiaries. Any Canadian citizen orpermanent resident has the right to be givenaccess to any record under the control of afederal government institution. TheGovernor in Council may extend the right ofaccess to include people who are notCanadian citizens or permanent residents.The ATIA provides protection to third partiesby restricting the disclosure of any recordthat contains:Ttrade secrets of a third party,Financial, commercial, scientific ortechnical information that isconfidential information supplied to agovernment institution by a thirdparty and is treated consistently in aconfidential manner by the thirdparty,Information that is supplied inconfidence to a governmentinstitution by a third party for thepreparation, maintenance, testing orimplementation by the governmentinstitution of emergencymanagement plans that concernsthe vulnerability of the third party’sPrivacy Law 85

uildings or other structures, itsnetworks or systems, or the methodsused to protect any of thosebuildings, structures, networks orsystems, orIinformation that could reasonablybe expected to interfere withcontractual or other negotiations of athird party.A third party may give its consent to thedisclosure of the records in question.With the exception of trade secrets, if thedisclosure of information listed above wouldbe in the public interest as it relates topublic health, public safety or protection ofthe environment, the record may bereleased in whole or in part. Further, therecord may be released if the public interestin disclosure clearly outweighs any financialloss or gain to a third party; any prejudice tothe security of its structures, networks, orsystems; any prejudice to its competitiveposition; or any interference with itscontractual or other obligations.The head of a federal government institutionmust make every reasonable effort to givethe third party written notice of the request.The third party may, within 20 days after thenotice is given, make representations to thehead of the federal government institutionas to why the record should not bedisclosed. The head of the institution mustthen make a determination as to whether ornot to disclose the record, and give writtennotice to the decision to the third party. Thethird party is entitled to request a review ofthe decision by applying to the FederalCourt.Any person who has been refused accessto a record may apply to the Federal Courtfor a review of the decision. If the record inquestion affects third party interestsdescribed above, the head of the federalgovernment institution, upon becomingaware of an application for review, mustgive the third party notice of the review. Thethird party may appear as a party to thereview.PROVINCIAL LAWSPersonal Health InformationNewfoundland and Labrador, NewBrunswick and Nova Scotia have enactedpersonal health information legislation thatapplies to both the private and public sector(“Health Information Acts”). As noted above,the legislation in New Brunswick andNewfoundland and Labrador has beendeemed substantially similar to PIPEDA.Nova Scotia’s legislation has not yet beendeemed to be “substantially similar”. Thereis no health privacy legislation in PrinceEdward Island.The Health Information Acts apply topersonal health information that is collected,used or disclosed by a custodian.The terms “personal health information” and“custodian” are defined in each specific act.In general, “personal health information”includes information that relates to: thephysical or mental health of an individual;the provision of health care to the individual;payments or eligibility for health care; andregistration information. A “custodian”generally includes entities such aspharmacies, health care professionals,hospitals and health authorities.Privacy Law 86

Similar to PIPEDA, the Health InformationActs impose obligations on custodians interms of providing access to information inrecords and ensuring safeguards for thecollection, use and disclosure of theinformation.Custodians are required to take reasonableand appropriate security measures for theprotection of the personal health informationin their custody. Appropriate securitymeasures may include the use of physicalsecurity controls onsite, such as alarmsystems and door locks; administrativesecurity controls, such as policies,procedures and guidelines; andtechnological security controls, such aspasswords, firewalls and encryption.While there are some specific exemptions inHealth Information Acts, the followingprinciples normally apply:Consent is required for anycollection, use or disclosure ofpersonal health information;Collection, use and disclosureshould be limited to the amount ofinformation required for the specifictask; andIn the event of a privacy breach, theindividual should be notified.An individual’s recourse regarding acustodian’s collection, use and/or disclosureof personal health information is through theapplicable Privacy Commissioner and/orthrough the provincial superior court.The Privacy Commissioner has variouspowers including the authority toinvestigate, enter premises and compelproduction of evidence. The failure of acustodian to abide by the legislatedrequirements is an offence and can result ina fine and/or a term of imprisonment.Information Held by Public BodiesAll four Atlantic Provinces have provinciallegislation that deals with personalinformation under the custody and control ofpublic bodies (“Access to Information Acts”).Such legislation is designed to create aculture of openness and accountability inthe public sector. The term “public body” isdefined in each specific act and includessuch entities as government departments,government agencies, health boards, schoolboards and municipalities.A “record” is defined very broadly under theAccess to Information Acts to includeinformation that is recorded in any form,including information that is written,photographed, recorded or stored in anymanner whatsoever.The Access to Information Acts areimportant to keep in mind when doingbusiness with, or obtaining financing from,any of the provincial governments of theAtlantic Provinces or any of their relatedpublic bodies. Information provided to suchbodies by individuals or companies may beliable to disclosure in accordance with theAccess to Information Acts.A request for access to information underthe Access to Information Acts can be madeat any time, by any person, and for anypurpose. For this reason, businesses shouldkeep in mind the limited number ofexemptions from disclosure, such asdisclosure harmful to a third party’sbusiness or financial interest, that arePrivacy Law 87

extended to them under the Access toInformation Acts, before doing business withpublic bodies in any of the AtlanticProvinces.What’s on the HorizonNova Scotia’s Access to Information Act(Freedom of Information and Protection ofPrivacy Act) is approaching its 40 th birthday.It has been noted by some groups that thelegislation is overdue for an extensivemodernization. Newly-elected PremierStephen McNeil promised, as part of hiselection platform, to review access toinformation laws with the aim of makingNova Scotia “the most open and transparentprovince in Canada.” Whether thelegislation receives such a review andcorresponding legislative updates remainsto be seen.Newfoundland and Labrador’s Access toInformation Act is in the initial stages of areview. The Review Committee hasrequested that individuals or organizationswho are interested in making submissionsto the Review Committee express theirinterest in doing so. The Review Committeeplans to assess the level and type ofinterest and then develop its policies andprocedures for the receipt of submissions.Ultimately, the Review Committee willsubmit a report to the provincial governmentin respect of its findings andrecommendations.PROVINCIAL CONSIDERATIONSNewfoundland and LabradorIn Newfoundland and Labrador, the PrivacyAct allows an individual to commence alegal action when that individual’s privacyhas been violated. The legislation providesexamples of actions that, without theconsent of the individual, will be presumedto be a violation of privacy: auditory andvisual surveillance; listening to or recordingof a conversation; the use of the name,likeness or voice of an individual for thepurposes of advertising or promotion ofsales; and the use of personal documents ofthe individual.The Privacy Act outlines several defencesto an action for invasion of privacy inclusiveof: consent; an action incidental to theexercise of a lawful right of defence ofperson or property; and an actionauthorized by law. Of note is that the natureand degree of privacy in any situation is thatwhich is reasonable in the circumstances,with regard to the lawful interests of others,the nature, incidence, and occasion of theact or conduct, and the relationship betweenthe parties.Business owners should be aware of theactions that constitute violations of personalprivacy and furthermore mitigate theseintrusions through consent, especially in thecontext of employee relations and with theuse of personalities for advertisingpurposes.Nova ScotiaNova Scotia’s Personal InformationInternational Disclosure Act (“PIIDA”) booststhe privacy protections offered by otherprovincial legislation, including its Freedomof Information and Protection of Privacy Act(“FOIPOP”).Privacy Law 88

PIIDPA applies to all records in the custodyor under the control of a public body,including court administration records. Thescope of application is limited to personalinformation, as defined under FOIPOP.Under PIIDPA, public bodies andmunicipalities are mandated to make surethat any personal information held by them(and by any service provider under theirdirection and/or authority), stays in Canadaand is only accessed and disclosed inCanada.Any individual employee who violates any ofthe above provisions is liable on convictionto a fine of up to $2,000 and/or six months’imprisonment. For businesses excludingcorporations, the penalty will not exceed$25,000. Corporations are subject to a fineof not more than $500,000.However, several circumstances exist underPIIDPA that provide exceptions from theabove standards. These exclusions shouldbe examined in detail before public bodiestake any action moving or storinginformation outside Canada. Private entitiesshould also be aware of protections forpersonal information outside Canada whenrequesting international record releasesfrom the Nova Scotia public sector.Offences under PIIDPA include, but are notlimited to:Mmalicious disclosure of personalinformation in contravention of thelegislation by a director, officer oremployee of a public body;Storage or access to personalinformation outside Canada by aservice provider without satisfying anexception; andCollection or use of personalinformation by a service providerbeyond what is necessary for itspurpose, or failure to makereasonable security arrangements toprotect that information.Privacy Law 89

Chapter 11Employment AndLabour Law

CHAPTER 11EMPLOYMENT AND LABOUR LAWIt has been said that employees are the greatest asset of mostbusinesses. At the same time, human resources usuallyconstitute one of the major expenses of running a business.Accordingly, it is important for businesses tounderstand the legal framework surroundingemployment relationships, to foster andgrow their greatest assets while at the sametime managing costs.EXECUTIVE SUMMARYLike other common law Canadianprovinces, employment relationships inAtlantic Canada are governed by bothlegislation and common law (i.e. judgemadelaw).Employment and Labour Law 90

Regarding legislation, a business is eithersubject to federal or provincial labour andemployment jurisdiction. The vast majorityof businesses are subject to provincialjurisdiction – meaning they are subject tothe labour and employment legislation of theprovince (or provinces) in which theyemploy their employees. Each Atlanticprovince has its own legislation that appliesto unionized and non-unionized workplaces;however, the legislation generally regulatesthe same matters and is similar, althoughnot identical. Each province has its ownrules and particularities. Labour andemployment legislation in the Atlanticprovinces generally regulates minimumemployment standards (including wages,vacation, overtime, etc.), occupationalhealth and safety, workers’ compensation,human rights, and labour relations (coveringthe process by which a union obtainsbargaining rights, the collective bargainingprocess and the rights and responsibilitiesof unions and employers). In Newfoundlandand Labrador and Nova Scotia, there arealso special rules and legislation that governemployment in the offshore oil and gasindustries.Federal jurisdiction over labour andemployment matters extends only to thoseworks or undertakings that fall within theclasses of subjects expressly exempt fromthe provincial heads of power and to thoseenterprises deemed vital, essential orintegral to a core federal work orundertaking. Examples of federallyregulated businesses include mostnavigation and shipping, inter-provincialtransport, air transportation,communications, broadcasting and banking.Federal statutes include the Canada LabourCode, whose three parts governemployment standards, health and safety,and unionization, and the Canadian HumanRights Act.While there are differences betweenlegislation in Nova Scotia, New Brunswick,Newfoundland and Labrador, PrinceEdward Island and the federal legislation,there are sufficient commonalities that weare able to provide a general overview (asset out below) of legislated employmentrequirements.In addition to the legislation of the differentjurisdictions, businesses are subject to thecommon law, which is the law as developedby judges or other decision makers. Thecommon law interprets legislation andestablishes other law, and governsemployment relationships in all jurisdictions.This body of law also creates severalimportant presumptions about employmentrelationships.For example, the common law presumesthat employees are hired for an indefiniteterm, unless a valid written contract ofemployment states otherwise. Theconsequence of this presumption, inconjunction with the laws set out inemployment standards legislation, is thatemployees who are terminated withoutcause must be provided notice oftermination or pay-in-lieu thereof. Unlike inthe United States, there is no “at-will”employment in Canada. Employeesterminated for “cause” are not entitled tonotice or pay in lieu, but the burden ofestablishing “cause” rests with the employerand can be difficult to establish.Practically, in order to manage liabilities, aswell as establish clear expectations for allEmployment and Labour Law 91

parties to the employment relationship, ournon-union clients generally prefer to havecarefully written employment contracts thatprovide a clear termination provision (whichmeets the minimum statutory requirements),job duties, salary, hours of work, andbenefits. Employers can also use writtenpolicies to govern and manage theworkplace and establish best practices forthe management of employees.Our unionized clients generally focus onstrategic bargaining to ensure a clearcollective agreement is adopted, which, inaddition to setting out employee benefits,establishes the employee responsibilitiesand employer rights, including a strongmanagement rights clause. Subject to theterms of the collective agreement, unionizedemployers can also enact reasonableworkplace policies to assist in managing theday-to-day issues of the workforce.These above issues are canvassed morethoroughly in the pages that follow.However, as the legislation, rules, andprecedents vary from province to province,employers should consult local counsel withrespect to any specific labour oremployment law issues.EMPLOYMENT AND LABOURLEGISLATIONLegislation in each jurisdiction is differentand it is not possible to provide a detaileddescription in this publication. Accordingly,the summary below provides an overview ofthe type of legislation that exists and what itgenerally covers.Employers should keep in mind that therealso exist numerous regulations madepursuant to each statute establishingspecific rights and responsibilities foremployers and employees, and that courts,boards, adjudicators and arbitrators havehad the opportunity to interpret meaning intothe legislation. Specific legal issues willrequire specific advice.Employment StandardsEach jurisdiction has employment standardslegislation. This legislation governs many ofthe basic terms of the employmentrelationship, establishing minimumstandards that employers must meet.Among other matters, this legislationgoverns:Minimum wage;Overtime pay;Hours of work;Vacation entitlements;Paid statutory holidays;Unpaid leaves; andMinimum notice of terminationrequirements.With the exception of entering into acontract that provides a greater benefit tothe employee, employers and employeescannot contract out of employmentstandards legislation and any contract thatpurports to do so may be void to that extent.However, some businesses and types ofemployment are exempt from all or parts ofemployment standards legislation. Also,there may be exemptions for unionizedemployees, although the extent of theexemptions varies between jurisdictions(where the collective agreement wouldapply).Employment and Labour Law 92

For example, in Nova Scotia, there is aspecial legislated rule that applies toemployees with 10 or more years of service.Subject to some exceptions, an employeewith 10 or more years of service in NovaScotia cannot be discharged except for justcause. One important exception, however,is where there is a “lay-off” which involves atermination of employment due to a lack ofwork, including an elimination of position.Another example is that in New Brunswickthe legislation requires that an employerprovide written reasons for dismissing anemployee for cause, otherwise the dismissalfor cause could be invalid.Human RightsEach jurisdiction has human rightslegislation that provides for an individual’sright to equal treatment with respect toemployment and prohibits discrimination onthe basis of an enumerated list ofcharacteristics. Each jurisdiction has adistinct list of protected characteristics, butall prohibit discrimination based on thefollowing (local legislation should beconsulted for a complete list of all theprotected characteristics):There are certain limited exceptions to theprohibition against discrimination, includingwhere the employer can establish that thediscriminatory treatment is based on a bonafide occupational requirement. In order tofall within this exception, an employer willneed to establish the following:The discriminatory standard isrationally connected to the functionperformed;The standard was adopted in anhonest and good faith belief that it isnecessary to fulfill a certain purpose;andThe individual cannot beaccommodated without unduehardship to the employer.Undue hardship is determined byconsidering different factors, which mayvary from jurisdiction to jurisdiction, butcould include the cost to the employer,health and safety implications andworkplace morale. Canadian courts havecommented that undue hardship is a high(but not impossible) standard for employersto meet.Occupational Health and SafetyAge;Race;Colour;Religion;National origin;Physical disability;Mental disability;Marital status;Sexual orientation; andSex (including pregnancy and childbirth).With a view to protecting the health andsafety of workers, each jurisdiction haslegislation that promotes safe workpractices and imposes shared responsibilityon the various stakeholders in theworkplace. The identified stakeholders varyin each jurisdiction, but would include theemployer and the employee, and couldinclude others such as owners,constructors, contractors, suppliers, etc.Employment and Labour Law 93

Duty to maintain a safe workplaceIn each jurisdiction, employers have ageneral duty to maintain a safe workplaceand to ensure that measures andprocedures prescribed in their respectivelegislation are followed.Investigators are, in most of thejurisdictions, permitted to conduct auditsand send officers or investigators toworkplaces and issue warnings or penaltiesto ensure enforcement of the legislation.Employers and others may also beprosecuted for violation of occupationalhealth and safety legislation. Suchprosecutions are considered “strict liabilityoffences”. This means that the prosecutorneed only establish the facts of the offence– intent does not have to be proven. If theprosecution can establish the factualelements of the offence, it falls to theaccused to establish a “due diligencedefence”. This means that the accused hasto establish that the offence was caused bythe accused’s reasonable reliance on amistaken belief or that it did everything thata reasonable person should do to preventthe incident.Employers are not held to a standard ofperfection, but they must have the requiredsafety policies in place and also have asystem to ensure those policies are followedand enforced. Employers should alsoproactively identify, assess and remedy orotherwise address hazards in theworkplace, and this should be done on anongoing basis.Right to refuse workAll employees in workplaces covered byoccupational health and safety legislationhave the legal right to be informed by theiremployer about hazards in the workplaceand to refuse to perform unsafe work, aslong as that employee has a reasonablebelief that the work or workplace is likely toendanger himself or herself, or anotheremployee. Employees who, in good faith,exercise their statutory right to refuse to dounsafe work may not be disciplined by theiremployer.Other requirementsAlthough not exhaustive, the following aresome other requirements under thelegislation in each jurisdiction:Employees must receive instructionand supervision with respect tohealth and safety issues.Appropriate protective equipmentmust be provided to and worn byemployees;Depending on the size of theworkplace, a health and safetyrepresentative or a joint health andsafety committee may have to beestablished and maintained inworkplaces; each jurisdiction has itsown rules about the composition,responsibilities and requirements ofthe committee.Hazardous materials in theworkplace must be properly labelled,stored and disposed of, andemployees must be instructed abouthazards in accordance with theWorkplace Hazardous MaterialsInformation System.Employment and Labour Law 94

OffshoreAccurate records of the handling,storage, use and disposal ofbiological, chemical or physicalagents must be maintained.Most jurisdictions have enactedspecific regulations governingcertain types of work and employersshould become familiar with theregulations that apply to theirworkplaces.Special regulations and rules apply to theoffshore industry. Both Newfoundland andLabrador and Nova Scotia have worked withthe federal government in an attempt toestablish a common approach to health andsafety in their respective offshore industries.Criminal negligenceIn 2004, the Criminal Code of Canada wasamended to make it easier to imposecriminal liability on an organization orindividual where that organization orindividual fails to take reasonable steps toprevent workplace accidents. The CriminalCode does not oust the jurisdiction ofprovincial occupational health and safetylegislation, so it is possible that proceedingsmay be brought both under the CriminalCode and applicable occupational healthand safety legislation in respect of the sameevent. Thus far, there have been relativelyfew Criminal Code prosecutions. They havebeen reserved for the most egregiousconduct.Labour RelationsEach jurisdiction has legislation thatregulates provincial trade union activities,generally known as labour relations orindustrial relations legislation. Thislegislation governs both the process bywhich a trade union acquires bargainingrights and subsequent collective bargainingprocedures between trade unions andemployers.Certification in most industriesIn each jurisdiction, unions are required toseek certification from a statutory board(titled the “Labour and Employment Board”in New Brunswick, the “Labour Board” inNova Scotia, the “Labour Relations Board”in Prince Edward Island and Newfoundlandand Labrador, and the “Canada IndustrialRelations Board” for businesses underfederal jurisdiction). While there aredifferences in each jurisdiction, they alladdress the following:Certification: the process foracquiring bargaining rights andforming a bargaining unit. Indetermining whether a bargainingunit is appropriate for collectivebargaining, the board may include orexclude employees based, forexample, on whether the employeesare management or not, andwhether a certain class ofemployees belongs in the bargainingunit.Statutory “Freezes”: once a labourboard is served with an applicationfor certification, an employer isunable to alter wage rates, terms ofemployment or any otherEmployment and Labour Law 95

employment privilege. The freezeremains in effect until the union’sapplication is either dismissed orcertified and notice to bargain isgiven. If the latter occurs a second,virtually identical, statutory freezecommences.Strike/Lockout: strike action isprohibited during the term of anexisting collective agreement.Decertification: decertification is theprocess by which union membersmay apply to revoke a union’srepresentational rights.Decertification may take place whenthe board is satisfied that the unionhas lost the support of the majorityof the employees in a unit. Thetimelines and conditions for adecertification vary.Successorship: when an employersells, leases or otherwise disposesof a business, the union’s rightsfollow the business. An employerthat purchases all or part of abusiness is bound by the collectiveagreement as if it is a party to it andinherits any incumbent unions’bargaining rights.Unfair Labour Practices: legislationin the various jurisdictions prohibitsemployer interference in theformation of trade unions, orinterference in an employee’s choiceto become a member of a tradeunion. It also prohibits penalizingemployees for becoming a unionmember or exercising other rightsunder labour relations legislationgenerally. Examples of unfair labourpractices generally include:o Refusing to employ orcontinue to employ anooooindividual because of his orher union activities;Imposing conditions in anindividual’s contract ofemployment restricting unionannouncements;Threatening dismissal,imposing a penalty, orintimidation by any othermeans due to union activity;Illegal strikes and lockouts orthreat of same; and,Employer participation in orinterference with theformation or administration ofa trade union.Consequences associated with unfair labourpractices vary by jurisdiction. For instance,in New Brunswick and Nova Scotia, thelegislation provides for certification at thediscretion of the Labour Board (NovaScotia) or the Labour and EmploymentBoard (New Brunswick), where the boarddetermines that employee rights have beenviolated to such an extent that it is unlikelythat the employee’s true wishes regardingcertification can be ascertained. The PEILabour Relations Board has the authority tomake any order it considers just in thecircumstances.Certification in the construction industryIn each of the Atlantic provinces, thecertification process in the constructionindustry is significantly different fromcertification in other industries. Theconstruction industry is subject to specificregulation and authorities. Given thedifferences in each province and thecomplexities involved, our clients generallyprefer to work closely with a local lawyerEmployment and Labour Law 96

who has significant experience inconstruction industry certifications, ifcertification becomes a possibility.Workers’ CompensationEach province provides a no-fault insuranceprogram to compensate workers in theevent of work-related accidents oroccupational illness. Compensation isfunded through employer-paid premiums,assessed based on the payrolls ofparticipant employers. The “trade-off” is thatin return for receiving benefits employeesgive up their right to sue employers as aresult of their injuries. The purpose of thelegislation is also to promote healthyworkplaces and facilitate the recovery andreturn to work of injured workers. Thelegislation applies to the majority ofemployers with some exceptions, whichvary amongst jurisdictions.Legislation in each province:Prohibits any discriminatory ordisciplinary action against anemployee who has been injured atthe workplace, who is or may beentitled to workers’ compensationbenefits;Requires the re-employment of anemployee who has been injured orwho suffers from an occupationaldisease; andImposes a duty to accommodate aninjured employee, in accordancewith human rights principles, to theextent that the accommodation doesnot cause undue hardship. Theemployer and employee mustattempt to identify employment atthe workplace that is consistent withthe employee’s functional abilitiesthat will restore the employee’s preinjuryearnings to the extentpossible.Most employers are required to register withprovincial workers’ compensation programs.Employers, including federally regulatedemployers, will want to check with theWorkers’ Compensation Board in theprovince they are operating in to determinetheir registration requirements. Employerscan obtain additional information from thefollowing websites:New Brunswick:www.worksafenb.caPrince Edward Island:www.wcb.pe.caNova Scotia:www.wcb.ns.caNewfoundland and Labrador:www.whscc.nf.caOffshore IndustryThe offshore oil and gas industry in AtlanticCanada (Nova Scotia and Newfoundlandand Labrador) is subject to jointmanagement by the provincial and federalgovernments. However, labour relations onoffshore platforms is subject to provinciallaw.In the oil and gas industry in Newfoundlandand Labrador, the offshore is subject tospecific provisions of the Labour RelationsAct, which mandate that for the purposes ofcertification and collective bargaining, thereEmployment and Labour Law 97

is only one bargaining unit comprised of allemployees employed on a particularoffshore platform. As well, once certified,the operator and various employers arerequired under the legislation to form amandatory employers’ organization.In Nova Scotia, special exemptions alsoexist under the Labour Standards Code inrelation to offshore and refinery businesses.Also, in both Newfoundland and Labradorand Nova Scotia, special regulations applyin relation to occupational health and safetyrequirements, which are, in part, aimed atfurthering cooperation with the federalgovernment on safety issues.Special Projects (Natural Resources)In Newfoundland and Labrador, theprovincial government has the authority todesignate an “undertaking for theconstruction of works designed to develop anatural resource or establish a primaryindustry that is planned to require aconstruction period exceeding two years” tobe a “special project”.Currently, there are special projectdesignations for the construction of the Valeprocessing facility, the construction of theHebron platform and the construction of theLower Churchill project. Special projectdesignations create a unionized worksitewith an employers’ association, and anorganization representing the varioustrades, who negotiate a site-specificcollective agreement for the duration of theproject.Other Industry-Specific StatutesEach Atlantic province has a number ofindustry-specific statutes that may governhow an employee is certified and/orregistered with the province, how thatemployee maintains certification, and theresponsibilities of employers to ensure thatemployees are properly certified andregistered. Such legislation generallyapplies to workers in the health care sector,in the trades and in self-regulatedprofessions (e.g., law, architecture,accounting, etc.).Privacy LegislationThe federal Personal Information Protectionand Electronic Documents Act (“PIPEDA”)governs the collection, holding, use anddisclosure of personal information. PIPEDAapplies to federally-regulated employers,and purports to apply to all privateemployers in any province that does nothave provincial privacy legislation.Under PIPEDA, employers under federaljurisdiction must establish policies for thecollection, use and disclosure of employeeinformation.Nova Scotia, New Brunswick and PrinceEdward Island have not enacted provincialprivacy legislation applicable to privatesectoremployers. Newfoundland andLabrador does not have legislation similar toPIPEDA, but its Privacy Act does allowclaims against natural persons for violationof privacy.Employment and Labour Law 98

Canada Pension PlanUnder Canada’s Pension Plan, retired anddisabled employees receive a pensionincome from the federal government. ThePension Plan is paid for through payrolldeductions from employees and mandatoryemployer contributions. Employers arerequired to deduct the contributions from anemployee’s compensation, to match thecontributions, and remit the total to thefederal government.Employment Insurance ActThe federal Employment Insurance Actprovides temporary benefits to qualifyingemployees who are unemployed, or withoutincome due to pregnancy, parental leave,temporary sickness or who are oncompassionate care leave. It is agovernment-run insurance plan paid forthrough mandatory contributions from bothemployees and employers, remitted to thefederal government by employers.THE COMMON LAWThe “common law” is “judge-made” law,consisting of the decisions of judges andother decision makers. In the employmentand labour context, precedents may beestablished by judges, adjudicators,arbitrators and statutory boards (e.g., labourboards, etc.). By interpreting and applyingregulations, decision makers have created abody of common law setting out legal tests,exceptions, applications and precedentsaffecting the legal obligations of employers.While it would be impossible to highlightevery aspect of the workforce that istouched by the common law, it is worthwhilehighlighting a few of the most significantareas.Implied Contractual TermsAbsent a written contract of employmentproviding for the contrary, certain termshave become “implied terms” of every nonunionizedemployment relationship. Suchimplied terms include:Employees are generally consideredto be hired for an indefinite period;An obligation to provide reasonablenotice of termination of employment,or pay in lieu of reasonable notice, inthe absence of just cause fortermination of employment; andDuties on employees, such as theduty of honesty, duty ofconfidentiality, and the duty to avoida conflict of interest with theemployer during the course ofemployment.Reasonable Notice PeriodsCourts have confirmed that the mandatorynotice periods provided to employees underlegislation are minimums; they are a “floor”and not a “ceiling”. Accordingly, employeesare generally entitled to greater notice oftermination than is provided for in thosestatutes. This is known as “common lawnotice”, which is determined on a “case bycase” basis, but all of the Atlantic provincesgenerally consider three key factors, whichare:The age of the employee (generally,older employees receive morenotice);Employment and Labour Law 99

The employee’s length of service(longer serving employees generallyreceive more notice); andThe availability of similar work (ifcomparable employment isunavailable this may extend thenotice period).In Nova Scotia, Prince Edward Island andNewfoundland and Labrador, the positionheld by the employee is also a relevantfactor (generally, more notice is awarded tomanagers or specialized trades). In NewBrunswick, the Court of Appeal has ruledthat is not a relevant factor except to theextent that the nature of the position affectsthe availability of similar work.There is no fixed formula for determining thelength of notice, however, generally it is onlyin exceptional circumstances that thereasonable notice period exceeds 24months (e.g., a very long service employeeor one who is long service and occupies asenior position).For unionized businesses, notice periodsmay be set by the collective agreement.PRACTICAL CONSIDERATIONSThe Hiring ProcessThe employment relationship begins to bedefined before an employee is even hired.Each step that the employer takes duringthe posting, recruitment, interview andbackground check process can haveimplications for the future of theemployment relationship. We havehighlighted below a few considerations foremployers to consider before beginning thehiring process.Job postingsJob postings may be relied on if there is adispute regarding the duties or expectationsof the employees, the skills required for theposition or the changes that have occurredin the position. In addition to being relevantto human rights complaints, job postingsmay be relevant in termination andconstructive dismissal cases.In unionized settings, job postings are oftenalso relied upon during grievancearbitrations and hearings to determine, forexample, whether a position should beincluded in the bargaining unit. A collectiveagreement may have specific requirementsin relation to job postings.It is important to pay careful attention to thecontent of job postings, ensuring accuracyand consistency, and making it clear thatduties and requirements may be added orremoved from to the position at the solediscretion of the employer.Recruitment and inducementIn determining a notice award aftertermination, courts may consider whetheran employee was induced to acceptemployment, and in particular whether theemployee gave up secure employment, inassessing the amount of reasonable noticeto be awarded when the relationship endswithout just cause, particularly where theemployment relationship is of a shortduration.Employment and Labour Law 100

Those responsible for the hiring processshould be given instructions as to anypermissible representations. In instanceswhere employers are using the services of“head hunters”, the retainer should clearlyoutline the scope of the individual’s authoritywith respect to representations about thejob.Many of our clients include in theiremployment agreements an “entireagreement” clause, specifically negatingany pre-contractual representations.Background checksStudies suggest that up to one-third of jobapplicants misrepresent themselves or theircredentials on their applications andrésumés. For this reason, backgroundchecks are an important tool for employers.It is reasonable to require proof ofqualifications.However, the ability to conduct backgroundchecks is not limitless, and to avoidintrusion on a candidate’s privacy oraccusations of discriminatory hiringpractices, employers may want to consider:Ensuring the same backgroundchecks are conducted on allcandidates;Stating on application forms thatthey will seek references;Obtaining express permission fromthe candidate prior to contactingreferences;Avoiding questions to referencesthat ask for information or forconjecture about the applicant, andasking only structured and relevantquestions that will enable theemployer to gain accurate additionalinformation about the candidate’sabilities;Informing the candidate how thepersonal information provided will behandled and kept;What, if any, social media checksare required and whether it isappropriate to seek permission fromthe candidate prior to performingthese checks;Whether it is permissible underapplicable human rights legislationto perform a criminal backgroundcheck or credit check (this variesamongst the jurisdictions and therecan be specific legislation in relationto credit checks); andPerforming background checks onlyafter a conditional offer is made (thismay limit both the costs associatedwith the hiring process – as fewerbackground checks will beconducted – and an employer’sexposure to complaints).When conducting any reference orbackground investigation, employers needto be aware of the risk of attracting a humanrights complaint from a candidate who is nothired on the basis of the reference orbackground investigation. Employers havethe responsibility to ensure that no unlawfuldiscrimination occurs in the recruitment andselection process based on human rightsprotections. Equality of opportunity is anintegral part of the recruitment and selectionprocess and employers have an interest indeveloping and adhering to fair, nondiscriminatoryrecruitment and selectionpolicies.Employment and Labour Law 101

Interviewing: asking the right questions (andavoiding the wrong ones)Human rights obligations continue throughthe interview process.Questions about health, illness,mental disorders, medical history,workers’ compensation claims, oraccommodation of disability-relatedneeds.The effect of human rights legislation is thatemployers are prohibited from elicitinginformation, directly or indirectly, about anyprotected characteristics (as previouslymentioned, these characteristics varyamongst the jurisdictions). Questionsrelating to any of the prohibited groundslisted in the provincial legislation should beavoided in the pre-employment stage, sincethis could lead to a complaint ofdiscrimination from a prospective employeewho is not awarded the job. Inquiries thatgenerally should be avoided, unless thesituation involves an exemption from humanrights legislation such as where bona fideoccupational requirements exist, include:Questions about physicalcharacteristics such as eye or haircolour or requests for photographsas this may elicit information relatedto an individual’s race;Questions about religious affiliations,churches attended or customsobserved;Questions regarding citizenship(however, an application orinterviewer may ask whether theapplicant is legally entitled to work inCanada);Questions about “maiden” or “birth”name, child care arrangements,marital status, or any informationabout a spouse that maydiscriminate on either the basis ofsex or family status; andEmployers should be aware that candidateswho later make a human rights complaintmay have the right to ask for copies of anynotes made during the interview. Likewise,the employer may defend itself bydepending on notes made during theinterview.The Employment AgreementParties to all employment relationships havean employment agreement whether writtenor not. Employment contracts can be inwriting, oral or implied. The terms of anagreement may provide for matters such asduration and the parties’ obligations upontermination of the relationship.Our clients generally prefer to enter intocarefully drafted written agreements withemployees that define and limitentitlements. Employment contracts usuallycontain details of the duties expected of theemployee, remuneration and other benefits.Such contracts may also containconfidentiality clauses, restrictivecovenants, and provide for agreed-uponemployee entitlements on termination.Courts and other decision makers willcarefully scrutinize employmentagreements, in part because there is aconcern that there is an imbalance ofnegotiating power between employers andemployees. That said, a guiding principle ofEmployment and Labour Law 102

contract law is that the parties should beheld to the bargain they struck.All employment agreements, materials andpolicies that address the terms andconditions of the employment of employeesshould be drafted in clear and unambiguouslanguage. Employment materials shouldalso be brought clearly to the attention ofemployees at the time of hiring andemployees should be given time to carefullyreview them before accepting employment.Employees should execute theiragreements before commencingemployment.Termination clauses: establishing a clearnotice period to limit future liabilityEmployers who want to limit their liability foran employee’s notice period may considersetting out a specific notice period in theiremployment agreements. When noticeperiods are not set in advance, terminationcan result in uncertain – and usuallyexpensive – obligations (i.e. the commonlaw reasonable notice period).Where notice provisions of an agreementare drafted properly and satisfy minimumstatutory obligations for termination, theemployment agreement may prevail,notwithstanding what the employee mighthave been entitled to at common law.Clauses that set notice periods must becarefully drafted with consideration forclarity, legality, and effectiveness to ensurethat a reviewing judge or other authorityupholds the intent of the parties. Wheretermination clauses are ambiguous oruncertain, they will not rebut thepresumption of common law reasonablenotice upon termination.Restrictive covenants: non-competition andnon-solicitation clausesCovenants not to competeDepending on the particular employmentrelationship, an employer may restrictformer employees from becoming engagedby a competitor, or becoming a competitor,immediately following termination orresignation.Courts have held that these clauses mustbe reasonable, and often refuse to upholdnon-competition clauses where the natureof the employee’s employment does not callfor such a clause to protect the interests ofthe employer, where the clause covers toobroad a geographic scope or where theclause restricts competition for anunnecessarily long period of time.Non-compete clauses are more likely to beupheld where the employee was a fiduciary(i.e. one who held a senior position or whohad access to sensitive information aboutthe employer’s business that might allowthem to compete unfairly with their employerfollowing employment), or where anemployee was formerly an owner and soldthe business to the employer.Non-solicitation of employees andcustomersAgreements containing non-solicitationclauses are more readily enforceable inCanada than non-competition clauses, asthey are less restrictive in nature. Suchclauses, however, will still be subject to aEmployment and Labour Law 103

“reasonableness” analysis by a court.Overly restrictive and unreasonable clauseswill be unenforceable.Confidentiality and trade secrets clausesUnder the common law, employees mustnot divulge confidential information or tradesecrets that they acquire during theiremployment. This does not preventemployees from bringing general knowledgeand skills they learned from their previousemployer to a new employer. But generally,confidential information must not bedivulged to third parties. Confidentialinformation can include marketingstrategies, personnel information, businesspractices of the employer, trade secrets(such as manufacturing processes), salesinformation, commercial contracts,computerized data and supplier andcustomer lists. However, trivial or selfevidentmatters or information otherwiseavailable in the public domain is generallynot confidential information.Many of our clients prefer to spell out in theemployment agreement the obligation tokeep information confidential.Managing the Employment Relationshipthe same policies or types of policies. Someof our clients prefer to have minimal, basicpolicies while others have dozens of specificpolices tailored to their work environment.In unionized environments, the right toenact workplace policies and rules isgenerally preserved in the managementrights clause of the collective agreement,but generally policies and rules may beintroduced (without agreement by the union)where they are shown to be:Consistent with the collectiveagreement;Reasonable;Clear and unequivocal; andBrought to the attention of theemployee(s) affected, includingnotice of any consequences as aresult of a failure to adhere to thepolicy or rule.The policy or rule should be consistentlyenforced.Statutory leaves of absenceEmployment standards legislation providesemployees with a variety of protectedleaves of absence, such as:Workplace policiesPolices in the workplace not only setexpectations for employees, but if draftedand communicated properly they provideevidence that expectations were made clearand can assist in justifying disciplining anemployee who has violated a policy.Polices can be developed on just aboutanything. No two workplaces need exactlyMaternity/pregnancy leave;Parental leave;Bereavement leave;Sick leave;Reservists leave; andTime off to meet child careresponsibilities or due to the illnessof family members.Employment and Labour Law 104

The types of leave, time frames for noticeand responsibilities of the employer vary byprovince. Generally, employers are notrequired to pay wages during a leave ofabsence. However, employers are requiredto reinstate the employee to his or herformer position (or, if it is not available, to acomparable position) with the same salaryand benefits, at the end of the leave.Employers may be required to continue tomake contributions to certain benefits plansduring the leave.To minimize the risk of a human rightscomplaint, employers should ensure thatemployees on different types of leave aretreated similarly, regardless of the reasonfor their leave of absence.In the unionized environment, collectiveagreements may address leaves of absenceand set out additional employeeentitlements and employer responsibilities.Accommodating the disabled employeeEmployees who are temporarily orpermanently disabled may requireworkplace accommodations. Employers arerequired under human rights legislation toaccommodate employees to the point ofundue hardship.Employees requiring accommodation havea duty to self-identify, to requestaccommodation and to cooperate in theaccommodation process.In most cases, the employer can requireproof of disability and an abilitiesassessment from the employee to ease theaccommodation process.Dealing with workplace violence andharassmentOccupational health and safety legislationgenerally provides a requirement thatemployers provide a safe work environment.Employers should ensure they havecomplied with any statutory requirementsregarding workplace programs or policies toaddress harassment and violence; shouldaddress any problems or accusations thatarise immediately, through a full andimpartial investigation; and should takeproactive steps to ensure a workplaceculture of respect, including enacting aRespectful Workplace policy.Ending the Employment RelationshipMandatory retirementMandatory retirement policies may beconsidered invalid and unenforceable underAtlantic Canada's provincial human rightslaws unless the policy falls under anexception in the legislation. For example,mandatory retirement may be allowed if agecould be established to constitute a bonafide occupational requirement foremployees, or if there is a bona fide pensionplan that is adopted in good faith by anemployer and not for the purpose ofavoiding human rights protections.Terminations for causeGenerally, employees can be summarilydismissed without notice if just cause fortermination exists. Just cause takes intoaccount not only the actions of theemployee, but the seriousness of thebehaviour, its impact on the workplace, theculture of the workplace, whether theEmployment and Labour Law 105

employee knew or was warned that his orher behaviour was wrong, as well ascountless other factors. As what constitutes“just cause” varies with the circumstances, itis impossible to provide a list of behavioursthat will justify the summary dismissal of anemployee. However, clear evidence of thefollowing behaviours can generally justifytermination:Gross incompetence;Insubordination;Conflict of interest; andTheft.Terminations without causeWhen laying off employees or terminatingwithout cause, employers must providereasonable notice or pay in lieu of notice.Employers will have several decisions tomake including how much notice to offer,how to structure the notice, and whether torequire employees to re-pay the pay in lieuof notice if they obtain alternativeemployment during the notice period.unionized employers may want to givesome consideration to:SUMMARYstrike planning and avoidance;strategic collective bargaining andthe bargaining process; andthe practicalities of managinggrievances and grievancearbitrations.This chapter provides a broad overview ofsome of the laws that apply to employmentrelationships in Atlantic Canada. There aresignificant and complex issues that affectthe workplace, but most, if not all, can beaddressed and managed through theadoption of an appropriate legal and humanresources strategy.As noted above, a properly draftedemployment agreement may provide for anemployee’s entitlement and an employer’sobligations upon termination.Additional Practical Considerations forUnionized EmployersWhile a number of minimum statutoryrequirements do apply to employers whoare unionized, the rights and responsibilitiesof such employers are further defined by thecollective agreement negotiated betweenthe parties. In addition to understanding allof these rights and responsibilities,Employment and Labour Law 106

Chapter 12Environmental Law

CHAPTER 12ENVIRONMENTAL LAWREGULATORY FRAMEWORKBusinesses in Atlantic Canada should befamiliar with various environmental laws andpolicies that may apply to their businessactivities, especially those involvingpurchasing or leasing real property inAtlantic Canada, industrial development, orthe production, movement or disposal ofdangerous goods, toxic substances orwastes in and around the region.Environmental matters in Atlantic Canadaare governed by statute and common law.All four Atlantic Provinces have their ownsets of statutes and regulations that addressenvironmental matters within each province.The federal government also legislates withEnvironmental Law 107

egard to the environment. In addition, somemunicipalities have enacted by-laws inrelation to the environment through authoritydelegated to them by the provinces. Anenvironmental matter, therefore, may begoverned by federal, provincial, and/ormunicipal law depending on thecircumstances. This generally reflects theconstitutional division of powers in Canada.The Constitution Act, 1867, does not assignexclusive jurisdiction over the environmentto the federal government or the provincialgovernments. Rather, the power to legislatewith regard to the environment falls undervarious heads of constitutional authority.Generally, when an environmental matterrelates to a matter of federal jurisdiction oris of national or international concern and acompelling case exists for a nationalresponse, the federal government will havelegislative authority. Where a matter is oflocal concern, the provinces are more likelyto be the regulating authority. In otherinstances, one level of government manyhave jurisdiction, but will coordinateadministration with the provinces.FEDERAL ENVIRONMENTAL LAWAs noted, the federal government regulatesaspects of the environment primarily whenan environmental matter relates to an areaof constitutional federal jurisdiction (e.g.,sea coast and inland fisheries), or is ofnational or international concern (e.g.,transportation of dangerous goods acrossprovincial boundaries).This section will first discuss in more detailfederal areas of regulation, then examinecertain key federal laws, and finally reviewthe following aspects of federalenvironmental law that are often points ofheightened interest for those doing businessin Atlantic Canada: (i) enforcement; (ii)environmental assessments; and (iii)director & officer liability.Federal Areas of RegulationThe primary areas of federal regulation thatbusinesses should be aware of include:Air PollutionAir, water and land pollution;Toxic substances; andTransportation of dangerous goodsand hazardous wastes.The federal government has enactednumerous air pollution regulations under theCanadian Environmental Protection Act,1999 (“CEPA”), to limit the concentration ofa variety of industrial emissions, including:(1) asbestos emissions from asbestosmines and mills; (2) lead emissions fromsecondary lead smelters; (3) mercury fromchlor-alkali mercury plants; and (4) vinylchloride from vinyl chloride and polyvinylchloride plants. Further regulations havebeen enacted to limit the manufacture, use,sale, and/or import or export of ozonedepletingsubstances (such as refrigerants),and to require the largest industrial emittersto annually report facility greenhouse gasemissions.Water PollutionAlthough CEPA regulates waste disposal,dumping in Canada’s territorial seas, andinternational water pollution, and theCanada Shipping Act, 2001 addressesEnvironmental Law 108

certain aspects of marine pollution related toships, the federal government’s primaryregulatory power over water pollution ispursuant to the Fisheries Act.The Fisheries Act prohibits the deposit ofdeleterious substances in any watersfrequented by fish or areas constituting afish habitat. The term “deleterioussubstance” means any substance thatwould degrade or alter the quality of thewater and render it harmful to fish or fishhabitat.If an activity will cause harmful alteration tofish that are part of a commercial,recreational or Aboriginal fishery, or to fishthat support such a fishery, approval mustbe obtained from the federal Minister ofFisheries and Oceans, or the activity mustpre-authorized and be carried out inaccordance with certain conditions.Regulations under the Fisheries Act identifycertain substances as being deleterious andestablish permitted levels of effluentdischarges for industrial facilities such aspetroleum refineries, pulp and paper mills,meat and poultry processing plants, andmines. Industries located on watercoursesmust be aware of the impact their activitiesmay have on fish and fish habitat.Active depositing and a lack of interferenceor a failure to prevent deposits constitute anoffence under the Fisheries Act. Penaltiescan be significant including fines of up to$12 million for corporations, and $2 millionand three years’ imprisonment, or both, forindividuals.Under the Navigation Protection Act apermit is required before the infill ofnavigable water or the construction of astructure in navigable water. The term“navigable water” is construed quite broadlyand would generally include water that issufficient to float a small boat or canoe.Land PollutionThe pollution or contamination of land isgenerally dealt with by provincial authorities.The federal government is, however,responsible for all federally owned lands. Inaddition, the federal government works inconjunction with the provincial governmentsin developing national soil and groundwatercleanup guidelines.Toxic SubstancesAnother aspect of the federal government’scontrol over environmental matters is itsregulation of toxic substances under CEPA.A “toxic substance” is a substance that in aparticular quantity or concentration has along-term harmful effect on theenvironment, constitutes or may constitute adanger to the environment on which lifedepends, or constitutes or may constitute adanger to human health.Under CEPA, the federal governmentmaintains a Toxic Substances List whichsets out all substances designated as toxic.Once a substance is added to the list, thegovernment may make regulations whichregulate every aspect of the substance,including restricting or banning its use.These conditions include specifyingacceptable levels of concentrations thatmay be released or conditions prescribingthe use, handling, manufacture, testing andtransportation of the substance.Environmental Law 109

The federal government also maintains aPriority Substances List and a DomesticSubstances List under CEPA. The PrioritySubstances List contains those substancesdeemed to be, or to have the potential ofbecoming, toxic. These substances aresubject to assessment and investigation inorder to determine if they are toxic andhence should be added to the ToxicSubstances List. The competent ministersare responsible for compiling and amendingthe list, although any person may requestfor an addition to the Priority SubstancesList.The Domestic Substances List identifieschemical and biotechnical substancescurrently used in Canada. Before newsubstances (i.e. substances not included onthe Domestic Substances List) can beimported into Canada, manufacturers andimporters must notify the federalgovernment and provide detailedinformation concerning the nature of thesubstance, including its intended use, safetydata and hazard identification. With that inmind, businesses intending to introduce anew substance into the Canadianmarketplace should provide for sufficientlead time.In the event of an unlawful release of a toxicsubstance, CEPA requires persons andorganizations to immediately report therelease and to take all reasonableemergency measures to contain the spill.These obligations are triggered when thereis a release or there appears to be areasonable likelihood of a release of thesubstance into the environment.Transportation of Dangerous Goods andHazardous WastesThe federal government and the provincialgovernments have effectively harmonizedtheir approach to the transportation ofdangerous goods. Generally, provincialstandards that govern the transportation ofdangerous goods within the provinceincorporate the federal Transportation ofDangerous Goods Act, 1992 (“TDGA”) byreference. That being said, businessesinvolved in the transport of dangerousgoods should be aware of both federal andprovincial laws.When dangerous goods are transportedwithin Canada the federal TDGA applies.The TDGA does not expressly define“dangerous goods” but classifiessubstances into various classes ofcompounds listed in its accompanyingschedules. Any substance listed in theschedules is designated as beingdangerous.Dangerous goods include explosives,compressed gases, poisons, flammable andcombustible liquids and solids, nuclearsubstances, oxidizing substances, toxic andinfectious substances, radioactive materials,corrosives and various miscellaneousproducts provided for in the regulations. Thekey requirement under the TDGA is thatprescribed safety standards be compliedwith when transporting dangerous goods.Pursuant to CEPA, the InterprovincialMovement of Hazardous Waste Regulationslist special shipping requirements for thetransportation of hazardous wastes. Aprescribed “waste manifest” must becompleted by the shipper, the carrier andEnvironmental Law 110

the receiver. Waste manifests are alsorequired under provincial law and copies ofthe manifest must be sent to the appropriateprovincial department for both the place oforigin and destination. Where the place oforigin or destination is outside Canada, acopy of the manifest must be sent toEnvironment Canada.Permits are required for the import, exportand transport of hazardous waste.Hazardous waste includes dangerousgoods and any substance in the Export andImport of Hazardous Waste and HazardousRecyclable Material Regulations. Allimporters and exporters of hazardous wastemust provide notice of the waste shipmentto the relevant Canadian authorities.Federal Environmental LegislationCanadian Environmental Protection Act,1999CEPA’s overall purpose is to set andenforce environmental quality standards. Asindicated above, it contains provisionswhich regulate all aspects of theenvironment under federal jurisdiction,including air pollution, ocean dumping, theregulation of toxic substances and themovement of hazardous waste. CEPA alsocontains provisions that apply specifically tofederal departments, agencies, crowncorporations, works, undertakings andlands. The federal Minister of Environmenthas authority to appoint inspectors for thepurpose of administering and enforcingCEPA.Where the owner or person in control takesno response measure, inspectors areauthorized to take any actions required byCEPA to control the release of a regulatedsubstance. Authorized actions includeentering onto private property in order totake necessary measures, but do notinclude entering a private dwelling unlessauthorized by a warrant. In somecircumstances, however, there is authorityfor a warrantless search. Seized goods canbe detained under specific provisions ofCEPA.CEPA also provides for the issuance ofenvironmental protection orders andincludes penalties that can be imposed for acontravention of the Act or its regulations.Maximum penalties are a fine of up to $1million and/or five years’ imprisonment.Fisheries ActThe Fisheries Act is administered by thefederal Department of Fisheries andOceans. The purpose of this legislation toprotect Canada’s fisheries and, bynecessary extension, it applies to protectfish habitat. It applies to all waters inCanadian fishing zones, all waters in theterritorial sea of Canada and all internalwaters of Canada. Although this legislationmainly regulates the harvesting ofcommercial fisheries in Canada’s territorialand inland seas, it has also been used toprotect recreational and environmentallysensitive fish stocks as well as habitat forfish and other organisms.Inspectors under CEPA have the power toinspect any place where there is asubstance or activity regulated by the Act.Environmental Law 111

Transportation of Dangerous Goods Act,1992The TDGA is administered by TransportCanada. It applies to all modes oftransportation of dangerous goods withinfederal authority. This includes interprovincialtransport and goods carried byship or aircraft. The TDGA prohibits anyperson from handling, offering for transportor transporting any dangerous goods unlessapplicable safety requirements are met. Itestablishes specific safety requirements forthe packaging, labelling and documentationof dangerous goods, as well as for thenotification and reporting of dangerousgoods and the training of employees whohandle dangerous goods.Other Federal StatutesArctic Waters Pollution PreventionAct and accompanying regulations;Canada-Newfoundland AtlanticAccord Implementation Act andaccompanying regulations;Canada-Nova Scotia OffshorePetroleum Resources AccordImplementation Act andaccompanying regulations;Canada Shipping Act, 2001 andaccompanying regulations;Canada Oil and Gas Operations Actand accompanying regulations;Migratory Birds Convention Act,1994 and accompanying regulations;Navigation Protection Act andaccompanying regulations;Species at Risk Act andaccompanying regulations; andlegislation pertaining to publicharbours and port authorities.EnforcementCurrent StatusThe federal government utilizes variousmeans of ensuring compliance withenvironmental legislation such asestablishing reporting requirements,authorizing inspections and tests, issuingcontrol orders, cleanup orders, remedialorders or stop orders, and in some casesprosecution under federal statute.Most environmental offences are strictliability offences meaning the prosecutiononly has to show that the impugned act wascommitted regardless of intent. Thedefendant is then entitled to raise a “duediligence” defence, through which liabilitymay be avoided if it can be shown thatreasonable care was taken under thecircumstances.Penalties for offences under federalenvironmental legislation can be substantial,with serious contraventions attracting jailterms of up to five years and fines of up to$1 million per offence. Where an offence iscommitted or continued on more than oneday, the person who committed the offenceis in many cases liable to be convicted for aseparate offence for each day on which itwas committed or continued.Offenders who are found to have shownwanton or reckless disregard for the lives orsafety of other persons thereby causingdeath or bodily harm are subject toprosecution and punishment under sections220 or 221 of the Criminal Code. Themaximum penalty for causing death bycriminal negligence is life imprisonment,while the maximum penalty for causingEnvironmental Law 112

odily harm by criminal negligence is tenyears’ imprisonment.Legislative Reforms Related to EnforcementOn May 13, 2009 Canada’s Parliamentpassed Bill C-16, the EnvironmentalEnforcement Act (“EEA”). The EEA is beingimplemented in three stages, the first ofwhich began on December 10, 2010. Theselegislative changes include:Amending the penalty provisions ofcertain statutes by establishingdistinct ranges of fines for differentoffences, by creating minimum finesfor the most serious offences, byincreasing maximum fines ($1million for individuals, $6 million forcorporations), by specifying rangesof fines for individuals, otherpersons, small revenue corporationsand ships of different sizes and bydoubling the fine amounts forsecond and subsequent offences.Amending the sentencing provisionsof certain statutes by adding apurpose clause, by specifyingaggravating factors that, ifassociated with an offence, mustcontribute to higher fines, byrequiring courts to add profits gainedor benefits realized from thecommission of an offence to fineamounts, by requiring courts to ordercorporate offenders to disclosedetails of convictions to theirshareholders and by expanding thepower of the courts to makeadditional orders having regard tothe nature of the offence and thecircumstances surrounding itscommission, and by doubling finesfor second and subsequentoffences.Adding to certain statutes arequirement that details ofconvictions of corporations be madeavailable to the public and that allfines collected be credited to theEnvironmental Damages Fund andbe available for environmentalprojects or the administration of thatFund.Creating the EnvironmentalViolations Administrative MonetaryPenalties Act which establishes anadministrative monetary penaltyscheme applicable to certainstatutes.Environmental AssessmentsIn June, 2012 the Canadian EnvironmentalAssessment Act was amended with thepassing of Bill C-38, the federalgovernment’s “omnibus” budget bill (theJobs, Growth and Long-Term ProsperityAct). Bill C-38 repealed the previous CEAA(“CEAA 1995”) and replaced it with the“new” Canadian Environmental AssessmentAct, 2012 (“CEAA 2012”).CEAA 2012 is significantly changed in somerespects relative to the earlier CEAA 1995.The amendments were part of thegovernment’s Responsible ResourceDevelopment Plan, and were intended, inpart, to increase the efficiency andtimeliness of the approval of projects, anddecrease administrative drag on applicantsapplying for environmental assessment(“EA”) approvals.CEAA 2012 grants the federal governmentthe power to require an EA concerning theEnvironmental Law 113

environmental impact of new physicalundertakings and alterations to existingundertakings. Certain projects listed infederal regulations could require registrationwith the federal government.Once a project is registered, the CanadianEnvironmental Assessment Agencydetermines whether an EA is required.Projects under the control of the NationalEnergy Board and the Canadian NuclearSafety Commission automatically require anenvironmental assessment. However, theEA process can be substituted by aprovincial EA, provided that the processmeets federal standards.Once an EA begins, the project cannotproceed until the assessment is complete.There are two types of assessment: astandard EA and a panel review. Under astandard EA, the responsible federalauthority has one year to complete theassessment and the process could requirepublic participation.Within 60 days of the EA process, theresponsible Minister can refer the EA to apanel review. This process can take up totwo years and there is mandated publicparticipation. If the EA takes longer than twoyears, it is referred to the CanadianEnvironmental Assessment Agency, whichcompletes the process and files its report.Liability of Directors and OfficersVarious federal statutes, including CEPAand the Fisheries Act, impose personalliability on directors and officers ofcorporations for failing to take reasonablecare to ensure that the corporation does notcause or permit harm to the environment.Typically, directors and officers can avoidpersonal liability by establishing a defenceof due diligence. The threshold forestablishing due diligence differs for anygiven offence. One way of establishing adue diligence defence is by demonstratingthat the company had an environmentalmanagement program in place and wasadhering to it at the time of the offence.Developing an environmental managementprogram entails implementing corporatepolicies and reporting structures,establishing training programs andconducting regular environmental audits.Many corporations in Canada have alsoestablished work committees to overseetheir environmental management system.Regardless of the program chosen,directors and officers must regularly reviewthe program and are expected to actimmediately when a problem occurs or islikely to occur.OFFSHORE OIL & GAS REGULATIONThe areas offshore from Nova Scotia andNewfoundland and Labrador are rich inenergy resources and present valuablebusiness opportunities. Although theoffshore typically falls under federaljurisdiction, due to competing claims overthe areas offshore Nova Scotia andNewfoundland the federal government andthe provinces jointly administer the offshoreregime. This is done through the Canada-Newfoundland and Labrador OffshorePetroleum Board and the Canada-NovaScotia Offshore Petroleum Board (the“Boards”). The acts behind these regimesare essentially mirror images of each other,with a corresponding federal act.Environmental Law 114

Each Board consists of members appointedby the federal and provincial governments.The Boards’ powers include the ability tomandate environmental assessments forproposed developments, consult withprovincial agencies on environmentalregulation and prohibit or shut downoperations that may present a seriousenvironmental problem.LicensingThe Boards administer a multi-stagelicensing regime which covers every stageof offshore development from exploration tocommercial production. Every licence typeis unique in terms of its rights and duration,so it is essential for operators to be aware ofthe timelines and how to progress from onelicence to the next. There are three types oflicences:An exploration licence is obtainedthrough a bidding process with theBoard on select offshore areas. Itconfers exploration rights for aperiod of nine years; however, thelast three years of this period willonly be activated if certain conditionsare met during the first six years.Exploration licence holders canobtain a significant discovery licenceonce they demonstrate the existenceof hydrocarbons in a geologicalfeature that suggests the potentialfor sustained production. The licenceconfers developmental rights for anunlimited term.Exploration or significant discoverylicence holders can obtain aproduction licence once theydemonstrate the existence ofpetroleum reserves that justify theinvestment of capital and effort tobring the discovery to production.The licence confers commercialrights for a period of 25 years or foras long as commercial productioncontinues.Benefits PlansTo ensure that the people of each provincebenefit from offshore resource development,operators are required to submit a benefitsplan before the Board will approve theproject. Every benefits plan must:LiabilityGive first consideration to provincialresidents for training andemployment;Give first consideration to servicesprovided and goods manufactured inthe province, so long as thoseservices and goods are competitivein terms of fair market price, quality,and delivery; andPromote education and training aswell as research and developmenton petroleum activities in theoffshore area.On January 30, 2014, the federalgovernment introduced Bill C-22, theEnergy Safety and Security Act. This bill willhave an important impact on offshoreresource development in terms of liability.Some key changes to the offshore regimeinclude:Introducing director and officerliability for a corporation’s failure tocomply with an order;Environmental Law 115

Raising the maximum fine for spillsto $1 billion without proof of fault ornegligence (up from $30 million inNewfoundland and Labrador and$40 million in Nova Scotia;Creating an administrative regimefor monetary penalties, includingfines of up to $25,000 for individualsand up to $100,000 for corporationsfor regulatory infractions; and Setting a minimum security of $100million, which operators must post inadvance of drilling. Regulators mayincrease this amount at theirdiscretion.PROVINCIAL ENVIRONMENTALREGULATIONAll four Atlantic Provinces have legislatedextensively in the area of environmentalprotection. Further, as noted earlier,municipalities within each province havepassed by-laws relating to the environmentpursuant to authority granted them underprovincial legislation (solid waste disposal,industrial discharge into the wastewatersystem, and pesticide regulation arecommon areas addressed by municipal bylaws).The environmental legislation in the AtlanticProvinces, although different in significantrespects, contains certain common features.One notable feature common to NewBrunswick, Nova Scotia and Newfoundlandand Labrador, for instance, is a broadapproach to assigning responsibility forcleanup following the release of pollutantsor contaminants. The responsibility forcleanup in these provinces extends beyondthe person(s) who caused thecontamination, to current owners/occupiers,current or past parties having care,management or control over thecontaminant that has been released into theenvironment, and in some cases others aswell. Responsibility for cleanup can beassigned to these varied parties regardlessof actual fault or legal liability. A currentowner of contaminated property may beordered by the responsible minister to cleanup the property even though the owner maynot have owned the property when thecontamination occurred.For this reason, it is imperative forprospective purchasers to conductappropriate due diligence investigationsbefore acquiring property and to haveappropriate protections to enable this tooccur built into any agreements for thepurchase of property. Due to the potentialwide-ranging responsibility forcontamination or a contaminated site, it isalso essential that property owners oroccupiers be aware of the notificationrequirements should a spill or release occur.The Atlantic Provinces have alsoestablished numerous regulations undertheir primary environmental laws. The focusof these regulations is the management ofenvironmental concerns identified in thestatutes, including the following:Air PollutionRegulation of airborne emissionsOzone layer protectionsPermit requirements for theoperation of fuel burning equipment,incinerators and other industrialsourcesEnvironmental Law 116

Water PollutionWater quality testingWater well constructionDrinking water guidelinesWatercourse alterationBeach and coastline preservationWatershed protectionLand PollutionSolid waste disposalHazardous waste disposal (e.g.,used-oil, lead-acid batteries)Underground storage tanks (e.g.,petroleum tanks)The sections below will discuss in moredetail each province’s approach toenvironmental regulation, in particular as itrelates to contamination/contaminated sites,enforcement, director and officer liability,and environmental assessments/approvals.This chapter will conclude with a review ofother specific provincial legislation outsideof these areas.New BrunswickIn New Brunswick, environmental issues fallunder the authority of the Department of theEnvironment and Local Government. TheDepartment is responsible for theadministration of several statutes, with theClean Environment Act, Clean Water Actand Clean Air Act being central to theadministrative scheme.The Minister of the Department has theability to designate as a "contaminant"anything that causes harm to theenvironment, the health and safety of aperson or animal, or to property. Personsare prohibited from releasing anycontaminant into the environment unlessthey are acting under and in compliancewith authority or permission given under aprovincial statute.When contamination does occur, the personresponsible must take steps to minimize theharm done by emission of the contaminants.The person must also notify the Ministerimmediately with a report which includes,among other things, the nature of thecontamination and the remedial action takento minimize the pollution and futurereoccurrence.In situations where the Minister finds that aperson has violated or failed to comply witha provision of an act or regulation, an ordermay be issued directing compliance inaccordance with what the Minister considersnecessary. Where there is non-complianceor the Minister deems it necessary, remedialaction can be taken with the associatedcosts becoming the liability of those whofailed to comply with the order or whose actor omission caused the release of thecontaminant.The Minister may designate inspectors whocan enter upon the lands or premises wherethey reasonably believe a contaminant wasor will be produced and has been or will bereleased. The inspector can conduct thenecessary tests and take samples of anysubstance or material in an attempt tocollect evidence to show non-compliancewith an act or regulation. An owner orperson responsible for overseeing the areamust reasonably assist the inspector andmay not impede the inspection.Environmental Law 117

The issue of director and officer liability isnot specifically addressed in the legislation.A person who violates any provision of anact or regulation, or fails to comply with aministerial order, commits an offence. Uponconviction, they are liable to a fine of notless than $1,000 and up to $1 million. Thefine can accrue for each day in which noncompliancecontinues. Where the offence iscommitted for financial advantage the fineimposed will be such that no advantage isgained from the offence. Costs incurred bythe Minister are the liability of all personswho failed or refused to comply with anyorder which directed them to act or whoseact caused the release of the contaminant.Schedule A of the Environmental ImpactAssessment Regulation outlines theundertakings that must be registered withthe Minister, following which a determinationwill be made as to whether anenvironmental impact assessment isrequired. The Minister must either decidethat the undertaking can be completedwithout an assessment or the provincialcabinet must approve the undertakingfollowing the assessment. Theenvironmental impact assessment involvesmultiple stages.In May 2013, the province released ablueprint to help guide the oil and gasindustry. The blueprint focuses on variousprinciples including environmentalresponsibility, effective regulation andenforcement, community relations and FirstNations engagement.Prince Edward IslandThe environmental regulatory scheme forPrince Edward Island is predominantlycollected under the EnvironmentalProtection Act (“EPA”) and correspondingregulations, rather than in several discretepieces of legislation. While the provincepreviously lacked the more thoroughlegislation found in other jurisdictions inCanada, recent amendments in 2008 and2009 have made its legislation morecomparable. For example, watercoursesand wetlands are now more heavilyregulated, and persons deemed to be incontravention of legislation may now appealenvironmental protection orders.The EPA allows the Minister ofEnvironment, Labour and Justice to controlaspects of all surface, ground and shorewaters, as well as beaches, sand dunes andwetlands within the province.Contaminated sites are listed in theprovince’s contaminated sites registry. Asite may be designated as a contaminatedsite in defined circumstances, such aswhere an analysis of soil and groundwateron the property indicates it is contaminatedin excess of acceptable cleanup criteria orwhere the site is an inactive ordecommissioned landfill facility. Once anarea has been designated, the personresponsible for the area may not alter thesite without authorization from the Minister.The EPA is enforced primarily by theMinister and his or her delegates (i.e.employees of the Department ofEnvironment, Labour and Justice).Environmental protection orders mayrequire persons to do the following: meetwith the Department; carry out inspection,testing, and sampling; clean, repair andrestore affected areas; and take otherspecified actions to prevent danger to theEnvironmental Law 118

environment or the life, health, or propertyof a person. The contravention or violationof the EPA by any person or corporation willresult in penalties, as specified in the EPA,including fines, imprisonment, payment ofrestitution, or a combination of these.The EPA does not provide specifically for adue diligence defence in the event a personis charged with an offence. However, theoffences in the EPA are public welfareoffences and this defence may neverthelessbe open to persons charged. Therefore, asin other jurisdictions, the importance ofestablishing an effective environmentalmanagement system cannot beunderstated.As with many other provincial and federalenvironmental statutes, the EPA providesfor certain types of director/officer liability, inparticular where an officer or director“directs, authorizes, assents to, acquiescesin, or participates in” the commission of anoffence carried out by the corporation. Adirector or officer may be liable on summaryconviction to a fine not less than $200 ormore than $10,000 or to imprisonment for90 days, or both.When initiating any undertaking (includingconstruction, industry, operation or otherprojects), a written proposal must be filedwith the Department and approval must begiven before the undertaking proceeds.When considering proposals, the Ministermay require an environmental impactassessment and statement to be carried outand submitted. During this process, theapplication for assessment will be reviewedand the public will receive an opportunity toreview the proposed project and makecomments or identify concerns. Followingthis process, the Minister will approve ordeny the project.Environmental Impact AssessmentGuidelines and current projects underreview can be found on the Government ofPrince Edward Island website. A full list ofapplications for licences, certificates andpermits is included on the provincialwebsite. There are specific applications forpesticide vendors, petroleum storage tankcontractors, water and wastewater facilitiesoperators, persons handling and purchasingozone depleting or regulated substances,and persons carrying on watercourse,wetlands and buffer zone activities, amongothers.Nova ScotiaThe Environment Act is the primaryenvironmental legislation in Nova Scotia.The Act was amended in some significantways in 2012. For instance, theamendments expanded the power ofinspectors to issue directives asenforcement tools, and the Act now placesa reporting obligation on any person whodiscovers or is aware of an unlawfulrelease.One of the biggest changes in theregulatory regime in Nova Scotia was therecent coming into force of newContaminated Sites Regulations (in forceJuly 6, 2013), and the related release ofMinisterial Protocols that govern, amongother things, notification of contaminationand remediation of contaminated sites. TheRegulations provide for a process that willlead to a form of regulatory closure, either a“Record of Site Condition” or a “Declarationof Property Condition”. The RegulationsEnvironmental Law 119

also create new duties and responsibilities,requiring a person responsible for acontaminated site to notify and takereasonable measures to remedy thedamage caused, at their own expense.Nova Scotia Environment (“NSE”) isresponsible for ensuring enforcement andcompliance with the Act and Regulations.Enforcement is carried out throughinspections and investigations by NSEinspectors, who have relatively broadpowers to enter and inspect property, seizeproperty, and issue directives. Unlikeministerial orders, directives are notappealable. Ministerial orders may require aperson, at that person’s expense, toremedy, clean up or rehabilitate adverseenvironmental effects, among other things.It is an offence to fail to comply with adirective or ministerial order.Environmental assessments and approvalsare regulated under the Environment Act, inconjunction with the Activities DesignationRegulations and the EnvironmentalAssessment Regulations. Environmentalassessments are only required forundertakings listed in the EnvironmentalAssessment Regulations. Likewise, theActivities Designation Regulations set outthe activities for which an approval isrequired.Under the Environment Act any officer,director or agent of a corporation can befound personally liable if they direct,authorize, acquiesce in or participate in aviolation of the Act or Regulations, whetheror not the corporation has been prosecuted.A director or officer who establishes thatthey exercised due diligence to prevent thecommission of the offence or that theirconduct was innocent in the circumstancescannot be convicted under the Act. As withother jurisdictions, directors and officersmust ensure there are environmentalmanagement systems in place, and cannotturn a blind eye to environmentallydamaging corporate activities.The Environmental Goals and SustainableProsperity Act is legislation unique to NovaScotia. It sets out the government’scommitments to a cleaner and moreeconomically sustainable province. The Actestablishes far-reaching goals for theprovince that range from reduced airemissions and waste, to new energystandards for buildings, increased protectionfor water and land and encouragement ofsustainable purchasing of goods andservices.Newfoundland and LabradorNewfoundland and Labrador’s principalenvironmental legislation is theEnvironmental Protection Act (“NLEPA”).The NLEPA and its accompanyingregulations set environmental standardsand procedures for business activities thatmay have significant environmental effect.The NLEPA and its regulations specify thepermissible amount, concentration and rateof release for substances released into theenvironment that may have an adverseeffect, and impose reporting requirements inthe event a release occurs that may havesuch an adverse effect. Personsresponsible for unauthorized releases arerequired to remedy the adverse effects ofthe substance and/or dispose of thesubstance at their own cost. As with manyother provincial statutes, “personEnvironmental Law 120

esponsible” is a defined term, and casts abroad net.Areas designated as contaminated sitesrequire an environmental assessment and aremedial action plan to be submitted to theMinister of Environment and Conservationby the person responsible for thecontamination. The Minister has the powerto approve or reject the plan and to issuespecific standards and criteria forrehabilitation of the contaminated site.The NLEPA provides broad powers ofinspection, particularly with respect toanything licensed under the Act. Inspectorsmay enter buildings or premises to ensurecompliance with the Act and may alsoobtain warrants for search and seizure.Persons charged and convicted of offencesunder the NLEPA are liable on summaryconviction to fines ranging from $1,000 to$1 million for corporations, and fines ofbetween $1,000 and $50,000 and/or amaximum term of three to six months’imprisonment for individuals, depending onthe offence. Particularly egregious conductcan be subject to more severe penalties.Ministerial orders are an additional form ofenforcement under the NLEPA and can beissued regardless of whether or not aperson was charged or convicted of anoffence. These orders may require a personto stop or shut down an activity orundertaking or mandate the cleaning andrestoration of contaminated areas. Awhistleblower provision in the NLEPAprohibits employers from penalizingemployees who report environmentaloffences by their employers.Directors and officers of corporationsconducting business in Newfoundland andLabrador should be diligent in ensuringcorporate compliance with environmentallegislation. Liability for corporatecontravention of the NLEPA can beimposed on directors and officers in somecircumstances, regardless of whether or notthe corporation itself has been prosecutedor convicted. As with other provinces, thedefence of due diligence is available.It is also possible for directors and officersto be personally named in ministerial ordersmandating the remediation of contaminatedareas. The “person responsible” provisionsof the NLEPA provide the Minister with alarge degree of latitude in determiningliability and do not necessarily precludedirectors and officers.Any business activity that may have asignificant environmental impact is definedas an “undertaking.” Although the NLEPAprovisions apply to environmental mattersfalling under provincial jurisdiction, theprovince has a history of combining withfederal processes to avoid duplication andwill typically defer to the federal systemwhen a merged assessment is done.All undertakings must be registered forassessment and approval by the Ministerbefore they commence. The Minister maymandate an environmental impactstatement, environmental preview report,and issue orders containing additional termsand requirements that must be met prior toapproval. The environmental assessmentprocess may also involve consulting withinterested governmental departments andholding public hearings to record andaddress concerns. Approved undertakingsEnvironmental Law 121

may also be subject to monitoring to ensurecompliance.Additional Environmental LegislationThe provinces have also passed many otherpieces of legislation that deal with narrowerenvironmental issues. For example, all fourAtlantic Provinces have passed specificlegislation dealing with the intra-provincialtransportation of dangerous goods. Thesestatutes complement, and generally adopt,the safety standards, packaging andlabelling requirements set out in the federalTDGA which applies to the inter-provincialtransportation of dangerous goods.Other examples of related environmentallegislation passed by some or all of theAtlantic Provinces include the following:Oil and gas legislation, whichregulates activities relating to theexploration and exploitation ofpetroleum and natural gas, andwhich imposes measures aimed atpreventing spills or leakages of suchsubstances into the environment.Pesticides control legislation, whichregulates the use, storage andhandling of pesticides.Emergency measures legislation,which provides for the coordinationof emergency operations when adisaster occurs that may affect theenvironment or human health, safetyor welfare.Endangered species legislation,which attempts to prevent anyprovincial species from becomingextinct as a consequence of humanactivities.Wildlife conservation legislation,which seeks to maintain the diversityof provincial species through forestmanagement and the regulation ofhunting and fishing.Legislation protecting wetlands andwatercourses and restricting activityin mandated buffer zones aroundwetlands and watercourses.Legislation requiring that waste besource-separated intocompostables, recyclables andwaste materials.Delegated authority to municipalitiesto enact by-laws pertaining todiverse matters relating to theenvironment such as the use ofpesticides, effluent quality fordischarge into municipal sewers,topsoil removal and grade alteration,development adjacent toenvironmentally sensitive areas suchas watercourses and wetlands, andprohibition of nuisances from smoke,dust, odours and the like.Environmental Law 122

Chapter 13CommercialReorganization andInsolvency Law

CHAPTER 13COMMERCIAL REORGANIZATION ANDINSOLVENCY LAWLEGISLATIVE REGIMEBankruptcy and insolvencylaw falls under federaljurisdiction. 7 However, manyfactors which influencebankruptcy and insolvencyproceedings and creditors’rights and remedies, such assecurities law, property lawand civil rights, fall underprovincial jurisdiction. 8 As a7 Please note that this chapter does not address consumerbankruptcies.8 For more information on the rights and remedies available tocreditors, please see Chapter 14 – Enforcement of Creditors’ RightsCommercial Reorganization and Insolvency Law 123

esult, in a bankruptcy orinsolvency proceeding, bothfederal and provincial statutesmay need to be considered.Federal LegislationFederal legislation governing bankruptcyand insolvency proceedings include:The Bankruptcy and Insolvency Act(“BIA”) and the General Rules madethereunder: The BIA establishesCanada’s bankruptcy regime. Itcontains the rules and methods bywhich individuals, corporations andother persons may liquidate orreorganize.The Companies’ CreditorsArrangement Act (“CCAA”): Theprimary aim of the CCAA is to allowfinancially distressed businesses tomake a plan of compromise orarrangement with their creditors. TheCCAA sets out a framework forcorporations with debts totaling over$5 million to work with their creditorsto reorganize or sell the business.The Wage Earner ProtectionProgram Act (“WEPPA”): TheWEPPA provides compensation forremuneration owing to employees inthe case of the bankruptcy orreceivership of their employer.The Winding-up and RestructuringAct (“WURA”): The WURA primarilyapplies to the wind up of regulatedbodies (e.g., banks, insurancecompanies and trust corporations).Provincial LegislationProvincial legislation which may impactbankruptcy and insolvency proceedingsincludes:The Personal Property Security Act(“PPSA”): Each of the Atlanticprovinces has enacted PPSAlegislation that sets out how tocreate and perfect valid securityinterests, how to determine prioritiesamong creditors and how to enforcesecurity interests. The PPSAlegislation is similar to the variousUniform Commercial Codes in effectin many jurisdictions in the UnitedStates.The Judicature Act and Rules ofCourt: Each of the Atlantic Provinceshas enacted a Judicature Act andRules of Court which set out therequirements for drafting materialsand appearing before the courtunless superseded by rulescontained in the applicable federalstatute or BIA rules.COURT JURISDICTIONIn Canada, there is no separate bankruptcycourt. Pursuant to both the CCAA and BIA,authority to hear matters related tobankruptcy and insolvency is vested in thesuperior courts of each of the provinces.The judges of these courts are federallyappointed and exercise general jurisdiction.Commercial Reorganization and Insolvency Law 124

Because the BIA and CCAA are federalstatutes, each contains provisions requiringthat orders made by provincial superiorcourts sitting in bankruptcy are recognizedand enforced by courts in other provinces.Nevertheless, an application to a provincialsuperior court may be necessary to giveeffect to the orders of another province’ssuperior court.REORGANIZATIONIt is always open to debtors to informallyagree with their creditors on a method torestructure the debt. However, the BIA andCCAA provide formal means by whichdebtors may propose arrangements (CCAA)or proposals (BIA) with their creditors.BIA ProposalA proposal pursuant to Part II of the BIA is awritten document by which the debtormakes an offer to settle its creditors’provable claims. Under the BIA, a debtor’sproposal must include an arrangement withboth the preferred creditors and unsecuredcreditors. The proposal may also includesecured creditors. Preferred creditors mayinclude the trustee, employees and/or alandlord.A trustee appointed under a proposal mustcall a meeting of the creditors of the debtorto be held within 21 days after the filing of aBIA proposal. All unsecured creditors andthose secured creditors in respect of whosesecured claims the proposal was made areentitled to vote. All creditors vote by classexcept that all unsecured claims shallconstitute one class unless the proposalprovides for more than one class ofunsecured creditors.CCAA Plan of ArrangementUnder the CCAA, a debtor is able to make aplan of arrangement with any particularclass of creditors, although it is often thecase that a plan will be proposed to most, ifnot all, of the creditors of the applicant.Similarities between the BIA and CCAAOnce a proposal or arrangement isproposed, the debtor’s creditors vote on theproposal or plan of arrangement. In order tobe successful, both a majority in number ofcreditors and two-thirds of the value of theclaims of each class voting in person or byproxy must be attained. If the vote on theproposal or plan of arrangement issuccessful, an application is made to thecourt for approval.The restructuring of a debtor is monitoredby a neutral party under both the BIA andCCAA. Under the BIA, the proposal mustinclude provision for the appointment of atrustee. Under the CCAA, a monitor (whomust be a licensed trustee in bankruptcy) isappointed. Both the trustee and monitorfulfill a similar role: monitoring the debtor’sbusiness and/or financial affairs during therestructuring process, reporting to the court(and also the creditors) on any materialadverse changes affecting the debtor andreporting on the reasonableness of thedebtor’s cash flow statement.Differences between the BIA and CCAAAs indicated above, there are manysimilarities between the BIA and CCAA.However, there are also importantdifferences which may influence one’sdecision about which act to use:Commercial Reorganization and Insolvency Law 125

There are strict guidelines andtimeframes under the BIA, includinga maximum of six months withinwhich to file a definitive proposal.The CCAA is less detailed and hasbeen given a liberal interpretation bythe judiciary. As such, the CCAA ismore flexible.If a proposal made under the BIA isrejected by the unsecured creditorsor the court refuses to approve it, thedebtor is automatically declared tobe bankrupt.If a plan of arrangement is rejectedunder the CCAA, either by creditorsor the court, the debtor is notautomatically declared a bankrupt.Under the BIA, a stay of proceedingsis obtained when the debtor files anotice of intention with theSuperintendent of Bankruptcy.Conversely, under the CCAA, a staymust be obtained by court order.The CCAA applies only tocorporations or corporate groupsthat meet the $5 million debtthreshold dictated by the Act.As indicated above, under the BIA aproposal must be made tounsecured creditors, whereas underthe CCAA a plan of arrangementcan be made to secured creditorsalone, leaving unsecured creditorsunaffected.A proposal under the BIA isgenerally less expensive than a planof arrangement under the CCAA, asthe BIA is more detailed andstructured, with the result that fewercourt applications are normallyrequired than under the CCAA.RECEIVERSHIPIn addition to the provisions noted above,the BIA also provides for the enforcement ofsecurity, a scheme of distribution among adebtor’s creditors and the appointment ofreceivers. When a secured creditor decidesto enforce its security on all or substantiallyall of the insolvent debtor’s assets, thesecured creditor must give the debtor priornotice unless a court orders otherwise.Following the provision of notice, thesecured creditor must wait 10 days (unlessthe debtor consents or a court ordersotherwise) to take further steps to enforceits security.One of the common methods ofenforcement of a creditor’s security is theappointment of a receiver. A receiver isnormally appointed by one of two methods:by a secured creditor according to a securityagreement (private appointment), or bycourt order (court appointment).Once appointed, the receiver must givenotice of its appointment to all the debtor’screditors. The receiver must issue reportson a regular basis outlining the status of thereceivership, prepare a final report andstatement of receivership accounts whenthe appointment is terminated, and makethose reports available to creditors uponrequest.Private AppointmentWhen a receiver is appointed under asecurity agreement, the security agreementmust also set out the powers the receiver isto have. These powers are typically broadand may include the power for the receiverto carry on the debtor’s business and sellCommercial Reorganization and Insolvency Law 126

the debtor’s assets by auction, tender orprivate sale.A private receiver’s loyalties lie with thecreditor that appoints it and the privatereceiver will work to maximize the recoveryof the creditor. As a result, appointment of aprivate receiver provides the securedcreditor with greater control over theenforcement process. It can also be morecost effective. In contrast, a court appointedreceiver is an officer of the court and hasduties to all creditors, not just the appointingcreditor.However, a court appointed receiver may beadvisable in the following circumstances:Where there are disputes among thecreditors;Where there is a dispute betweenthe creditor and the debtor;Where the debtor opposes theappointment of a receiver and willnot allow the receiver to takepossession of the debtor’s property;Where there is a clear sign that courtassistance will be required; andWhere the assets and operations ofa debtor are complex and/or locatedin a number of jurisdictions and thevarious secured creditors arecompeting for priority.Court AppointmentThe court’s jurisdiction to appoint a receiveris found in the BIA, provincial statutes andprovincial Rules of Court.An application to appoint a receiver iscommonly made under all three sources toprovide maximum flexibility to the receiver.The order appointing the receiver normallyalso includes the following provisions:A stay of proceedings against thereceiver;The receiver is granted control overthe assets of the debtor;The receiver is authorized to carryon the debtor’s business;The receiver is authorized to borrowmoney on the security of thedebtor’s assets; andThe receiver is authorized to sell thedebtor’s assets with approval of thecourt.Depending on the circumstances, the courtmay also consider it necessary to authorizethe receiver to commence and defendlitigation in the debtor’s name.BANKRUPTCYA bankruptcy can happen in one of severalways:The debtor makes a voluntaryassignment;An application by one or morecreditors is made to the court and areceiving order against the debtor isissued;Either the debtor’s unsecuredcreditors or the court refuses toapprove the debtor’s proposal; orThe proposal is approved, butsubsequently annulled by the court.Commercial Reorganization and Insolvency Law 127

Once a person or corporation is declaredbankrupt, a licensed trustee in bankruptcy isappointed and a stay of proceedings isimposed.The bankrupt’s property is vested in thetrustee and the trustee is then responsiblefor the administration of the bankrupt’sestate.The bankrupt’s unsecured creditors fileclaims for their debts with the trustee. As asecured creditor, it is important to ensurethat your security is properly registeredbecause the trustee is responsible to reviewthe validity of the security over thebankrupt’s assets and apply to the court toset aside security that is not valid. If thesecured creditor has valid security, subjectto a limited stay provision, the securedcreditor is entitled to take possession anddispose of the secured propertynotwithstanding the bankruptcy. To theextent that the amount of a securedcreditor’s debt exceeds the value of theproperty subject to its security, a securedcreditor may participate in the bankruptcyprocess and file a proof of claim for theunsecured portion of its claim.Generally, creditors will elect one or moreinspectors to guide the conduct of thebankruptcy proceedings. Where inspectorshave been appointed the trustee must workwith the inspectors and must obtain theconsent of the majority of the inspectors tosell assets, carry on the business of thebankrupt, commence or continue legalproceedings, or settle any claims made byor against the bankrupt estate unless thedecisions of the inspectors are overriddenby the creditors or the court.PrioritiesThe bankrupt’s creditors may includesecured creditors, preferred creditors and/orunsecured creditors.Secured creditors rank in priority tounsecured creditors in a liquidation;however, there are certain statutorilyprescribed super-priority claims (e.g.,government claims for source deductions)that will rank ahead of secured creditors.Unsecured creditors are entitled to sharepro rata in the realization of the bankrupt’sassets after payment of preferred creditorsand are subject to the claims of securedcreditors.Amendments made to the BIA and CCAA in2009 allow for debtor in possession (“DIP”)financing and recognize a “super-prioritycharge” for lenders who provide interimfinancing to debtor companies. Previously,courts invoked their inherent jurisdictionwhen authorizing DIP financing.DIP financing is only allowed if it has beenapproved by court order. In order for DIPfinancing to be approved, the existingsecured creditors must be provided notice.The DIP lender’s super-priority will survivein a bankruptcy even if the DIP restructuringfails.There are new super-priority claims createdin the CCAA and BIA for wages andpension arrears, and the WEPPA providesfor the payment of wage arrears in aninsolvency.Additionally, there are a number of otherfederal and provincial statutory liens anddeemed trusts that have priority overCommercial Reorganization and Insolvency Law 128

secured creditors outside of bankruptcy, butwhich are treated as ordinary unsecuredclaims following bankruptcy (e.g., liens forfederal goods and services tax).Once the super-priority claims and securedcreditor claims are satisfied, the BIA setsout the priority scheme for distribution tounsecured creditors as follows:1. The costs of administration of thebankruptcy;2. A Superintendent of Bankruptcy’slevy on all payments made by thetrustee to creditors;3. Preferred claims, secured creditors’claims in the amount equal to thedifference between what theyreceived and what they would havereceived but for the operation of thewage and pension super-priorities,and landlords’ claims up to themaximum amounts prescribed bystatute; and4. Unsecured claims on a pro ratabasis.Avoidance TransactionsPursuant to the BIA and various provincialstatutes, the trustee may set asidefraudulent preferences, fraudulentconveyances and transfers under valuemade by the bankrupt. Keep in mind thatlimitation periods apply in each case.Furthermore, different rules and onuses ofproof apply depending upon whether atransaction/payment was at arm’s length.Interim ReceiverUnder the BIA, an interim receiver may beappointed to preserve and protect an estatepending the outcome of insolvencyproceedings. An interim receiver may beappointed:On or after the filing of an applicationfor a bankruptcy order;On the filing of a notice of intentionto file or the filing of a proposal; orWhen an enforcement notice hasbeen or is about to be sent by asecured creditor indicating itsintention to enforce its security.The appointment of an interim receiver isnormally of short duration. In the orderappointing the interim receiver, the court willspecifically set out the powers of the interimreceiver. Generally speaking, the interimreceiver will be instructed to takepossession of the assets and control thereceipts and disbursements of the debtor,but not to otherwise interfere with the dayto-daybusiness of the debtor.Prior to the 2009 amendments to the BIA,interim receivers were often appointed witha mandate similar to that of a receiver.However, the 2009 amendments to the BIAensure that the interim receiver only carriesout an “interim” role.LIQUIDATING UNDER THE CCAAOnce CCAA proceedings have begun, courtapproval is required before a sale of thedebtor’s assets can be effected. Under theCCAA, a court may authorize a sale of adebtor’s assets notwithstanding theabsence of a plan of compromise orarrangement. Where the sale ofsubstantially all of the debtor’s assets iscontemplated (even when no plan isenvisioned), the court will consider theCommercial Reorganization and Insolvency Law 129

following factors when determining whetherto approve the sale:Was the process leading to theproposed sale reasonable in thecircumstances;Whether the monitor approved theprocess;Whether the monitor filed a reportwith the court stating that the salewould be more beneficial to creditorsthan a bankruptcy;Whether the creditors wereconsulted, and to what extent;What the effect of the proposed salewould be on the creditors; andWhether the amount to be receivedfrom the proposed sale isreasonable/fair considering theassets’ market value.CROSS-BORDER INSOLVENCYThe BIA and CCAA both contain provisionswith respect to cross-border insolvencies.These provisions are largely based on theUnited Nations Commission on InternationalTrade Law’s (“UNICITRAL”) Model Law onCross-Border Insolvency.For more information, please contact one ofthe professionals in our CommercialLitigation and Insolvency Practice Group.Commercial Reorganization and Insolvency Law 130

Chapter 14Enforcement ofCreditors’ Rights

CHAPTER 14ENFORCEMENT OF CREDITORS’RIGHTSSECURED CREDITORSPerfection and ProtectionApplicable laws in Atlantic Canada providethe means for secured creditors to perfector otherwise protect their security interestsin both real and personal property. Themethods of perfection are described inChapter 7 – Real Estate Law.Creditors in Atlantic Canadabenefit from a number ofpotential remedies. Theavailable remedies willdepend on whether creditorshave security over the assetsof the debtor.In order to protect the interests of securedcreditors, it is necessary to ensure that therequirements for perfection and protectionof security interests are carefully observed.Mortgages and other charging instrumentssecuring real property must be properlyregistered in accordance with the applicablelegislation in each province. For personalproperty, the perfection requirements willdepend on the type of property involved. Inmost cases, all that is required is a timelyregistration under the Personal PropertySecurity Act (the “PPSA”) in the appropriateprovince. Each such statute provides adetailed set of rules which govern thejurisdiction in which a registration must bemade based on the type of propertyinvolved.The PPSA also includes special rules whichimpose additional requirements to properlyperfect security interests in inventory andalso with respect to certain serial-numberedgoods. In addition to the registrationEnforcement of Creditors’ Rights 131

equirements under the PPSA, securityinterests in various types of investmentproperty will be subject to the additionalperfection requirements set out in theSecurities Transfer Act (the “STA”)applicable in New Brunswick, Newfoundlandand Labrador and Nova Scotia. There is noSTA in effect in Prince Edward Island.Additional registrations under federallegislation should also be considered inrelation to security interests in various formsof intellectual property and aircraft.Registrations may also be required underlegislation adopted in each of the AtlanticProvinces to ratify the internationalconvention relating to aircraft securityinterests. Depending on the type and size ofvessel involved, a registration may berequired under the Canada Shipping Act asopposed to the PPSA.With respect to certain classes of personalproperty (principally, inventory and accountsreceivable) chartered banks have the optionof perfecting security pursuant to the PPSAor under the Bank Act (Canada). Where abank elects to take security under the latter,it will be necessary to make a timely filing atthe appropriate office of the Bank ofCanada.Enforcement RequirementsPersonal PropertyThe enforcement rights available to securedcreditors are generally contained in thesecurity documents themselves. Typically,such documentation will provide for the rightof a secured creditor to seize personalproperty in the event of a default by a debtor(in payment or other breach of covenant)and the right to either sell such property orretain the property in satisfaction of the debtobligation. The security agreement may alsoprovide for the manner in which a sale willbe conducted (e.g., public auction, closedtender, etc.) or will allow the securedcreditor to define the sale process at thetime of enforcement.The PPSA provides detailed requirementsto be observed in relation to theenforcement of security interests in personalproperty governed by the PPSA.Specifically, the PPSA provides for variousnotices which must be delivered whenever asecured creditor (and also a receiverappointed by a secured creditor) elects tosell personal property subject to a securityinterest or retain such property in fullsatisfaction of amounts owing.In addition to the notice requirements in thePPSA, compliance is also required with anynotice or other requirements which may befound in the security documents.Real PropertySimilar to personal property, the remediesavailable to a mortgage lender are alsotypically found in the mortgage document.The laws in the Atlantic Provinces providedetailed procedures which will govern therealization process against real estate.Unlike personal property, where the rulesare substantially similar in the AtlanticProvinces, the rules relating to real propertydiffer significantly from province to province.New Brunswick - A court order is notrequired for the sale of mortgaged propertyin New Brunswick. Mortgage lenders areallowed, after default in payment, to sell theEnforcement of Creditors’ Rights 132

mortgaged property through power of saleproceedings either by public auction or byprivate contract. If the public auction methodis adopted, the mortgage lender is entitledto bid on and purchase the property. Ineither case, specific notice and advertisingrequirements must be fulfilled. The publicauction, which is the remedy most oftenemployed, is conducted by a licensedauctioneer at the court house or other publicfacility in the county where the property islocated. Specific rules have been adoptedby the New Brunswick courts with respect toa deficiency claim against the mortgagedebtor in the event the sale proceeds areinsufficient to retire the debt.Newfoundland and Labrador - Enforcementof a real property mortgage can be pursuedin two ways: (1) by way of foreclosurepursuant to the Rules of the Supreme Court,1986; or, (2) pursuant to the power of saleprovisions under the Conveyancing Act. Theformer is rarely utilized, whereas proceedingby way of power of sale is the mostcommon and cost-effective means ofenforcing on a mortgage. The power of saleprocess begins by providing a 30 daydemand and notice to the mortgagor andany other registered encumbrancers orguarantors. If there is no satisfactoryresponse to the 30 day notice, themortgagee may then proceed to advertisethe sale of the property. Prior to sale, themortgagee is required to obtain an appraisalof the property. The appraisal must bedisclosed to the mortgagor following thesale and be provided in tandem with a fullaccounting of the power of sale process.The sale itself can be conducted anywherein the province by auction or sealed tender,and is usually conducted by the mortgageeor its legal counsel. If there remains abalance owing on the mortgage followingexercise of the power of sale, themortgagee can pursue a deficiency claimthrough the Supreme Court ofNewfoundland and Labrador. Strictcompliance with the power of saleprovisions in the Conveyancing Act isrequired in order to preserve themortgagee’s rights to a deficiency claim.Nova Scotia - Enforcement of a realproperty mortgage requires an order forforeclosure and sale from the Nova ScotiaSupreme Court. The process requires themortgage lender to commence a legalaction against the mortgage debtor for thedebt owing. The remedy usually adopted bymortgage lenders is to sell the mortgagedproperty at public auction. The sale isnormally conducted by the sheriff in thecounty where the property is located. Theforeclosure rules contain specific advertisingrequirements which must be strictlyfollowed. Specific rules are also included todeal with a deficiency claim against themortgage debtor in the event the saleproceeds are insufficient to retire the debt.Prince Edward Island - Enforcement of areal property mortgage may be done in themanner described for Nova Scotia.Enforcement, however, is usually doneaccording to power of sale provisions foundin the mortgage document. The power ofsale process requires the mortgagee toprovide notice to the mortgagor of thedefault and impending sale. Generally, nopower of sale may be exercised until fourweeks’ notice of such sale has been givenand published in the local newspaper. Thesale is usually done by public auction, butmay be conducted by other means such astender process or real estate listing. AEnforcement of Creditors’ Rights 133

deficiency claim may be brought against themortgage debtor in the event the saleproceeds are insufficient to retire the debt.ReceivershipsA secured creditor may elect to realize onits security by using its own personnel ormay appoint an agent known as a receiverto manage the realization process. Wherethe secured creditor’s security extends overthe entire business of the debtor or asignificant portion of the business, thereceiver may be appointed to manage thebusiness for a period of time until it can besold as a whole. Alternatively, the receivermay simply be appointed to gather assetsand prepare them for sale.A receiver may be appointed in three ways:1. Privately in the security instrument;2. Under the Rules of Court of aprovince; or3. Under the Bankruptcy andInsolvency Act (the “BIA”).A receiver appointed under a securityinstrument will generally be viewed as anagent of the appointing creditor. A receiverappointed in this manner will generally beresponsible to enforce the security on behalfof the secured creditor. Where a receiver isprivately appointed, the realization processwill be determined by the receiver inconsultation with the creditor.Receivers appointed under either the Rulesof Court or the BIA will initially be appointedby a court in a jurisdiction which generallyhas a substantial connection to the debtorand its business. The application is typicallymade on the instruction of the securedcreditor. However, once appointed, thereceiver will function as an officer of thecourt with responsibilities to all creditors ofthe debtor, not just the secured creditor whomade the initial application. The court willsupervise the receivership process. Thesale process will be subject to courtapproval. The process for appointmentsunder local court rules and the BIA will besimilar. The distinction is largely based onwhether the debtor’s assets are located inone jurisdiction (which would favour anapplication under local court rules) orwhether such assets are located in severaljurisdictions (which would favour anapplication under the BIA).Receivers, regardless of the method ofappointment, must comply with notice andreporting requirements under the BIA andthe PPSA.Secured creditors should note that theymay, in certain circumstances, beconsidered a receiver where they engagetheir own forces in the realization of adebtor’s assets.Builders’ LiensThe liens on the debtor’s assets discussedin the previous section are consensual liens(i.e. they have been provided with theagreement and consent of the debtor).Creditors who supply labour and materials(and, in some cases, assets) in relation tothe improvement of the real or personalproperty of a debtor may also benefit from astatutory lien (usually described as abuilders’ or mechanics’ lien) on suchproperty in the event of non-payment. Theestablishment and perfection of such liensEnforcement of Creditors’ Rights 134

in Atlantic Canada is strictly governed byapplicable legislation.UNSECURED CREDITORSRight of Action to Enforce ClaimUnder the Canadian constitution, theprovincial legislatures (including those ineach of the Atlantic Provinces) haveauthority over property and civil rights,including the responsibility for determiningthe rights and remedies of unsecuredcreditors.By operation of the common law and theenactment of provincial legislation, courts inAtlantic Canada provide a right of action tounsecured creditors to enforce claimsagainst debtors for the collection of debts.Proceedings are heard by a single judge.Although it is common practice for a futureplaintiff to send a demand letter prior toinstituting court proceedings, it is notnecessary. Each province prescribes itsown time periods within which a proceedingmust be commenced.Where necessary, interim proceedings(known as motions) may be made to thecourt at any time, usually with notice to theother party, for additional related relief suchas an injunction, preservation of property orother necessary interim orders.Alternative dispute resolution, throughmediation, is available between the partiesto facilitate a settlement if all of the partiesto the dispute agree to the terms ofmediation and any settlement. Parties mayalso choose to resolve a dispute througharbitration. Arbitration can generally beagreed to by the parties subject to theArbitration Act in each province.Superior Court, Trial DivisionWith few exceptions, the civil court in eachof the four Atlantic Provinces is theappropriate forum for an action for acollection of a debt. There is no maximumdollar limit with respect to any claim in civilcourts and there are other strategic benefitspursuant to the Rules of Court in each of theprovinces for proceedings in the superiorcourts. Actions in the Federal Court, TrialDivision, offer a more limited forum but maybe useful in certain circumstances. A right ofappeal exists to the Court of Appeal in eachprovince.Simplified Procedures under Civil ProcedureRulesAll of the Atlantic Provinces apart fromNewfoundland and Labrador have adoptedsimplified procedures under their civilprocedure rules for claims under a certaindollar value.New Brunswick – The simplified procedureunder Rule 79 provides for claims of$75,000 or less to be brought pursuant tothat Rule, which is intended to be more costeffective for creditor collection. Thesimplified procedure eliminates oralexamination for discovery but provides fordocumentary disclosure prior to trial.Nova Scotia – There are two ways analternative proceeding may be commencedin the Nova Scotia Supreme Court: (1) asan action for debt; or (2) as an action fordamages under $100,000. Each type ofproceeding is set out below.Enforcement of Creditors’ Rights 135

An Action for DebtRule 4 in Nova Scotia allows for anaction for debt to be commenced by aparty claiming only on a debt, with nointerest other than prejudgment interestat a rate of 5% a year, to be calculatedonly from the time the debt became due.While an action for debt may be usefulin certain circumstances, the limit on theamount of interest that may be claimedwill not be attractive to many creditors,where the amount of interest owing isfar in excess of the amount that can beclaimed under Rule 4.An Action for Damages Under$100,000Rule 57 in Nova Scotia provides astreamlined approach on claims foractions for damages under $100,000. Inorder for a claim to fall under Rule 57,three requirements must be met: (1) theclaim must be for damages only (i.e. noother relief can be sought from theCourt); (2) the claim for damages mustbe based only on debt, injury toproperty, personal injury, supply ofgoods and services, or losses causedby breach of contract or breach of trust;and (3) the total of all claims (excludingcosts and future interest) must be lessthan $100,000.The discovery examination process foractions under Rule 57 is shortened to alimit of three hours per party.Documentary disclosure is still requiredand Rule 57 allows trial dates to besought once the pleadings have closed.A will-say statement must be filed foreach witness who will be called at trial,with the exception of witnesses whohave been examined on discovery orexpert witnesses. A witness may, exceptin certain circumstances, be limited tothe subjects set out in the will-saystatements.Prince Edward Island – The simplifiedprocedure under Rule 75.1 provides forclaims of $25,000 or less to be broughtpursuant to that Rule, which is intended tobe more cost-effective for creditor collection.The simplified procedure eliminates oralexamination for discovery but provides fordocumentary disclosure prior to trial.Newfoundland and Labrador – Instead ofsimplified procedures, the Rules of theSupreme Court, 1986 provide proceduresfor summary judgments and summary trials.These mechanisms are not based on thedollar value of a claim. Rather, they arebased on the complexity of a matter. Thatis, if the Court is convinced that a matter issuitable for such an attenuated hearing andcan be fairly determined with the assistanceof only affidavit evidence, then the partiescan proceed in a summary fashion.Consequently, these procedures are wellsuited for dealing with debt claims or simplebreaches of contract.Small ClaimsIn addition, “small claims” procedures areavailable in all of the Atlantic Provinces andare limited to claims under certain dollarvalues ($12,500 in New Brunswick, $8,000in Prince Edward Island, $25,000 inNewfoundland and Labrador, and $25,000in Nova Scotia).Enforcement of Creditors’ Rights 136

Pre-Trial Disclosure ProcessOral Discovery and Document DisclosureThe nature of any dispute, including acollection action, is defined by the pleadingsdelivered by the parties, in writing, in theaction. The pleadings define the facts andalleged issues that are relevant for trial.The provincial Rules of Court provide for fulldisclosure of all relevant non-privilegeddocumentation that is in the possession,custody or control of the parties to anaction. They also provide for attendance ata recorded examination under oath, prior totrial. Sanctions are available pursuant to theRules for refusal or neglect to attend suchan examination and for refusal or failure toproduce relevant documentation.Procedures also exist for writteninterrogatories or written examinations fordiscovery, but are less often employed.Judgment Collection and EnforcementEnforcement of a Judgment Recovered inthe ProvinceEach of the provinces allows for registrationof a court ordered judgment in real propertyand personal property registries andenforcement of a judgment for the paymentof money through a process of seizure andsale. However, while a judgment may berecorded in the land registry office in PrinceEdward Island, it does not need to be. Onceissued and filed in the court it binds the realproperty of the debtor.Registrations of judgments are effective fora certain term of years and are renewable toa maximum term. Registration operates asa lien to bind the real and personal propertyof the judgment debtor after registration.Newfoundland and Labrador is a statutorylien regime. In order to enforce courtjudgments, they must be registered with theJudgment Enforcement Registry, which isgoverned by the Judgment EnforcementAct. Once registered, the judgmentthereafter binds all real and personalproperty of the judgment debtor in thejurisdiction – there are no further filingsrequired. The statute contemplates variousenforcement mechanisms, such as assetseizures and garnishment of bank accounts.Funds seized and the proceeds from thesale of seized assets are subject to pro ratadistribution amongst registered judgmentcreditors. All such seizures and garnisheesare instituted or conducted by the Office ofthe High Sheriff upon written instructionfrom a registered judgment creditor.In New Brunswick, Nova Scotia and PrinceEdward Island, an Order for Seizure andSale is delivered by a judgment creditor to aSheriff in the jurisdiction where thejudgment debtor is located, for enforcementby the Sheriff. Collection by a Sheriff mayresult in a pro rata distribution of saleproceeds, after payment of the costs of anysale, amongst all judgment creditors.Garnishment of a judgment debtor’s wagesis available in all of the Atlantic Provincesexcept New Brunswick. In Prince EdwardIsland there is also a pre-judgmentgarnishment process where a claim is for aliquidated debt. Monies garnished under thisprocess are paid into court pendingresolution of the court action. An actionmust be commenced within five days ofEnforcement of Creditors’ Rights 137

issuing a pre-judgment garnishmentprocess.New Brunswick’s Enforcement of MoneyJudgments Act, while not yet in force, isintended to streamline enforcement ofmoney judgments and provide for agarnishee order against wages. This statutewill consolidate the law with respect to theenforcement of judgments in NewBrunswick and will involve the repeal ofseveral other antiquated statutes, as well asamendments to numerous other statutes. Italso contains provisions relating topreservation orders, judgment registration,examination of a judgment debtor,enforcement instructions to a Sheriff andenforcement actions in general.Enforcement of Foreign JudgmentsA judgment of the civil court in one provinceis not automatically enforceable in anotherprovince. There are well establishedcommon law principles and statutoryprocedures which enable a money judgmentfrom a “foreign jurisdiction” (including aforeign country) to be made enforceablewithout re-litigating all of the case on itsmerits.Examination in Aid of ExecutionThere currently exist in each of the AtlanticProvinces provisions for examination, underoath, of a judgment debtor or arepresentative of a corporate judgmentdebtor in aid of execution of a judgment.In New Brunswick, two similar yet distinctprocedures exist which provide forexamination, under oath, of a judgmentdebtor. Both methods provide for anopportunity for full disclosure of thejudgment debtor’s ability to pay thejudgment debt. The Arrest andExaminations Act provides for examination,under oath, by the clerk of the court andmay result in a payment order enforceableby the court. Alternatively, examinationsunder the Rules of Court requireattendance, under oath, before a courtreporter. This method, which is most oftenemployed, does not require a court order forattendance or the appearance or theinvolvement of the clerk of the court. Apayment order is not available from anexamination of a judgment debtor under theRules of Court.In Nova Scotia, a judgment debtor may berequired to attend at a discoveryexamination in aid of execution. Such anexamination requires attendance, underoath, before a court reporter. A judgmentdebtor who refuses to attend at a discoveryexamination in aid of execution, as is oftenthe case, may be required to do so undersubpoena.In Newfoundland and Labrador, a judgmentdebtor may be examined under oath incourt. If the judgment under which theexamination is being conducted is out of theSupreme Court, then the examination isheld in the Supreme Court before a clerkand is recorded. If the examination is basedon a small claims judgment, theexamination is held in Small Claims Courtbefore a judge.Fraudulent Conveyances andPreferencesCreditors have at their disposal two sets ofstatutory regimes to set aside a preference,Enforcement of Creditors’ Rights 138

namely the federal Bankruptcy andInsolvency Act (the “BIA”) and the followingprovincial statutes: the Assignments andPreferences Act in New Brunswick andNova Scotia, the Judgment EnforcementAct in Newfoundland and Labrador, and theFrauds on Creditors Act in Prince EdwardIsland.If a transaction with a debtor has the effectof giving a specific creditor a preferenceover other creditors it will, with respect toany suit or proceeding brought to impeachor set aside such transaction, be presumedto have been made with “fraudulent intent”and to be an unjust preference. In order toestablish that a debtor committed apreference which is liable to be set asideunder section 95 of the BIA, a creditor mustfirst obtain a bankruptcy order against thedebtor.Under the Assignment and Preferences Act,a creditor must establish that the paymentwas made by the debtor at a time when heor she was in insolvent circumstances, wasunable to pay his or her debts in full andwas on the eve of insolvency.In Prince Edward Island, where a debtorgives a preference to another person orcreditor, for sixty days following thetransaction that resulted in the preferencethere is a rebuttable presumption that thetransaction was done to defeat, hinder ordelay other creditors from enforcing theirrights. A creditor may challenge atransaction after the sixty day period, butthe onus is then on the creditor to show thatthe transaction was done to defeat, hinderor delay the creditor’s collection efforts.In Newfoundland and Labrador,impeachable transactions are dealt withpursuant to the Judgment Enforcement Act.These provisions apply to the enforcementof creditor rights under any other legislationor the common law. As such, a creditorneed not have a registered judgment inplace to benefit from the protection offeredunder this statute. Generally speaking, anytransfer of property made by an insolventperson with the intent to defeat, hinder,delay or prejudice one or more of his or hercreditors is void as against the creditor soinjured, delayed or prejudiced.In addition, Newfoundland and Labradorhas a Fraudulent Conveyances Act, whichdefines certain transactions involving real orpersonal property as being void where thereis intent to defeat, delay, hinder or prejudicecreditors.The Statute of Elizabeth, an act ofparliament in England, laid the foundationsfor fraudulent transactions to be unwoundand is part of the law of all the AtlanticProvinces except Newfoundland andLabrador. The Statute of Elizabeth may beapplicable to set aside a conveyance ofproperty made to defraud a creditor even ifthe debtor was not in insolventcircumstances at the time of theconveyance.Enforcement of Creditors’ Rights 139

Chapter 15Municipal Law

CHAPTER 15MUNICIPAL LAWMunicipalities constitute a third level of government, below thefederal and provincial/territorial levels. Through legislation, theprovinces devolve some of their powers and responsibilities forlocal matters to municipalities.Municipal Law 140

The form of such legislation varies fromprovince to province. In Prince EdwardIsland and Newfoundland and Labrador,some of the larger municipalities are subjectto their own particular legislation (e.g. theCharlottetown Area Municipalities Act andthe City of St. John’s Act), with theremaining municipalities being covered by ageneral municipalities statute. In NovaScotia, all legislation relevant tomunicipalities, including planning legislation,was combined into the MunicipalGovernment Act (“MGA”) in 1999. HalifaxRegional Municipality (“HRM”) has its ownHRM Charter. All municipalities in NewBrunswick are governed principally by asingle municipalities act.While the form of the legislation may vary, insubstance, most municipalities acrossAtlantic Canada have very similar powersand responsibilities. Municipalities aregoverned by elected councils, which aregenerally empowered to enact regulationsor by-laws governing matters such as waterand sewage, land use, buildingconstruction, fire prevention, street lighting,parking, recreation, community economicdevelopment, animal control, heritagebuildings, noise and other nuisances, andadministration of the municipality, all ofwhich are commonly referred to as “local”matters. Municipalities are also oftenconsulted by the relevant provincialauthority in the context of other areas ofprovincial jurisdiction, such as liquorlicensing.Municipal by-laws (and/or administrativeorders) are available for examination atmunicipal clerk offices. Unofficial versions ofmunicipal by-laws of most major centres arealso published or available through eachmunicipality’s official website. However, theparticular municipality should always beconsulted directly, to confirm the nature ofany relevant regulation or by-law that mayexist.DEVELOPMENT AND PLANNINGLand use planning and development controlare governed by provincial planninglegislation in all the Atlantic provinces.Planning legislation provides for thedevelopment by municipalities of municipalplans which set out statements of policywith respect to the future development anduse of land, including such factors asconservation, abatement of pollution,development of communications andtransportation systems, and provision ofmunicipal services. Municipalities aregenerally prevented from undertaking futuredevelopments in a manner that isinconsistent with their municipal plans.In Nova Scotia, the MGA includes sixProvincial Interest Statements, andmunicipalities may not adopt a municipalplanning strategy ( “MPS”) that isinconsistent with a provincial Statement.Nova Scotia also has provincial SubdivisionRegulations which apply to everymunicipality and they set out the frameworkfor subdividing land; municipalities may alsoenact their own subdivision by-laws.In addition to the municipal plan,municipalities are often required to adopt adevelopment scheme setting out in greaterdetail whether certain lands are to bedesignated for industrial, commercial, orresidential use. Zoning by-laws adopted bymunicipalities must be consistent with theirmunicipal plans and development schemes.Municipal Law 141

An MPS may also provide that certain typesof development are enabled by adevelopment agreement negotiatedbetween a council and developer.Development proposals that do not conformwith zoning by-laws are prohibited, unlessthe use or structure is legally nonconformingor the developer is able toobtain a variation to the zoning by-laws forthe proposed development. This processtypically involves public notice to affectedcitizens and neighbours and the opportunityfor them to state their objections. Whengranting a variance, municipal councils canimpose reasonable terms and conditions.Municipalities are able to change theirmunicipal plans, but the process is lengthyand requires public input and ministerialapproval.It is important to determine the zoning ofproperty before commencing any type ofdevelopment to ensure that it is compatiblewith the municipal plans and by-laws in use,siting and form. At a minimum, appropriatepermits must be secured; more complexprojects may require public hearings andcouncil approval. Failure to seek and obtainmunicipal approval can result in stop workorders, as well as prosecution under theparticular municipal legislation or regulation.Decisions made by municipal councils aresubject to review (in certain specifiedcircumstances) by local appeal boards or byprovincial superior courts with the potentialfor further court appeals.In some provinces, there may be provincialareas which are not within municipalboundaries and are not subject to municipalregulation. However, such lands may still besubject to development restrictions. Forexample, the use of Crown lands is subjectto many limits; private development on FirstNations reserves also has uniqueconsiderations. As well, lands may besubject to various licensing restrictions,such as those contained in forestry andmineral licences.In Prince Edward Island, land holdings areregulated under the Lands Protection Act.Corporations and non-residents cannot holdmore than five acres of land or 165 feet ofshore frontage without first obtainingExecutive Council approval. The ExecutiveCouncil commonly approves acquisitions ofparcels over five acres or in excess of 165feet of shore frontage, but often imposesnon-development conditions on the parcelto limit future subdivision and commercialuse. The other Atlantic Provinces do nothave similar legislation.Development of condominium projectsattracts additional considerations, requiringnot only compliance with municipal plansand by-laws but also compliance withcondominium legislation and, in someprovinces, specific approval processesrelating to condominium development. InNova Scotia, the absence of air rightslegislation presents certain challenges,particularly when developing an in-fillcondominium. Specific legal advice fromlocal counsel should therefore be soughtregarding the development of any lands inthe Atlantic region.MUNICIPAL TAXATIONMunicipalities are generally required andauthorized by provincial legislation toimpose real property taxes. The rate oftaxation imposed on non-residentialMunicipal Law 142

properties is usually higher than forresidential properties. These municipaltaxes help pay for services offered bymunicipalities to their citizens, includingpolicing and fire services, sidewalks,recycling and garbage collection.Municipalities in the province ofNewfoundland and Labrador are alsorequired to impose an annual business taxon businesses operating in the municipality.In Nova Scotia, there are separate chargesfor residential and commercial properties(further classified as urban, suburban orrural in HRM) plus additional area rateswithin a district. There is also a specialmunicipal taxation regime for wind energy.from abrupt increases in rates. Taxagreements are certainly worth considering,especially if a business becomes thesignificant industry in a town, thus makingthe business the largest target for taxrevenue. In Nova Scotia, municipalities aregenerally prohibited from entering such taxagreements but the provincial governmenthas entered such arrangements wherebygrants in lieu of municipal taxes are set forlarge enterprises.Individual municipalities set their ownmunicipal tax rate, arising out of their annualbudgeting procedures. Property andbusiness taxes are normally based on a setrate multiplied by the assessed value of aproperty. Rates and taxation practices varyfrom municipality to municipality, soinquiries should be made of the specificmunicipality to ascertain precise tax levelsand obligations.Property assessments for mostmunicipalities are carried out by provincialbodies under provincial assessmentlegislation. Appeal mechanisms existwhereby property owners can challengeassessments, although appeal periods areexceedingly tight and stringently enforced.Legislation often allows for businesses toenter into tax agreements withmunicipalities, specifying certain rates oftaxation for certain years. Many largercompanies will negotiate these agreementswith municipalities, as it provides certaintyMunicipal Law 143

Chapter 16Aboriginal Law

CHAPTER 16ABORIGINAL LAWThis chapter provides a brief introduction to the key issuesconcerning Aboriginal title and treaty rights in Atlantic Canada andexamines how these issues may affect businesses in the region.Aboriginal Law 144

To understand the importance of Aboriginallaw in Atlantic Canada it is helpful to firstreview the key constitutional and statutoryprovisions. It is also important to rememberthat this area of the law is anything butstatic, with new legislative developments,more movement towards Aboriginal selfgovernment,and increased economicinteraction between private industry andAboriginal groups happening all the time.The intersection between generalcommercial law and Aboriginal law is notalways considered, but a proactiveapproach may make for more streamlined,efficient, and cost-effective businessdealings.CONSTITUTIONAL AND STATUTORYFRAMEWORKConstitution Act, 1867Section 91(24) of the Constitution Act, 1867assigns exclusive legislative authority over“Indians, and Lands reserved for theIndians” to the federal government. Section91(24) has been interpreted to includefederal jurisdiction over the Inuit, as well asthe jurisdiction to negotiate treaties withAboriginal groups and exclusive jurisdictionover land held pursuant to Aboriginal title.But the jurisdiction under section 91(24) isnarrower than it may appear, given theextensive provincial legislation that will alsoapply to First Nations.To date, the federal government has takenthe view that section 91(24) does notconvey jurisdiction over the Métis, but theFederal Court of Appeal has recently heldthat the Métis are included in section91(24), which could lead to changes in thefederal government’s relationship with theMétis. However, the decision will likely beappealed to the Supreme Court of Canada,so the constitutional status of the Métis maybe in flux for the foreseeable future.The more recent legislative efforts of thefederal government appear geared towardsdelegating more authority to First Nationsthemselves.Indian ActThe federal Indian Act is a specific exerciseof the federal government’s constitutionalauthority over “Indians, and Lands reservedfor the Indians.” The Indian Act defines whois an “Indian” and, with a few exceptions, itapplies to all registered Indians and bandgovernments across Canada.It should be noted that the term “Indian” inreference to Aboriginal people is nowconsidered to be an out-of-date term;however, the term “Indian” has yet to bereplaced in the Indian Act, so it continues tobe used in reference to that statute.Although the Inuit are deemed to be “Indian”for the purposes of federal jurisdiction undersection 91(24) of the Constitution Act, 1867,they are not subject to the Indian Act. TheMétis and non-registered Indians are alsonot covered by the Indian Act. (Note,however, that status under the Indian Actmay not necessarily coincide with anindividual person’s cultural identification witha particular band.)Much of the Indian Act relates to reservelands. The underlying title to reserve landsremains with the federal Crown, whichstrictly curbs the ability of First Nationsbands to alienate their land. There are twomain, legally authorized ways for non-bandmembers to acquire a property interest on aAboriginal Law 145

eserve: through a temporary permit orthrough a designation, which is a form ofsurrender. The Act provides procedures forboth, and currently, each route requires theextensive involvement of Aboriginal Affairsand Northern Development Canada.The Act also contains provisions on thedistribution of property on death (wills andintestacy), “mentally incompetent Indians”,guardianship of infants, financialmanagement, taxation, education, bandelections and the authority of band councilsto make by-laws.First Nations Land Management ActThe First Nations Land Management Act(“FNLMA”) enables First Nations to developtheir own regimes for managing land,resources and the environment, through amulti-stage process that can be quitelengthy.The FNLMA regime is meant to promoteFirst Nations economic development andbusiness endeavours. No First Nations inAtlantic Canada currently have a land codein force, but several are either at the“developmental” or “interested” stage andevolution in this area is expected over thenext few years. Where a First Nation hasdeveloped its own land code, the reserverelatedprovisions of the Indian Act nolonger apply.Constitution Act, 1982Section 35 of the Constitution Act, 1982expressly “recognized and affirmed” existingAboriginal and treaty rights, including rightsstemming from historic treaties and modernland claims agreements. “Aboriginalpeoples of Canada” is defined to include the“Indian, Inuit and Métis peoples of Canada.”Prior to 1982, Aboriginal rights existed atcommon law but were subject to extensiverestriction by the federal Crown and couldbe extinguished unilaterally by thegovernment where it had a clear and plainintention to do so. This changed in 1982with section 35. The entrenchment of theserights in the Constitution, and the case lawinterpreting section 35, have affordedincreased protection to distinctive featuresand customary practices of First Nationsand made it more difficult for governmentsto intrude in these areas, as will bediscussed more below. The Crown owesfiduciary duties to Aboriginal peoples undersection 35, which means that the Crown willhave to justify any legislation, regulations orconduct that infringes Aboriginal rightsand/or Aboriginal title.Canadian Charter of Rights andFreedomsThe Canadian Charter of Rights andFreedoms (the “Charter”) as a whole appliesto Aboriginal peoples in Canada, but certainprovisions in particular should behighlighted.Section 25 of the Charter states that therights and freedoms guaranteed under theCharter are not to abrogate or derogatefrom any Aboriginal, treaty, or other rights orfreedoms pertaining to Aboriginal peoples ofCanada. The purpose of this interpretiveprovision is to protect Aboriginal rights frombeing infringed or impaired by Charter rightsor freedoms. Section 15(2) of the Charterhas a wider but similar function, protecting a“law, program or activity that has as itsobject the amelioration of conditions ofdisadvantaged individuals or groups” frombeing found discriminatory.Aboriginal Law 146

Section 25 does not stand alone, however,and must be read in conjunction with othersections of the Charter, including section 1which provides that the rights and freedomsset out in the Charter are subject to “suchreasonable limits prescribed by law as canbe demonstrably justified in a free anddemocratic society.”Recent Federal Statutory DevelopmentsThis is another fluid area of Aboriginal law.The federal government has recentlyenacted legislation governing matrimonialproperty on reserves, and has alsoproposed legislation on First Nationseducation. Both aim to give First Nationsmore control over these areas.The Application of Provincial StatutesIt has been discussed that section 91(24) ofthe Constitution Act, 1867 gives Parliamentthe exclusive power to make laws related to“Indians, and Lands reserved for theIndians.” Historically, one effect of thisconstitutional authority was to limit theapplication of certain provincial statutes toFirst Nations and to reserve lands.Determining whether and which provincialstatutes apply to reserve lands can be acomplicated process. There are two options:provincial laws may apply “ex propriovigore” (of their own force) – the usual route– or via section 88 of the Indian Act. It isdifficult to provide a comprehensive list ofwhich provincial statutes will or will notapply, and extra care should be takenwhere the provincial law relates to land.However, the law seems to be movingtowards a general assumption that theprovincial legislation applies, unless there isa specific interference with Aboriginalinterests that cannot be justified.This is certainly the case where the land isheld under Aboriginal title. The SupremeCourt of Canada has recently said that“provincial laws of general application” willbe presumed to apply to land held underAboriginal title, unless the provincial lawbreaches the Aboriginal right to the land. Abreach will be proven if the provinciallegislation is unreasonable; imposes unduehardship on the Aboriginal group; preventsthe Aboriginal group from exercising its rightover the land in its preferred manner; andcannot be justified by the province. It isunlikely that provincial laws governingmatters like environmental protection wouldbe found to unjustifiable infringe Aboriginaltitle, so legislation of that nature would likelyapply.ABORIGINAL TITLESui Generis Land InterestIn Canada, Aboriginal title refers to a distincttype of proprietary land interest that arisesfrom the occupation and use of land byAboriginal societies prior to Europeansettlement. It is often described as a suigeneris interest, meaning that it is unique toAboriginal people and Aboriginal culture.Aboriginal title operates differently fromtypical proprietary land interests, in that:Title must be held by a communityrather than an individual;The land interest is communal,where all members of an Aboriginalgroup have a collective right to theland interest;The root of Aboriginal title is nottraced from a Crown grant but tracedfrom the first occupancy of land byan Aboriginal group seekingentitlement; andAboriginal Law 147

The land interest cannot be sold,transferred or surrendered to anyoneother than the Crown and thirdparties can only acquire an interestin such lands from the federalgovernment with the consent of theAboriginal group in question.Once established, Aboriginal title confersthe exclusive right to the land itself to anAboriginal group, as well as the right to theeconomic benefit of the lands and resourcesand the right to decide how those lands willbe used.Aboriginal groups may use the land for anumber of modern-day uses provided thatthe activity is reconcilable with the group’shistorical attachment to the land.Establishing Aboriginal OccupancyTo successfully assert Aboriginal title, anAboriginal group must satisfy the “exclusiveoccupation test” established in the SupremeCourt of Canada decision of Delgamuukw v.British Columbia:The land must have been occupiedby the Aboriginal group prior toBritish sovereignty;If present occupation is relied uponas proof of pre-sovereigntyoccupation, there must be continuityin the possession between thepresent and the pre-sovereigntyoccupation; amdAt the time of sovereignty, theoccupation must have beenexclusive.Proof of occupancy must be grounded inboth common law and Aboriginalperspectives on the land, including anysystems of law respecting the land that anAboriginal society had in place at the time ofsovereignty.Factors such as the size of the Aboriginalgroup claiming entitlement, the group’smanner of life, material resources,technological abilities and the character ofthe lands claimed are each consideredwhen determining whether occupation issufficient to ground title. Typically, exclusiveoccupancy is established by showingregular occupancy by a group or use ofdefinite tracts of land for hunting, fishing orexploiting resources.While at least one Canadian court has ruledthat the existence of private interests onland cannot extinguish Aboriginal title, it isstill uncertain how Aboriginal title will bereconciled with the interests of private landowners, since the courts are only beginningto deal with these types of issues.Infringing on Aboriginal TitleThe test for determining whether legislationor an action interferes with an existingAboriginal or treaty right is comprised ofthree questions:1. Is the limitation on the right bylegislation or action reasonable?2. Does it impose undue hardship?3. Does it deny the rights of holderstheir preferred means of exercisingthe right?The burden of infringement is low and willbe established if any of these questions isanswered in the negative.Only the federal government has jurisdictionto extinguish Aboriginal title, but both thefederal and provincial governments haveAboriginal Law 148

the power to infringe upon Aboriginal titleprovided the infringement is justifiable.To be constitutionally justifiable, the Crownmust demonstrate, in a two-part test, that:An infringement of Aboriginal titlemust be pursuant to compelling andsubstantial objectives. This includesdevelopment of agriculture, forestry,mining, hydroelectric power andother land resources; andThe actions comprising theinfringement must be consistent withthe federal government’s fiduciaryduty toward Aboriginal people.These fiduciary obligations includethe duty to consult with Aboriginalgroups. A review of some of AtlanticCanada’s current consultations withAboriginal groups is included later inthe chapter.TREATY RIGHTSMost of Atlantic Canada’s Aboriginal treatieshave existed for over 250 years. They raisemany unique and complex historical andinterpretative issues, and litigation overthose rights tends to be prolonged andexpensive.In the last 25 years, Canadian courts haveprovided guidance on the nature and scopeof the Aboriginal rights conferred by thesetreaties in several important cases.However, many questions about the extentof those rights and their implementationhave yet to be answered. Negotiationprocesses designed to address these andother issues are underway in all the AtlanticProvinces, but they are in their early stages.Under Canadian law, any written agreementbetween the Crown and competentrepresentatives of an Aboriginal peoplewhich imposes mutually binding obligationsis a “treaty”. The Supreme Court of Canadahas, however, emphasized that FirstNations treaties are more than merecontracts – they contain an exchange ofsolemn promises of a special, public, nature– and must be interpreted broadly, in theirfull historical context, and in a manner mostfavourable to Aboriginal people.All Aboriginal treaty rights existing as ofApril 17, 1982 are protected by s. 35 of theConstitution Act. To be covered by thissection, a treaty right must not have beensurrendered or expressly extinguished bythe Canadian government before that date.Even a constitutionally protected treaty rightis not absolute. The Canadian andprovincial governments can continue toenact statutes and regulations, and makedecisions, that affect these rights as long asthey can be “justified” (i.e. for conservationor other compelling and substantial publicinterest reasons). In order to establishjustification, government must also fulfill itsduty to consult.There are two main types of Aboriginaltreaties in Canada – “historic” and “modern”.Between 1713 and 1779, the British Crownentered into several “historic” treaties withrepresentatives of the Aboriginalcommunities which occupied AtlanticCanada at the time. Over the past 30 years,Canadian governments have alsoconcluded several much morecomprehensive and detailed “modern”Aboriginal treaties with First Nations acrossthe country.Aboriginal Law 149

“Historical” TreatiesThe region’s historic treaties include anumber of very similar “peace andfriendship” treaties which were entered intoby the British Crown and the Mi'kmaq andMaliseet people. In the 1700s, the Mi’kmaqoccupied parts of Nova Scotia, NewBrunswick, and Prince Edward Island, whilethe Maliseet resided along the St. JohnRiver in New Brunswick.These treaties are brief and difficult tointerpret. Their prime objective was to putan end to ongoing hostilities and to makeway for British settlement in the region, andto ensure that Aboriginal peoples would befree to carry on their hunting, fishing andother traditional activities withoutinterference.Most notably, under these treaties (unlikethose entered into later in the more westernparts of Canada) the Aboriginals did notsurrender any land or other resource claims.The application of these treaties withincertain areas of Atlantic Canada is not freefrom doubt. For example, whether any sucha treaty was signed by any authorizedrepresentative of the Mi'kmaq who occupiedPrince Edward Island has been the subjectof debate. The Newfoundland Court ofAppeal has also denied a Mi’kmaq claimthat they acquired a right to hunt, fish andtrap in a reserve located in the northern partof that province under these treaties (Drew,2006). In its view, these treaties do notapply in that province. The Supreme Courtof Canada denied leave to appeal in thatcase.In two landmark decisions which originatedfrom Nova Scotia, the Supreme Court ofCanada found that, under these treaties, theMi'kmaqs acquired a communal right toengage in traditional 1760 trading (andassociated harvesting) activities, to theextent required in order to sustain amoderate livelihood (Marshall I, 1999).It did, however, emphasize that this right didnot allow the open accumulation of wealth(Marshall II, 1999). The Supreme Court ofCanada has also recognized thatAboriginals had a right to fish for food,social and ceremonial purposes on theirtraditional lands (Sparrow, 1996).In another case, which involved NewBrunswick and Nova Scotia, that Courtrefused to extend this right to includecommercial logging. In its opinion, logs werenot a product that the Aboriginalstraditionally traded with the British in 1760.The Court pointed out that treaty rights arenot “frozen in time” but the contemporaryactivity claimed must have logically evolvedfrom a 1760 activity (Marshall III, 2005).This decision makes it unlikely that thesetreaties will be extended to cover resourcessuch as mineral and offshore petroleumdeposits.“Modern” Treaties“Modern” Canadian treaties typically containsome ceding of Aboriginal rights inexchange for hunting, fishing, trapping orother rights, participation in themanagement of resources, andcompensation. The self-government ofAboriginal peoples may also be addressed.These agreements can have a significantimpact on, for example, developmentprojects in the region because they mayaffect land tenure and regulatory andpermitting regimes. They may also imposeadditional requirements for consultation ornegotiation with First Nations communities.Aboriginal Law 150

In conducting negotiations with Aboriginalpeoples, government is under an obligationto uphold the “honour of the Crown” (e.g., tonegotiate in good faith and to avoid sharpdealings).The Supreme Court of Canada, in itsdecisions, has encouraged the settlement oftreaty and other Aboriginal rights and claimsby negotiation rather than litigation. Inresponse, the governments of NewBrunswick, Nova Scotia and Prince EdwardIsland (collectively, the “Maritimes”) andCanada and have undertaken discussionswith Mi'kmaq and Maliseet groups in theirprovinces.Several agreements of a preliminary andprocedural nature have been signedbetween the Mi'kmaq and the Nova Scotiaand Prince Edward Island governments.Although the federal government did takesteps to speed up the negotiation process in2012, it is unlikely that these processes willconclude in the near future.In Newfoundland and Labrador, the federaland provincial governments and the Inuit ofLabrador, after 15 years of negotiations,successfully concluded a comprehensiveagreement that covers a large area ofnorthern and eastern Labrador in 2005.Negotiations are still underway with the InnuNation of Labrador.AN OVERVIEW OF THE DUTY TOCONSULTThe Supreme Court of Canada has heldthat the “honour of the Crown” imposes onthe federal and provincial governments aduty to consult (“DTC”) with Aboriginalgroups in respect of any proposed actionthat could infringe upon a group’s Aboriginalrights, treaty rights, and potential orestablished Aboriginal title. The DTC hasgiven rise to a developing body of case lawinterpreting its exact content and meaning;mining and hydro projects have beenespecially contentious.The case law requires the federal andprovincial governments to give priority toAboriginal and treaty rights and, as such,the duty to consult exists independentlyfrom other public consultation requirements.This means that simply including Aboriginalgroups in a public review process in somecircumstances may not be sufficient todischarge the governments’ obligation toconsult, and a separate and distinctconsultation process may be required.There are four main steps to the DTCprocess: the trigger; determination of thescope of the DTC; the actual process ofconsultation; and accommodation. Whateach step of the process will look likedepends on the facts of the case, the natureof the project, the parties’ interest innegotiating, etc.There is a low threshold to trigger the DTC.In general, this will happen when the Crowncontemplates certain conduct and it has theactual or constructive knowledge that thisconduct might “adversely affect anAboriginal claim or right,” even if the claimor right has not yet been established in priorcourt proceedings. The scope of the duty isvariable, however, and in circumstanceswhere rights or title are claimed, but not yetproven in court, the manner and degree ofconsultation required may depend on thestrength of the Aboriginal group’s claim. Inother words, there is a “spectrum” ofconsultation and accommodation.In the specific context of Aboriginal title, thespectrum of required Crown conduct mayAboriginal Law 151

ange from good faith consultation with agroup claiming Aboriginal title andappropriate accommodation of its claimedinterest (e.g., preserving the area until theclaim is resolved), to the potentialcancellation of a project where an Aboriginalgroup has established title to the land inquestion and the Crown conduct wouldunjustifiably infringe that title.The Crown can only justify an interferencewith land held under Aboriginal title byproving that (a) it has fulfilled its DTC and(b) the proposed activity is necessary toachieve a legitimate government goal; theactivity will minimally impair the Aboriginalinterest in the land; and the expectedbenefits of the project are proportionate,meaning that they “are not outweighed byadverse effects on the Aboriginal interest.”(This justification process will not benecessary if the Aboriginal group consentsto the proposed Crown activity on the land.)There is some indication that the Crown willhave to contribute “capacity funding” toAboriginal groups to facilitate theirmeaningful participation in the consultationprocess. Some provinces have establisheda direct funding mechanism for consultation,and in other cases, funding has beenprovided as part of the overall publicconsultation process for a project.If the Crown breaches its DTC, theAboriginal group has several possibleremedies at its disposal: the group may tryto get a government decision quashed;move for an injunction to suspend theCrown project; seek a court order forcingthe Crown to consult; or sue for damages.The Duty to Consult and ProjectProponentsThe most contentious area of late has beenthe role of private industry projectproponents in the process of consultation,and whether and to what extent they shareresponsibility with the Crown toaccommodate Aboriginal interests. Therehas been litigation by Aboriginal groupsagainst proponents and, more recently, byproponents against the government.According to the Supreme Court of Canada,the Crown can delegate theoperational/procedural “on the ground”aspects of the DTC, but the permissibleextent of this delegation will continue to befleshed out by the courts.In practice, government regulators anddecision makers are placing increasedconsultation obligations on private industry.Although the DTC is ultimately the Crown’sresponsibility and case law emphasizes therole of government in the consultationprocess, governments are placingincreasing pressure on private companies toalso consult with Aboriginal groups and togo beyond existing regulatory and corporaterequirements. There are also severalgovernment policies in place, including inAtlantic Canada, that may outline duties ofproject proponents; these are an importantsource of information to review beforeembarking on projects that have thepossibility of affecting Aboriginal groups.Any authorizations or regulatory approvalsgranted by government without requisitesatisfaction of consultation obligations aresubject to legal challenge and can bequashed and remitted to the responsiblegovernment departments forreconsideration. Furthermore, a breach ofthe DTC may also entitle the First Nation toAboriginal Law 152

injunctive relief, damages, or simply tofurther negotiations.Disputes over the DTC process can causedelay and increase costs for projectproponents. However, many proponentshave willingly entered into negotiations aspart of the DTC and worked with Aboriginalcommunities to reach Impact and BenefitAgreements (“IBAs”), which can lead tobenefits on both sides, enabling proponentsto continue with projects but also bolsteringcommunity and economic development forFirst Nations.BUSINESS RELATIONS BETWEENINDUSTRY AND ABORIGINAL GROUPSAn OverviewFor practical and business reasons, privatecompanies have been increasingly active inworking with Aboriginal groups in situationswhere they are contemplating a significantproject on lands traditionally claimed by anAboriginal group. This has often involvedthe negotiation of IBAs between thecompany and the Aboriginal group, or othercooperative business relationships,including partnerships, corporate structuresor joint ventures. In some cases, theexistence of a comprehensive land claimsagreement may specifically mandate thenegotiation of an IBA, or otherrequirements, in order for a project toproceed on affected lands.For the offshore oil and gas industry, forinstance, there is no requirement for an IBAbut the Offshore Accord legislation in placein Newfoundland and Labrador and NovaScotia provides that the regulator mayrequire developers to prepare benefits planswhich include provisions that enable“disadvantaged groups” to have access totraining and employment opportunities.In many circumstances, the Indian Act willhave a prominent role to play in determiningthe shape of any business relationshipbetween industry and Aboriginal groups.This is because the Indian Act affects suchmatters as Aboriginal property ownership,commerce, and land possession, and assuch, is likely to play a role in manyproposed business opportunities involvingAboriginal groups.In the Maritimes, which is broadly an areasubject to historical rather than moderntreaties between Aboriginal groups andgovernment, there are unsettled Aboriginalland claims and the common law continuesto evolve in response to questions ofAboriginal land rights in the developmentcontext. The “peace and friendship treaties”(1760-1761) signed by the Mi’kmaq andMaliseet people in the Maritimes have beenfound to have not ceded rights to land andother resources, so any businessrelationship between industry and Aboriginalgroups must take this dynamic rightssituation into account. Conversely, inNewfoundland and Labrador, more recentagreements between Aboriginal groups andgovernments have been negotiated. This isdiscussed in more detail in the followingsection.Attempting to be as informed as possibleabout the specific historical and modernelements which will shape the businessrelationship between industry and Aboriginalgroups is likely to lead to more successfulrelations between industry and Aboriginalgroups.Land Claims Agreements in AtlanticCanadaAboriginal Law 153

The Labrador Inuit Land Claims Agreementand the Labrador Innu Agreement-in-PrincipleOn the island of Newfoundland andLabrador, there is a vibrant Mik’maqcommunity in the western, southern andcentral parts of the island, primarilyconcentrated in the Miawpukek First Nationreserve of Conne River, although the“landless” Qalipu Mi’Kmaq First NationBand has also recently been created.The greater proportion of the Aboriginalpopulation in the province is found furthernorth in Labrador, and Aboriginalconsultation issues often arise here due tothe extensive mining and hydro-electricdevelopment in the region.In recent years, both the Labrador Inuit andLabrador Innu have negotiatedcomprehensive land claims agreements,which have many potential impacts forthose developing ventures or carrying onbusiness in the affected lands.Presently, there is a concluded land claimsagreement between the federal andprovincial governments and the LabradorInuit, known as the Labrador Inuit LandClaims Agreement, which provided for thecreation of the Nunatsiavut Government asa self-governing body. The provincialLabrador Inuit Land Claims Agreement andits federal equivalent, the Labrador InuitLand Claims Agreement Act, have beenenacted to ratify the agreement. Since theconclusion of the agreement, variousprovincial and federal statutes have alsobeen amended to honour the agreement toensure that its contents maintainprecedence over any subordinatelegislation.In addition, the Labrador Innu are innegotiations with the federal and provincialgovernments towards the completion oftheir own comprehensive land claimsagreement and, on November 18, 2011, anAgreement-in-Principle was signed. Whilenon-binding, this Agreement-in-Principleprovides guidance as to the structure andcontent of the final comprehensiveagreement.Both the concluded Labrador Inuit LandClaims Agreement and the Labrador InnuAgreement-in-Principle provide for differentlevels of Aboriginal influence and rights indifferent designated areas, and eachdesignates affected lands in a similar way.Two of the key categories of lands includethe following:Lands and waters have beendesignated as forming part of the“Labrador Inuit Settlement Area” or“Labrador Innu Settlement Area”(“LISA”), wherein the Labrador Inuitand Labrador Innu will respectivelyhave an enhanced set of rights; andSmaller subsets of Labrador Inuitand Labrador Innu lands have beendesignated respectively as“Labrador Inuit Lands” or “LabradorInnu Lands” (collectively, “LIL”). InLIL, the Labrador Inuit and LabradorInnu will not only have enhancedrights, but also the jurisdiction tomake their own laws on certainsubjects.In addition to LISA and LIL, bothagreements also designate certain areas aseconomic development areas, where therelevant group will have the right to certainnegotiated benefits (under an IBA) inrespect of major developments in thesubject lands.Aboriginal Law 154

Other Aboriginal Interests in LabradorApart from the Labrador Inuit and LabradorInnu, other important Aboriginal interests inLabrador include the Aboriginal personsrepresented by NunatuKavut CommunityCouncil Inc. and various Québec-basedInnu groups asserting rights in the province.The Aboriginal persons represented byNunatuKavut Community Council Inc. haveset out the basis for their claim in a detaileddocumented titled “Unveiling NunatuKavut”.While this claim has not been finallyaccepted for negotiation by the federal orprovincial governments, the Newfoundlandand Labrador Court of Appeal haspreviously recognized a Crown duty toconsult its predecessor, the Labrador MétisNation, and it has been an active litigant inrecent years.Similarly, while the Québec-based Innugroups’ claims have not been accepted fornegotiation by government, some of thesegroups have been active litigants in recentyears, and some project proponents inWestern Labrador have negotiatedagreements with them.For more information on Labrador, pleasesee Chapter 17.Aboriginal Consultation PoliciesIn April 2013, the Government ofNewfoundland and Labrador released its“Aboriginal Consultation Policy on Land andResource Development Decisions” (the“Policy”). The Policy is the product ofconsultations with Aboriginal groups,industry stakeholders and the public and iswidely seen as a result of consultationclaims arising from the Labrador Troughmining projects and the Lower ChurchillHydro Project.The Policy applies broadly to all “land andresource development decisions that havethe potential to adversely impact assertedAboriginal rights or asserted treaty rights”.Its objective is for decisions to “minimize or,where reasonably practicable, eliminateadverse impacts on asserted rights”.The Policy applies to those Aboriginalgroups that have asserted claims inLabrador that have not been recognized oraccepted for negotiation. Such groupsinclude the NunatuKavut CommunityCouncil, the Québec-based Naskapi Nationof Kawachikamach and the communities ofMatimekush-Lac John, Uashat Mak Mani-Utenam, Ekuanitshit, Nutakuan, UnamenShipu and Pakua Shipi (all of whom arespecifically named in the Policy).Under the Policy, key expectations forproponents include: discussing potentialadverse impacts with key members ofAboriginal group(s); considering how tomitigate or eliminate impacts, in light of theobligation to “make reasonable efforts” to doso; and entering dialogue with Aboriginalgroups to address project-specificopportunities, with the goal of achieving “apositive, sustainable, mutually beneficialoutcome”.For Aboriginal groups, key expectationsinclude: to outline specific rights/interestsbeing affected; to respond to requests forinput promptly; to share traditional land-useinformation; and to work with thegovernment and proponents “to findsolutions or constructive approaches” toaddress concerns raised.Aboriginal Law 155

The Policy contemplates the creation ofdetailed Consultation Guidelines which areexpected to provide further guidance as tothe Policy’s application, but as of April 2014they had not yet been released.In New Brunswick, the official Duty toConsult Policy, released by the provincialgovernment in November 2011, providesthat “the Government of New Brunswick willconsult with First Nations before an actionor decision is taken that may adverselyimpact Aboriginal and treaty rights”, as persection 35 of the Constitution Act, 1982.This policy is based on five governingprinciples for consultation, namely integrityand good faith, mutual respect, thegovernment’s duty to consult, reciprocalresponsibility, and transparency andaccountability. This policy alsocomplements the Mi'kmaq, Maliseet, andProvince of New Brunswick RelationshipBuilding Bilateral Agreement, which wassigned on June 22, 2007, which provides aframework for the Aboriginal communities ofNew Brunswick and the provincialgovernment to deal with issues, includingdevelopment, in a mutually respectful,productive manner.There is currently an Interim ConsultationPolicy in Nova Scotia, released on June 19,2007 and intended to govern theconsultation work of provincial governmentdepartments. This interim policy applieswhere Aboriginal title, Aboriginal rights,and/or treaty rights are claimed. A final,more comprehensive policy was expected in2013 but as of April 2014 had not yet beenreleased.In the meantime, there are three otherdocuments that third parties should considerwhen about to embark on projects thatcould affect Aboriginal groups:The Memorandum of Understandingbetween Canada and Nova Scotia,signed in October 2012, whichaffirms federal-provincial plans tocooperate on matters regardingconsultation;The 2010 Terms of Reference for aMi’kmaq-Nova Scotia-CanadaConsultation Process, between theMi’kmaq of Nova Scotia asrepresented by the ThirteenMi’kmaw Saqmaq, Nova Scotia, andCanada and establishing an optionalbut preferred consultation process;andThe Proponents’ Guide: The Role ofProponents in Crown Consultationwith the Mi’kmaq of Nova Scotia,which was most recently revised in2012.This Guide advises project proponents,identified as including “private industry,consulting firms, government departmentsand municipalities,” on how to fulfill theprocedural aspects of consultation that maybe delegated to them in accordance with thecase law on duty to consult (but is notmeant to take the place of legal advice). It isclear that the provincial Crown maintainsultimate responsibility for the consultationprocess. The Guide stipulates that it will beespecially relevant for proponentsundertaking an Environmental Assessmentunder the Regulations to the EnvironmentAct, but will also apply more generally.The Guide sets out four principles ofengagement – “mutual respect”; “earlyengagement”; “openness andtransparency”; and “adequate time toreview/respond” – and outlines six steps ofengagement for proponents: notifying therelevant Mi’kmaq communities beforebeginning the project; providing as muchAboriginal Law 156

information as possible to the Mi’kmaqcommunities, including scope, location, andpotential impacts of the project; meetingwith the affected Mi’kmaq communities;completing a “Mi’kmaq EcologicalKnowledge Study” [“MEKS”] if the provincerequires, in accordance with the Assemblyof Nova Scotia Mi’kmaq Chiefs’ MEKSProtocol; addressing potential impacts,which may include providing funding to theMi’kmaq community to assist with theirreview of the proposal, and developingstrategies to minimize potential adverseeffects; and, finally, documenting theengagement process and updating theprovince on same. Proponents are advisedthat Benefit Agreements with Aboriginalgroups are considered a “best practice.”As of publication, all of these documentswere available on the Province of NovaScotia’s Aboriginal Affairs website[http://novascotia.ca/abor/]In Prince Edward Island, the provincialgovernment developed the Provincial Policyon Consultation with the Mi’kmaq in 2009,with the guiding principle that “policies orguidelines for consultations with Aboriginalpeoples must ensure that the duty to consultis fulfilled in a way that is consistent withcurrent legal decisions and will considerindividual communities' traditions andconsultation requirements”. A landmarkConsultation Agreement was signed by theMi’kmaq, the Prince Edward Islandprovincial government and the federalgovernment in August 2012, whichestablished a consultation process withPrince Edward Island’s Mi’kmaq.CONDUCTING BUSINESS ONRESERVESVarious differences exist when conductingbusiness in relation to Aboriginal reservesand Aboriginal groups as opposed to privateland and private land owners. The keydifferences relate to taxation and financing.TaxationDespite what many Canadians may believe,Aboriginal people are not generally exemptfrom taxation. Exemptions which do existextend only to status Indians as defined inthe Indian Act. In addition, exemptions onlyapply in relation to reserve lands andpersonal property of Indians situated on areserve. The relevant federal exemptionsare provided for in the Indian Act.Some provincial statutes make specialprovision for the exemption of Indians andIndian lands with regard to various types ofprovincial taxation. Provincial taxation lawsmust always be measured against theIndian Act, as any provincial law whichimposes a tax where the federal actprovides an exemption is invalid.The tax treatment of status Indians hasbeen somewhat fragmented. One of themore disputed issues with respect totaxation includes the treatment ofemployment income. Section 87 of theIndian Act generally exempts personalproperty of an Indian situated on a reserveand the courts have held that employmentincome of status Indians is property for thepurposes of section 87. As such,employment income earned on-reserve maynot be subject to income tax if the employeeis a status Indian. Generally speaking,where pension or other benefits areassociated with exempt employmentAboriginal Law 157

income, these other benefits will also beexempt.The difficulty is in determining whether theemployment income is “situated on reserve”for the purposes of section 87. While thecourts have developed the “connectingfactors” test to address this issue, and theCanada Revenue Agency has publishedcertain guidelines outlining its treatment ofthe issue, the approach taken by the courtshas not always been consistent. It is clear,however, that it will be very difficult to obtaina taxation exemption where employmentduties are performed off-reserve, even if theemployer is situated on-reserve, and it willbe recalled that only status Indians underthe Indian Act have access to suchexemptions.Section 87 of the Indian Act also has theeffect of exempting personal propertysituated on a reserve from provincial andfederal sales taxes. Where goods arepurchased off-reserve but are delivered tothe reserve and are to be consumed onreserve,the general rule is that they areexempt. Examples of this include food,furniture, cars, etc. That being said, thefederal and provincial governmentsfrequently challenge the treatment of offreservepurchases.Services provided to an Aboriginal personliving on-reserve and which are performedentirely on-reserve will be considered tohave been situated on the reserve. As such,they are not subject to sales and servicestax.Various other tax exemptions exist forcertain commodities purchased byAboriginal people. For example, provincialgasoline taxes and tobacco taxes may notbe imposed when these items arepurchased by Indians on-reserve. Taxexemptions will not generally extend toAboriginal persons who live off-reserve ifthey do not consume the goods or serviceson-reserve.It is also notable that Aboriginal bands maymake their own taxation by-laws for peopleand businesses on-reserve.Businesses should always seekprofessional tax advice before dealing withsituations involving tax exemptions.FinancingAboriginal people and bands living onreserveoften experience considerabledifficulty in obtaining financing. This ismainly due to the fact that pursuant tosection 89 of the Indian Act, the real andpersonal property of Aboriginal people orbands located on-reserve cannot be usedas security or collateral, nor can it be seizedby anyone other than an Aboriginal personor a band.Section 90 of the Indian Act also exemptsfrom seizure personal property which wasgiven to Aboriginal people or bands by theCrown pursuant to a treaty or agreementbetween a band and the Crown. The courtshave ruled that modern treaties and landclaims agreements are covered by thissection, meaning that any personal propertyconveyed by the Crown to an Aboriginalgroup under such a treaty or agreement willbe exempt from seizure.Accordingly, Aboriginal people living onreservemay have a difficult time providingsecurity for loans without the assistance ofgovernment or corporate guarantees.Aboriginal Law 158

There are, however, a number of exceptionswhich businesses should be aware of:Leasehold interests in landdesignated by an Aboriginalcommunity for leasing purposes cansometimes be mortgaged.Personal property purchased undera conditional sales contract can beseized as ownership remains withthe vendor until receipt of payment.Aboriginal people or bands may actas assignees or trustees for a non-Aboriginal financier.Corporate property is not exemptfrom seizure. As such, an Aboriginalperson who seeks financing may beasked to incorporate a company. Itshould be noted, however, that thecorporation is taxable.Aboriginal Law 159

Chapter 17Big Land

CHAPTER 17BIG LANDStewart McKelvey has had a long and historic connection withLabrador, the “Big Land”. Notably, our predecessor firm Higgins,Hunt and Emerson acted as counsel and solicitors to the colonialGovernment of Newfoundland in the 1927 Labrador BoundaryDispute with the Dominion of Canada.Big Land 160

In that case, the Judicial Committee of thePrivy Council decided the Labradorboundary question in Newfoundland’sfavour, effectively granting the 112,000square mile territory of Labrador toNewfoundland. Labrador was ultimatelybrought into Canada under the April 1, 1949Terms of Union between Canada andNewfoundland. In 2001, in recognition ofLabrador’s importance, the Province ofNewfoundland was renamed to be theProvince of Newfoundland and Labrador.Labrador hosts world-class naturalresources, including mines, water powersand forests. Development of these naturalresources has resulted in significanteconomic and business growth in theregion.Labrador’s legal landscape is somewhatsingular. Businesses planning any kind ofresource-based undertakings will need to befamiliar with its unique aboriginal rightsregime. Labrador is the home of numerousindigenous aboriginal groups, many ofwhose rights have been recognized andformalized. Of primary importance to thoseplanning to carry on business there will beawareness of and respect for legitimateaboriginal title and rights claims.For the Labrador Innu and the LabradorInuit, aboriginal title and rights have beenformalized by, respectively:the Labrador Inuit Land ClaimsAgreement Act, which establishesthe Nunatsiavut Government’sjurisdiction over Labrador Inuit lands;andthe November 18, 2011 LabradorInnu Agreement-in-Principle, whichidentifies Innu lands and provides forInnu self-government.Resource-based enterprises operating inthe Labrador Inuit lands will need to befamiliar with the permitting and land useregime administered for the Labrador Inuitby the Nunatsiavut Government. RelevantNunatsiavut Government legislationincludes the Nunatsiavut Labrador InuitLands Act, the Nunatsiavut EnvironmentalProtection Act and the Exploration andQuarrying Standards Act. A fullunderstanding of the land use regimecontemplated by the Labrador Inuit LandClaims Agreement Act will also requireknowledge of the Regional Land Use Plandeveloped thereunder.The Province’s Aboriginal ConsultationPolicy has application to unresolvedaboriginal title and rights claims to areas ofLabrador which have been asserted by theNunatukavut Community Council (formerlythe Labrador Métis Nation) and by theQuebec-based Innu groups known anddescribed as the Naskapi Nation ofKawawachikamach and the Innucommunities of Matimekush-lac John,Uashat mac Mani Utenam, Ekuanitshit,Nutakuian, Unamen Shipu and Pakua Shipi.The Aboriginal Consultation Policyprescribes the nature of proponent-ledconsultations which will be necessary priorto undertaking natural resource projects inthe areas of Labrador which are subject tosuch unresolved claims.Nalcor Energy’s Lower ChurchillDevelopment Project, the multi-billion dollarBig Land 161

hydroelectric generation mega-project beingbuilt to develop the waterpowers on thelower part of the Churchill River in Labrador,is one of Canada’s most significant ongoingresource developments. For thosebusinesses seeking to participate in thisproject, a knowledge of the EnergyCorporation Act will be necessary, inaddition to an understanding of conventionalpermitting and licensing requirements underthe law of Newfoundland and Labrador and,possibly, under federal immigration law.These subjects are addressed in otherchapters of this publication.For prospectors and mining enterprisesintending to carry on mineral explorationand development in Labrador’s vibrantmining sector, there are a number of keyprovincial enactments of relevance,including:the Mineral Act and MineralRegulations, which govern theissuance of mineral exploration andmining rights and titles, includingrelated surface titles;the Mining Act and the MiningRegulations, which regulate theestablishment and operation ofmining operations;the Quarry Materials Act, 1998 andthe Quarry Materials Regulations,which regulate the issuance ofquarry licences and permits; andthe Revenue Administration Act,which sets out the mining andmineral rights tax regime of theProvince.good understanding of the regulatoryregime enacted by the Province’s ForestryAct and Forest Protection Act, and theregulations promulgated under thislegislation, will be necessary.Resource-based Labrador projects will ofcourse also require environmentalassessment and permitting under theProvince’s Environmental Protection Actand Water Resources Act and (for certaincategories of projects) the CanadianEnvironmental Assessment Act, 2012.These matters are also discussed in thechapter of this publication entitledEnvironmental Law.In addition to mastering the legal regimedescribed above, Labrador businesses willneed to overcome the challenges presentedby Labrador’s shorter construction,exploration and development season, itslimited transportation infrastructure, and thelogistical difficulties in locating and housingworkers in the north. Undertaking businessactivities in Labrador will require patienceand careful planning.Stewart McKelvey’s Labrador PracticeGroup has been formed to specifically servethese needs.For those businesses planning to engage inthe Labrador timber harvesting sector, aBig Land 162

Appendix:Business Incentives

APPENDIX: BUSINESS INCENTIVESNEW BRUNSWICKNEW BRUNSWICK INNOVATION FOUNDATION (“NBIF”)The mandate of the NBIF is to contribute to the development and enhancement of innovationcapacity in New Brunswick. The NBIF supports targeted and leveraged investments ininnovation, and in research and development in New Brunswick. The NBIF has identified priorityareas for its funding initiatives, which include advanced manufacturing, energy andenvironmental technologies, the knowledge industry, life sciences and value-added naturalresources. Among the funds and programs available through the NBIF are:RESEARCH INNOVATION FUND (“RIF”)The RIF assists in building the innovation capacity of eligible organizations by supportinginnovation projects that have the potential for transforming new ideas into new products,services, technologies or processes. The RIF focuses on, but is not restricted to, applied R&Dand innovation activities performed in the province.STARTUP INVESTMENT FUND (“SIF”)The SIF provides entrepreneurs located in New Brunswick with access to startup capital tosupport the formation, initial capitalization and development of new and innovative growthbusinesses in the province. The SIF is designed to provide entrepreneurial New Brunswickerswith the unique opportunity to obtain the early-stage equity capital they require to transform theirinnovations and business concepts into commercially viable ventures. Companies may beeligible for up to $100,000 under the SIF.NBIF INNOVATION VOUCHER FUND (“NBIF IVF”)The NBIF IVF encourages collaboration and partnerships between small and medium-sizedenterprises (“SME”s) and research organizations. The NBIF IVF aims to accelerate innovationwithin SMEs by leveraging the talent, capacity and infrastructure of New Brunswick researchinstitutions. The ultimate goal is to apply innovation in a way that improves the profitability andthe competitiveness of SMEs in New Brunswick. Projects may range in size from $10,000 to$100,000. NBIF will fund 80% of the total project costs, up to a maximum of $80,000 per project.The company will be required to fund the remaining 20%.Business Incentives 163

VENTURE CAPITAL FUND (“VCF”)The VCF is an early stage venture capital investment fund designed to assist companies growand prosper by providing access to venture capital, business expertise, support and networkingopportunities. The objective of the VCF is to support promising innovative New Brunswickcompanies that are in the post-seed round of funding and have sound commercial products orservices and need capital to grow. Support is typically provided to companies in the form ofdirect equity investments through the purchase of common stock, or in some cases in the formof indirect equity investments through the use of convertible debt. VCF investments may rangefrom $50,000 to $1,000,000 per investment round; however, investments in pre-revenuecompanies are generally capped at $250,000. The Foundation may reinvest in subsequentrounds of funding.SPECIAL REGIONAL FUNDINGThe Northern Economic Development and Innovation Fund (“NEDIF”) has been created tostimulate economic development in northern New Brunswick. Visit the Regional DevelopmentCorporation at http://www2.gnb.ca/content/gnb/en/departments/regional_development.html forprogram details.EXPORT DEVELOPMENT PROGRAMThis program is intended to introduce New Brunswick companies to exporting, and to assist inthe development of new export markets outside of Atlantic Canada. To be eligible, companiesmust process, manufacture or produce an exportable product, service, technology or intellectualproperty of a business-to-business nature. A maximum contribution of $5,000 per project isprovided for, with a maximum assistance allowed per company of $20,000 per year.WORKFORCE EXPANSION PROGRAMThis program provides financial assistance to eligible employers in order to stimulate thecreation of long-term employment opportunities for unemployed individuals. The program alsoaims at encouraging the hiring of the province's post-secondary graduates. Funding is on thebasis of a wage subsidy. The percentage of wage reimbursement varies from 50% to 70% ofthe hourly wage to a maximum reimbursement of $8 per hour.ONE-JOB PLEDGEA wage incentive is available to an employer based on existing eligibility criteria. Thepercentage of wage reimbursement for a recent post-secondary graduate is 70% of the wage upto $10 per hour, for a maximum of 40 hours per week. The duration of a subsidy for a recentpost-secondary graduate is 52 weeks. The employee must be paid at least $4 per hour aboveBusiness Incentives 164

minimum wage. To be eligible, the employee must have graduated from a recognized postsecondaryeducation institution in the last four years. The job must be for a minimum of 30hours per week and related to the employee’s field of study.NB GROWTH PROGRAM (“NBGP”)The NBGP aims to create sustainable employment opportunities in New Brunswick byfinancially stimulating small businesses to pursue opportunities within targeted sectors of theeconomy and to stimulate capital investment for small business start-up, expansion,diversification, innovation and productivity improvement. Companies wishing to establishthemselves can apply for up to $100,000 in non-repayable contribution for 50% of eligible costs.Already established companies seeking to expand, diversify or improve productivity can applyfor up to $60,000 in non-repayable contributions for 30% of eligible costs. The “eligible costs” forthese contributions include capital costs between $5,000 and $500,000 and salaries for newlycreated full-time employment positions.FINANCIAL ASSISTANCE TO INDUSTRY PROGRAMThis program provides financial assistance towards the establishment, expansion ormaintenance of new or existing manufacturing or processing industries, selected commercialservice firms (business-to-business with focus on export activity or import displacement),tourism operations (consistent with the tourism strategy) and information technology companies(consistent with the information technology strategy). Financial assistance may be provided inthe form of a loan guarantee or direct loan.INNOV8 PROGRAMINNOV8 funding is designed for New Brunswick companies that are developing intellectualproperty, specialized software, hardware, equipment, or performing research and developmentor prototyping. Funding is available only to those firms that are clearly identified as belonging toone of these six sectors: ICT, biosciences, industrial fabrication, aerospace & defence, valueaddedwood and value-added food. Through INNOV8, a company may be provided with up to$50,000 in funding per project to a limit of $100,000 per year.ENERGY COSTSNB Power offers very attractive electricity rates for commercial and industrial customers.Additionally, NB Power provides a “Declining Discount Firm Rate” for new facilities with firm loadof at least 5000KW, which results in a 50% reduction in the demand charge for a period of oneyear. The discount decreases to zero in year six.Business Incentives 165

BUSINESS TAXATIONSMALL BUSINESS INVESTOR TAX CREDITThis credit offers a 30% non-refundable personal income tax credit of up to $75,000 per year oneligible investments made by eligible investors.RESEARCH AND DEVELOPMENT TAX CREDITNew Brunswick’s 15% R&D tax credit is fully refundable, meaning that the credit benefits NewBrunswick corporations even if the corporation does not have provincial tax owing. The refundamount is equal to the amount of credit in excess of tax otherwise payable under the NewBrunswick Income Tax Act. The credit does not have to be carried forward or back because it isfully refundable.PROVINCIAL SALES TAX REBATEBecause New Brunswick has combined its provincial sales tax rate with the federal rate, theentire 13% sales tax on business inputs and purchases is a refundable tax credit for mostbusinesses.NEW BRUNSWICK MULTIMEDIA INITIATIVEIn support of New Brunswick-based production companies and, in an effort to encourage andfacilitate training and hiring of New Brunswick human resources, the province is providingfunding of 25% to 30% of eligible expenditures incurred in New Brunswick, depending on theproject genre and company eligibility. Total provincial contributions will not exceed 30% on any production.Eligible costs are generally defined as expenditures where salaries, goods and/or services arepaid for, purchased and consumed in New Brunswick, including airfare. In cases where a goodor service is deemed essential to the production, but is not available in New Brunswick (such asfilm stock), an amount may be permitted given documented proof that the good or service inquestion is not available in New Brunswick.DIGITAL MEDIA DEVELOPMENT PROGRAM (“DMDP”)To encourage the growth of New Brunswick’s video game sector, the DMDP assists NewBrunswick companies to develop intellectual property by providing an annual payroll rebate foreligible full-time positions. The assistance is in the form of a non-repayable annual payrollrebate. The DMDP provides a 30% salary rebate up to a maximum of $15,000 per full-timeemployee per year. The rebate is provided for production employees who are, for tax purposes,New Brunswick residents. The rebate is limited to a maximum of $500,000 per company peryear.Business Incentives 166

There are a number of other programs available, such as industry-specific assistance foragricultural, fisheries and aquaculture operations. For further information on New Brunswick’sinvestment programs and incentives, contact:The Ministry of Economic Development,Chancery Place675 King StreetFredericton, NBE3B 1E9CanadaToll Free : 1.800.665.1800Reception : 506.453.2277Fax : 506.453.6389Email : tradenb@gnb.caWeb:http://www2.gnb.ca/content/gnb/en/departments/economic_development.htmlPRINCE EDWARD ISLANDINNOVATION PEIInnovation PEI is responsible for attracting out-of-province investment to Prince Edward Island.The current priority sectors for investment recruitment are advanced manufacturing andprocessing (including value-added food development and production), aerospace and defence,bioscience (including agriculture and fisheries), information and communications technology,financial services and renewable energy. Its programs include:CAPITAL ACQUISITION SUPPORT PROGRAMBusinesses are most exposed to financial risk during start-up and expansion. This programassists Prince Edward Island businesses in acquiring the infrastructure needed to develop fromstart-up through to international exporting.CRAFT DEVELOPMENT PROGRAMPEI Business Development will provide assistance to individuals, businesses and groupsengaged or planning to be engaged in craft production and who wish to exploit new marketopportunities as a means to creating full-time employment.ENTREPRENEUR LOAN PROGRAMTo stimulate small business activity throughout the province, PEI Business Developmentprovides guarantees on traditionally-financed loans for use as an investment in eligible new andexpanding businesses.Business Incentives 167

MARKETING SUPPORT PROGRAMMarketing is a key component to any successful business start-up or expansion. This programprovides a non-repayable contribution to Prince Edward Island businesses requiring marketingadvice and support.PROFESSIONAL SERVICE ASSISTANCE PROGRAMRecognizing that today's entrepreneurs do not always have the time or expertise to respondeffectively to all demands of their operation, PEI Business Development provides a nonrepayablecontribution to Island businesses requiring professional advisory support.QUALITY IMPROVEMENT SUPPORT PROGRAMThis program provides financial assistance to Prince Edward Island businesses to acquire theprofessional expertise that will provide quality assurance documentation, auditing, registrationand certification leading to the creation or enhancement of a Quality Improvement Program or acertified Quality Education Program for management and employees.RENTAL INCENTIVE PROGRAMTo meet the occupancy needs of new and expanding businesses, the Rental Incentive Programprovides financial assistance to businesses for leasing incremental space in any community inPrince Edward Island.TRADE ASSISTANCE PROGRAMThis program provides financial assistance to Prince Edward Island businesses for eligible costsassociated with participating in coordinated outbound trade missions and trade shows focusedon new business opportunities in international exporting. Through this program, government willprovide assistance to a business to participate in the areas of in-market business-to-businessmissions, in-market trade shows and in-market investigation and research.WEB PRESENCE PROGRAMPrince Edward Island is becoming one of the leading provinces for web presence in Canada.PEI Business Development provides a non-repayable contribution to Island businesses to assistthem in establishing a presence on the internet.Business Incentives 168

WINTER PRODUCTION FINANCING PROGRAMThis program provides financial assistance to new and expanding craft and giftwaremanufacturers to allow them to increase the inventory of their products during the winter monthsfor sale in the peak selling periods.For more information about these and other financial assistance programs contact:Innovation PEI94 Euston StreetPO Box 910Charlottetown, PE C1A 7L9Tel: 902.368.6300Fax: 902.368.6301E-mail: innovation@gov.pe.caWeb: http://www.innovationpei.com/BUSINESS TAXATIONTAX HOLIDAYSUnder the Aerospace Tax Holiday, Prince Edward Island has created a tax-free zone foraerospace companies that locate in Slemon Park in Summerside. The tax rebate incentiveprogram includes an annual 100% rebate of the provincial portion of corporate income tax andproperty tax to qualifying companies until the year 2022.Similarly, companies in the biosciences industry may be eligible for the Bioscience Tax Holiday,exempting them from provincial corporate income tax for a period of 10 years.INNOVATION AND DEVELOPMENT LABOUR REBATE (“IDLR”)The IDLR is a refundable labour rebate which may apply to projects in support of thedevelopment and/or commercialization of new products, processes and services that will besold primarily beyond the borders of Prince Edward Island. A new product, process or service isone that has not previously been successfully developed in Prince Edward Island forcommercial production or sale. The IDLR provides a rebate equal to 25% of eligible salaries andwages. Eligible salaries and wages are paid to Prince Edward Island residents for incremental,full time positions (1,850 hours per annum), and each position must have a gross wage of atleast $30,000 per annum. Any individuals maintaining ownership in the company are noteligible.Business Incentives 169

ENRICHED INVESTMENT TAX CREDITThis program provides an addition to the existing Investment Tax Credit of 10% applied tocertain capital investments by manufacturing and processing companies. For high-productivityapplications with a strong export focus, an enriched tax rebate of 25% will be available througha pre-approved certificate process.SHARE PURCHASE TAX CREDITThe Share Purchase Tax Credit provides a tax rebate on Prince Edward Island personal incometax in the amount of 35% of the value of an eligible investment in an eligible provincialcorporation. The maximum credit that an individual may claim in any taxation year is $35,000.SPECIALIZED LABOUR TAX CREDITThe Specialized Labour Tax Credit is intended to help kick-start new business growth byproviding an incentive for workers with specialized expertise or skills to accept employment inPrince Edward Island, where that knowledge or skill is not yet available in the provincial labourmarket. The 17% tax rebate applies to the personal income tax payable, for up to three years,on eligible income earned by the eligible individual.For further details on available tax incentives and other incentive programs, contact:Invest PEI94 Euston StreetPO Box 910Charlottetown, PEC1A 7L9Toll free: 1.866.822.5500Tel: 902.368.6300Fax: 902.368.6301Email: askus@investpei.caWeb: www.investpei.comBusiness Incentives 170

NOVA SCOTIASMALL BUSINESS FINANCING PROGRAMThis program gives small businesses access to capital through a loan guarantee programinitiated by the Department of Economic and Rural Development, Credit Union Central, and theNova Scotia Co-operative Council. Loans of up to $500,000 are available. The province willguarantee up to 75% of the loan, with the credit unions being responsible for the remaining25%.For further information, contact:Department of Economic and RuralDevelopmentCentennial Building1660 Hollis St., Suite 600Halifax, NSB3J 1V7Tel: 902.424.0377Fax: 902.424.0500Web: http://www.novascotia.ca/econ/PAYROLL REBATENova Scotia Business Inc.’s payroll rebate program is a performance-based incentive offered toeligible companies expanding in or locating to Nova Scotia. The rebate is a return (usuallybetween 5 and 10%) on the company’s eligible gross payroll. To receive the rebate, thecompany must create or retain a targeted number of jobs, at a minimum determined salary,within a set time-frame. The rebate is generally paid out annually over a term not exceeding fiveyears. For further details on this program, contact:Nova Scotia Business Inc.World Trade & Convention Centre1800 Argyle St., Suite 701P.O. Box 2374Halifax, NSB3J 3N8Toll free: 1.800.260.6682Fax: 902.424.5739E-mail: info@nsbi.caBusiness Incentives 171

BUSINESS TAXATIONNEW SMALL BUSINESS TAX DEDUCTIONNova Scotia’s New Small Business Tax Deduction effectively eliminates the Nova ScotiaCorporation Income Tax for the first three years for a new small business after incorporation.The Corporation must apply each year to the Nova Scotia Minister of Finance and TreasuryBoard for a Nova Scotia Tax Deduction Eligibility Certificate.Eligible Corporations: All new businesses incorporated in Nova Scotia after April 18, 1986 that:have at least two employees, one of whom must be full-time and unrelated to anyshareholder, for the specified taxation year; are not associated with anothercorporation(s);are not in a partnership or a joint venture with an ineligible corporation(s);are not a beneficiary of a trust where any beneficiary is ineligible;are not a previous active business with essentially the same owner(s) or relatedowner(s);are not a professional practice of an accountant, dentist, lawyer, medical doctor,veterinarian or chiropractor; andare not a business carrying on the same, or substantially the same, business activity aswas carried on as a sole proprietorship, partnership or corporation.RESEARCH AND DEVELOPMENT TAX CREDITNova Scotia’s Research and Development Tax Credit offers tax relief to incorporated NovaScotia firms that incur qualified scientific research and experimental development (“SR&ED”)expenditures made in Nova Scotia, as defined by the federal Income Tax Act.R&D Rate: The credit rate for qualified expenditures is 15%. The rate is applicable to allcorporations that incur SR&ED expenditures in Nova Scotia, regardless of size.Refundability: Corporations that incur qualified SR&ED expenditures will be eligible for a refundof the tax credit where the tax credit exceeds Nova Scotia tax payable. The refund amount isequal to the amount of the credit in excess of tax otherwise payable under the Nova ScotiaIncome Tax Act. Refundability is available to all corporations that incur qualified SR&EDexpenditures in Nova Scotia where the corporation has or would have taxable income allocatedto Nova Scotia.Business Incentives 172

FILM TAX CREDITNova Scotia’s Film Tax Credit is a refundable tax credit for costs directly related to theproduction of films in Nova Scotia. The program encourages the development, training andhiring of Nova Scotia film personnel in all disciplines.Eligibility: The tax credit is available to qualifying productions and co-productions producedand/or shot in Nova Scotia. Production companies applying for the tax credit must have apermanent establishment in Nova Scotia (a fixed place of business, a production office, abranch etc.) and must be incorporated under the laws of Nova Scotia, another province ofCanada, or Canada.There is no limit on the size of the production budget, no corporate or asset cap, and noCanadian content or copyright ownership requirements associated with the tax credit. The taxcredit is not reduced by any other tax credits that the production may receive.Calculations: As of November 30, 2010, the tax credit rate is 50% of eligible salaries, with anadditional 15% available for films shot in eligible geographical areas and by productioncompanies who have made three films in a two year period.Further information on Nova Scotia’s Film Tax Credit is available at:Film Nova ScotiaP.O. Box 34104Scotia Square, RPOHalifax, NSB3J 3S1Toll free: 1.888.360.2111Fax: 902.424.0617Web: http://film.ns.ca/DIGITAL MEDIA TAX CREDITThe Digital Media Tax Credit is a refundable tax credit for costs directly related to thedevelopment of interactive digital media products in Nova Scotia. The tax credit amount isdefined as the lesser of 50% of eligible labour expenditures or 25% of the total expendituresmade in Nova Scotia.NOVA SCOTIA EQUITY TAX CREDITThe Equity Tax Credit is designed to assist Nova Scotia small businesses, co-operatives, andcommunity economic development (“CED”) initiatives in obtaining equity financing by offering apersonal income tax credit to individuals investing in eligible businesses. Equity financing is analternative to other forms of financing such as debt and traditional government assistance. Thecredit is not a grant nor is it considered to be a tax shelter.Business Incentives 173

Eligible Investors: The credit is available to residents of Nova Scotia who are over 19 years ofage and who have bona fide reasons for making the investment, other than simply obtaining thetax credit. Each eligible issue of shares must have at least three eligible investors. It should benoted that any approval of shares issued under the program does not constitute anendorsement by government of the corporation or co-operative issuing the shares. The provincedoes not guaranty any investment. The investor is at risk for his or her investment.Eligible Investments: In the case of corporations, eligible investments must be newly issuedcommon voting shares of the corporation that are non-redeemable, non-convertible and are notrestricted in profit sharing or participation upon dissolution. The shares cannot be eligible for anyother tax credit or deduction allowed under the Income Tax Act, except as a deduction forRRSP purposes. In the case of co-operatives, eligible investments must be a share that would,if it were the only share issued to the investor, allow the investor to be a member in the cooperativeand allow the member to participate in the affairs of the co-operative. In addition,shares are not eligible if the investor disposed of any shares of the eligible business at any timeafter September 30, 1993 and before the specified issue of shares. The specified issue ofshares means the shares that are specified in the application of the eligible business to which aCertificate of Registration applies.Eligible Businesses: Eligible businesses include corporations and co-operatives incorporatedpursuant to the laws of Canada, including CED corporations and co-operatives. CEDcorporations and co-operatives are those organizations created to assist or develop localbusinesses within the community. The CED corporation or co-operative raises capital by issuingshares to individuals and in turn invests that capital in local businesses. In addition, eligiblebusinesses must meet the following criteria:be involved in active business or investing in other eligible businesses;have less than $25 million in assets;have at least 25% of salaries and wages paid in Nova Scotia;corporations must have authorized capital consisting of common voting shares;co-operatives must be marketing, producing or employee co-operatives; andcorporations must have at least three eligible investors taking part in the specified issue.Application: An eligible business must make application to the Department of Finance to obtaina Certificate of Registration prior to issuing shares to investors. This certificate makes thespecified shares eligible for the tax credit. Pre-approval of eligibility is required. This eligibilitydoes not constitute any approval that may be required from the Securities Commission underthe Securities Act.Prohibited Use of Funds: Funds raised by the eligible business must be used in an activebusiness and cannot be used for any of the following purposes:Business Incentives 174

lending, except under prescribed conditions;purchasing shares, other than shares in other eligible businesses;paying dividends or repaying shareholder debt to a director, shareholder or officer of thebusiness or an associate of a director, shareholder or officer of the eligible business;purchasing services or assets from the province to carry on a business activity that is thesame or similar to the activity carried on by the province where that eligible business hasreceived any assistance from the province;the redemption of shares or the funding of the purchase of all or substantially all of theassets of a previously existing proprietorship, partnership, joint venture, trust orcompany, except where that firm is in receivership or bankruptcy; andthe purchase of assets or services by the eligible business for a price greater than fairmarket value.Tax Credit: The tax credit is calculated at 35% of the investment made by the individual to amaximum annual investment of $50,000 (maximum annual credit of $17,500). The investmentmay be made within the calendar year or within 60 days of the end of the taxation year. Thecredit is not refundable but may be carried forward for seven years or carried back three years.The maximum credit which can be claimed in a single taxation year (including current year andthe carry forward or back amounts) cannot exceed $17,500.Investors are required to hold the investment for at least five years. If an investment is disposedof within this five year period, the individual may be required to repay the tax credits earned.For further information on available tax incentives, contact:Nova Scotia Department of Finance andTreasury BoardFiscal and Economic Policy BranchTaxation and Fiscal Policy Division1723 Hollis St.,Halifax NSB3J 1V9Tel: 902.424.5554Fax: 902.424.0635E-mail: FinanceWeb@gov.ns.caBusiness Incentives 175

NEWFOUNDLAND AND LABRADORBUSINESS ATTRACTION FUNDThe Business Attraction Fund is designed to attract medium and large scale businesses to theprovince by providing customized financial assistance. The fund consists of allocations for loansor incentives as well as non-repayable contributions.BUSINESS INVESTMENT PROGRAM (“BIP”)The BIP provides term loans and equity investments to SME in strategic growth sectors asidentified by the Department of Innovation, Business and Rural Development (“IBRD”). The fundis also available to businesses that have export potential and require assistance to enter orexpand in external markets. Funds are provided to complement funding from conventionalsources, where a need has been demonstrated, and are also intended to increase the capitalbase of businesses allowing them to leverage new private-sector investments. The BIP is in theform of repayable term loans to a maximum amount of $500,000 per government fiscal year atthe Department’s base rate of 3%. Equity funding in the form of redeemable preferred shares toa maximum of $500,000 per project; maximum aggregate of $1 million is available.BUSINESS DEVELOPMENT SUPPORT PROGRAM (“BDSP”)The BDSP assists Newfoundland and Labrador SMEs with opportunities to increase theirproductivity and improve their competitiveness. The BDSP supports SMEs that demonstrate adesire to develop and grow by improving the operations of their businesses, investing in theirpeople, and focusing on trade opportunities. IBRD assistance will be targeted towardsbusinesses in strategic sectors that normally focus on export markets and/or improve importsubstitution. Funding is available for productivity improvements, knowledge development,market development and/or professional technical advice. The BDSP is in the form of a nonrepayablecontribution(s) to a maximum amount of $100,000 per government fiscal year. Thecontribution level will be based on 50% of eligible costs, with the business identifying its sourceof the remaining 50% of funds required to complete the project(s).ECONOMIC DIVERSIFICATION AND GROWTH ENTERPRISES PROGRAM (“EDGE”)The EDGE program provides a package of incentives to encourage significant new businessinvestment in the province to help diversify its economy and stimulate new private sector jobcreation, particularly in rural areas.Eligible Companies: A new business or an existing business interested in expanding in theprovince may apply for EDGE status if it meets the following criteria:Business Incentives 176

It will create and maintain 10 new permanent jobs in the province;It is prepared to make a minimum capital investment of $300,000 or generate incremental annual sales of$500,000;It would not establish or expand in the province in the absence of the EDGE incentives;The EDGE incentives will not give it a direct competitive advantage over other existing businesses in theprovince; andThe new business activity will have a substantial net economic benefit to the province.EDGE Incentives: Companies approved for EDGE status are entitled to the following incentivesand benefits:A 100% rebate on provincial corporate income tax and the provincial payroll tax;A 50% rebate on federal corporate income tax;A 100% rebate on municipal property and/or municipal business taxes in participating municipalities; andAccess to unserviced Crown land for $1.00 where such land is required to implement the company’sbusiness plan.For more information on these and other programs, contact:Department of BusinessGovernment of Newfoundland and Labrador6th Floor, East Block Confederation BuildingP.O. Box 8700St. John's, NLA1B 4J6Tel: 709.729.3254Fax: 709.729.3306E-mail: business@gov.nl.caWeb: www.nlbusiness.caBUSINESS TAXATIONNewfoundland and Labrador has one of the most favourable business tax climates in Canada.The Corporate Income Tax (“CIT”) rates are amongst the lowest in the country. The HarmonizedSales Tax (“HST”) has resulted in the removal of tax on business inputs. Unlike many provinces,Newfoundland and Labrador does not impose a general capital tax. While Newfoundland andLabrador imposes a 2% payroll tax, the exemption threshold relieves virtually all smallbusinesses from this tax. A number of tax credits and incentives are designed to encourageeconomic growth in strategic areas.MANUFACTURING AND PROCESSING PROFITS TAX CREDITThis credit applies to corporations that carry out manufacturing and processing from apermanent establishment located in Newfoundland and Labrador. The credit allows a deductionBusiness Incentives 177

from CIT payable of 9% on taxable manufacturing and processing profits earned in the province.This results in an effective CIT rate of 5% for manufacturing and processing profits.DIRECT EQUITY TAX CREDIT PROGRAMThe Direct Equity Tax Credit Program is designed to encourage private investment in new orexpanding small businesses as a means of creating new jobs and diversifying the economy. Aninvestment credit, in the form of a provincial income tax credit, is available to individuals andarm’s length corporations that invest as shareholders in eligible small business activities. Thereare two tax credit rates. Where the qualifying activities are undertaken in the province outsidethe North East Avalon, a 35% rate applies. Where the qualifying activities are undertaken withinthe North East Avalon, a 20% rate applies. In cases where qualifying activities are undertaken inboth areas, a reasonable proration applies.FILM AND VIDEO TAX CREDITThis refundable provincial CIT credit is provided for eligible local film projects. The credit is 40%of eligible local labour costs, but may not exceed 25% of production costs or a singlecorporation credit limit of $3 million. The corporation must also pay at least 25% of its salariesand wages to residents of the province. The corporation must first apply for eligibility to theNewfoundland and Labrador Film Development Corporation prior to the commencement ofproduction.For further information on available tax incentives, contact:Department of FinanceTaxation and Fiscal Policy BranchP.O. Box 8700St. John’s, NL A1B 4J6Toll free: 1.800.729.6297Fax: 709.729.2856E-mail: taxpolicy@gov.nl.caMore information on Newfoundland and Labrador business incentives can be found at thefollowing website: http://www.fin.gov.nl.ca/fin/tax_programs_incentives/business/index.htmlBusiness Incentives 178

CANADAATLANTIC CANADA OPPORTUNITIES AGENCY (“ACOA”) BUSINESS DEVELOPMENTPROGRAMACOA provides unsecured, interest-free loans towards the eligible costs of new establishments,expansions, modernizations or projects which improve business competitiveness. ACOA'scontribution is repayable on a time schedule tailored to the circumstances. The maximum levelof assistance under the program is 50% of eligible costs for start-ups, expansions andmodernizations, and 75% of eligible costs for activities such as training and quality assurance.ACOA’S ATLANTIC INNOVATION FUND (“AIF”)The AIF is a program designed to strengthen the economy of Atlantic Canada by acceleratingthe development of knowledge-based industry. The program focuses on R&D projects in thearea of natural and applied sciences, as well as in social sciences, humanities and arts andculture, where these are explicitly linked to the development and commercialization oftechnology-based products, processes or services.The Atlantic Innovation Fund can provide assistance of up to 80% of total eligible costs for noncommercialprojects and up to 75% of total eligible costs for commercial, private sector projects.For further details on these and other ACOA programs, please contact:ACOA Head OfficeBlue Cross Centre, 3 rd Floor644 Main StreetP.O. Box 6051Moncton, NBE1C 9J8Toll free: 1.800.561.7862Fax: 506.851.7403Web: www.acoa-apeca.gc.caATLANTIC INVESTMENT TAX CREDIT (“AITC”)The AITC is a 10% credit available for certain investments in new buildings, machinery andequipment used in the Atlantic region and the Gaspé Peninsula. Currently, the credit supportsinvestments in farming, fishing, logging, manufacturing and processing, oil and gas, and mining.This credit is currently in the process of being phased out. The credit will apply at a rate of 10%for assets acquired before 2014 for use in oil and gas and mining activities and at a rate of 5%Business Incentives 179

for such assets acquired in 2014 and 2015. The credit will not be available for such assetsacquired after 2015. Certain projects may qualify for transitional relief until 2017.SCIENTIFIC RESEARCH & EXPERIMENTAL DEVELOPMENT (“SP&ED”)The SR&ED Program is a federal tax incentive program, administered by the Canada RevenueAgency (“CRA”), that encourages Canadian businesses of all sizes and in all sectors to conductresearch and development in Canada. The SR&ED Program gives claimants cash refundsand/or tax credits for their expenditures on eligible research and development work done inCanada. The SR&ED program is complex and professional tax advice should be sought byclaimants wishing to take advantage of it. Visit the CRA website at http://www.craarc.gc.ca/sred/for additional information.FOREIGN TAX CREDITCorporations which have foreign source income and are resident in Canada at any time in theyear are eligible for a credit on foreign taxes paid. A credit is allowed against Canadian taxpayable for the lesser of the foreign tax paid and the Canadian tax on the foreign sourceincome.DUTY DEFERRAL PROGRAMThe Duty Deferral Program aims to improve the competitiveness of Canadian businesses byoffering relief from the payment of most duties and taxes on imported goods that are ultimatelyexported, whether or not the goods are further manufactured in Canada. This program groupsthree sub-programs through which businesses can defer, relieve or refund the payment ofduties on imported goods. These sub-programs are the following: The Duties Relief Program, The Drawback Program and The Customs Bonded Warehouse Program.These three programs operate individually or in combination in the way that best suits businessneeds. If preferred, goods can even be moved between programs without paying duties.Overall, the Duty Deferral Program offers Canadian businesses many of the same duty and taxincentives as those in free trade zones around the world.Business Incentives 180

CANADIAN FILM OR VIDEO PRODUCTION TAX CREDIT (“CPTC”)The CPTC is a fully refundable tax credit for films and videos produced and owned by Canadiancorporations. Under the CPTC program, the Canadian Audio-Visual Certification Office(“CAVCO”) performs two distinct functions:1. Canadian content certification, and2. Estimation of the eligible expenses of production.In order for a production to qualify as Canadian content for tax credit purposes through CAVCO,the production must meet specific criteria for key creative personnel and production costs, whichare outlined in their guidelines. The CPTC is available at a rate of 25% of eligible salaries andwages. Eligible salaries and wages qualifying for the tax credit may not exceed 60% of the costof the production, net of assistance, as certified by the Minister of Canadian Heritage.Therefore, the tax credit could provide a refund of up to 15% of the cost of production, net ofassistance.For further information, visit http://www.cra-arc.gc.ca/tx/nnrsdnts/flm/ftc-cip/menu-eng.html .Business Incentives 181

Charlottetown, PE65 Grafton StreetCharlottetown, PE C1A 1K8P 902.892.2485F 902.566.5283charlottetown@stewartmckelvey.comFredericton, NBSuite 600, Frederick Square77 Westmorland StreetFredericton, NB E3B 6Z3P 506.458.1970F 506.444.8974fredericton@stewartmckelvey.comHalifax, NSSuite 900, Purdy’s Wharf Tower 11959 Upper Water StreetHalifax, NS B3J 3N2P 902.420.3200F 902.420.1417halifax@stewartmckelvey.comMoncton, NBSuite 601, Blue Cross Centre644 Main StreetMoncton, NB E1C 1E2P 506.853.1970F 506.858.8454moncton@stewartmckelvey.comSaint John, NBSuite 1000, Brunswick House44 Chipman HillSaint John, NB E2L 2A9P 506.632.1970F 506.652.1989saint-john@stewartmckelvey.comSt. John’s, NLSuite 1100, Cabot Place100 New Gower StreetSt. John’s, NL A1C 6K3P 709.722.4270F 709.722.4565st-johns@stewartmckelvey.comCharlottetown Fredericton Halifax Moncton Saint JohN St. John’s stewartmckelvey.com

INVESTING IN CHILEFelipe Cousiño and Cristóbal Riffo, Alessandri, Santiago de ChileIntroductionChile is one of the preferred investment destinations in Latin America due to its open andstable economy, with low inflation rates. Chile is very rich in natural resources, and themost active industries are mineral and energy resources, fisheries, forestry, agriculture,manufacturing and service industries. Chile is a unitary republic. The political systemincludes a strong executive, a legislature and an independent judiciary. In general,individual guarantees are well defined and protected by the Constitution.1. - Foreign investmentEl Regidor 66, 10th floorLas Condes, Santiago, ChilePO Box 136-34 - Las CondesTel. (562) 2787 60 00Fax.(562) 2787 60 62(562) 2787 60 73alessandri@alessandri.clip@alessandri.clpatents@alessandri.clCapital and loans can be brought into Chile under either Decree Law 600 or Chapter XIV ofthe Foreign Exchange Regulations of the Central Bank of Chile.As a rule, foreign exchange transactions must be reported to the Central Bank of Chile, butcompliance with foreign exchange control regulations is generally not an issue.www.alessandri.clArturo Alessandri C.Rodrigo Velasco S.Fernando JamarneFelipe CousiñoRodrigo Velasco A.Felipe SchusterMarcos MoralesLoreto BreskyRaúl MonteroCristóbal RiffoAndrea DawsonBernardita DittusCarla PachecoMatías ValenzuelaMariana VieraDiego MorandéM. Alejandra ChávezSebastián MolinaSofía HauptFrancesca RodríguezNicolás YáñezDiego MaldonadoFrancisco EspinozaCarolina BockIsidora AlemparteJaviera BadillaGuillermo CorreaAndrés DigheroMauricio LeónJosé Manuel UrendaFrancisco CabezasNicolás MirandaAgustina Davis1.1 - Chapter XIVThe capital that may be registered under Chapter XIV must exceed US$10,000 or itsequivalent in other currencies. Funds must be brought through the Formal ExchangeMarket (commercial banks and authorized exchange houses).After the funds enter the country they can be either converted into local currency ordelivered to the beneficiary in foreign currency. Under Chapter XIV there are no restrictionson repatriations of profits or capital.ConsejerosArturo Alessandri B.Alfredo Valdés R.Andrés Rodríguez M.José Miguel Cuadra.

1.2 - Decree Law 600The minimum amount that may be registered under D.L. 600 is of US$5,000,000 or itsequivalent in other currencies. Investment may also be made in tangible assets, technologyand capitalization of loans or profits, in which case the minimum amount is US$2,500,000.Investment under D.L. 600 can be structured as a mixture of capital contribution andforeign loans, in which case the loan cannot exceed a 3:1 loan/capital contribution ratio(extra amounts can be brought in under Chapter XIV). Except for mining investments, theperiod within which the foreign investor must bring the capital into Chile must not exceedthree years. Repatriation of capital is only allowed after the first year, but profits can berepatriated when earned.Under D.L. 600, the foreign investor enters into a contract with the State of Chile, whichgoverns all the rights and obligations related with the investment. Like all contracts, itsamendment requires consent from both parties. Thus, the State of Chile cannot unilaterallyalter it. Among other guarantees, D.L. 600 guarantees free access to foreign exchange forthe remittance of capital and profits.D.L. 600 also considers the possibility of choosing an overall effective income tax burdenof 42% for a ten year period. Foreign investors are entitled to waive only for one time thisright and be subject to the general tax treatment (see below Corporate tax system). Theadvantage of choosing the 42% tax burden is that if there is ever an increase of the taxburden under the general tax treatment exceeding 42%, the burden for the investor shallremain at 42%.2. - Type of entitiesForeign investors normally organize in Chile using a stock corporation, a limited liabilitycompany or a branch. Most recently, the newly created joint stock company (known as“SpA”) is also becoming commonly used. The use of a Permanent Establishment (PE) of aforeign entity is also usual since its tax treatment is equivalent to the one applicable toother entities.El Regidor 66, 10th floorLas Condes, Santiago, ChilePO Box 136-34 - Las CondesTel. (562) 2787 60 00Fax.(562) 2787 60 62(562) 2787 60 73alessandri@alessandri.clip@alessandri.clpatents@alessandri.clA Chilean company requires at least 2 shareholders or members, either legal entities orindividuals, resident in Chile or abroad. However, SpAs can be held by a single shareholder.Due to tax reasons, a Chilean entity or PE also requires a business space and a residentmanager or representative. Setting up an entity in Chile is not expensive and the timenecessary to do so is short.www.alessandri.cl

3. - Corporate tax systemThe Chilean tax treatment of stock corporations, limited liability companies, branches andpermanent establishments is similar. Thus, the choice of entity is normally based on taxconsiderations of the home country. Income derived by a Chilean entity is taxed atcorporate level with the so called “First Category Tax” at 20% on the net accrued profits.Intercompany dividends paid to another Chilean entity or PE are exempt from FirstCategory Tax in the hands of the recipient entity. Dividends and branch/PE profitsdistributed abroad are subject to the so called “Additional Tax” at 35%, with the FirstCategory Tax paid on the underlying profits being creditable, thus resulting in a total taxburden of 35%.3.1 - Taxation of individualsBoth employment income and personal income is subject to income tax at progressive ratesranging from 0 to 40%.Expatriate workers are normally taxed at 15% during their first 6 months in Chile.3.2 - Taxation of outbound paymentsOutbound payments to abroad are generally subject to withholding tax on e.g. dividends at35% (less credit for First Category Tax); interest normally at 35% or 4%; royaltiesnormally at 30% or 15%; service fees normally at 35% or 15%; capital gains at 35%, 20%or exempt.3.3 - Transaction taxesEl Regidor 66, 10th floorLas Condes, Santiago, ChilePO Box 136-34 - Las CondesTel. (562) 2787 60 00Fax.(562) 2787 60 62(562) 2787 60 73alessandri@alessandri.clip@alessandri.clpatents@alessandri.clVAT applies at 19% on customary sales and most of services. Exports are zero rated.Excise taxes apply on at different rates on e.g. certain luxury items, vehicles, beverages,fuels and tobacco products. Import duties generally apply at 6%, unless a free tradeagreement (FTA) is in place. Chile’s FTA network includes a FTA with the European Union.www.alessandri.cl

3.4 - Other taxes on businessLoans are generally subject to a stamp tax at 0.033% per month on the principal, up to amaximum of 0.4%.A business license fee generally applies at 0.5% on the tax equity. Most of social securitycontributions are borne by the employee, except for the contributions for unemploymentinsurance and the contributions for the insurance against labor accidents.Profit sharing is compulsory, but normally may be limited to reasonable amounts.3.5 - Tax treaty networkChile has an increasing tax treaty network, which includes effective double taxation treatieswith the following countries: Belgium, Brazil, Canada, Colombia, Croatia, Denmark,Ecuador, France, Ireland, Korea (Rep.), Malaysia, Mexico, New Zealand, Norway, Paraguay,Peru, Poland, Portugal, Russia, Spain, Sweden, Switzerland, Thailand and the UnitedKingdom.In addition, Chile has already signed double taxation treaties with, Australia, Austria, SouthAfrica and the United States of America. , which are awaiting congressional approval.Further, there is tax treaty negotiation activity with several other countries.El Regidor 66, 10th floorLas Condes, Santiago, ChilePO Box 136-34 - Las CondesTel. (562) 2787 60 00Fax.(562) 2787 60 62(562) 2787 60 73alessandri@alessandri.clip@alessandri.clpatents@alessandri.clwww.alessandri.cl

TRIANA, URIBE & MICHELSENDOING BUSINESS IN COLOMBIA1. OverviewGeneral DataOfficial Name: Republic of ColombiaCapital: Bogotá D.C.Area: 2.129 748 km²: 1.141.748 km² of land masses; 928.660 Km² maritime areas.Population: 47.121.089Official Language: Spanish. English is also official in San Andrés and Providencia.Currency: Colombian Peso (COP).Currency exchange: TRMMacroeconomic dataGDP (millions of USD$): 378.125 (2013).GDP per capita: 10.919 (2013)GDP growth rate: 4% (2013)Inflation: 1,94% (2013)Exports 2013 (millions of USD$): 58.822Imports 2013 (millions of USD$): 59.397About Colombia…As far as population goes, Colombia is twice the size of Australia and far larger than allthe Centro-American countries.55% of Colombian population is below the age of 30. Furthermore Colombiapossesses 7 metropolitan areas with more than one million inhabitants.Colombia is the second country with the largest bio diversity in the world and it isconsidered one of the 12 countries to be mega diverse.Colombia is the only country in South America that has a privileged access to bothoceans the Atlantic and the Pacific.At the moment there are more than 2.500 multinational corporations working inColombia.Colombia is the ninth purveyor of exotic fruits worldwide. Exports of fruits likegooseberry (uchuva), tamarillo (tomate de árbol), tamarind and sweet granadilla havehad in the past three years a relevant growth.Agriculture is characterized by the technician regional plantations of sugar cane,coffee, flowers, cotton, plantain, bananas, sorghum, corn, rice, African oil palm,potatoes, cassava among others, because of the varied temperatures and soilsthroughout the country.Analphabetism among population older than 15 years of age went from 19% in 1993 to5.9% in 2012.Calle 93B No. 12-48 P. 4, Bogotá D.C., ColombiaTels.: (57-1) 601 9660 – 621 5810 Fax: (57-1) 611 4209 – 635 1914E-mail: tum@tumnet.com Website: http://www.tumnet.com

2Access to public utilities has presented a rapid rise: 97.6% of homes have electricpower, 57.3% have access to natural gas and 87.4% have access to water andaqueduct.Health coverage is almost universal, 90.6% of homes are affiliated to a contributiveregime or to a subsidy regime.Preferential access to more than 1.5 Billion consumers, due to international tradeagreements.IMF Survey / March 14 th 2014Prudent economic policy management and a strong policy framework have supportedColombia’s remarkable economic performance in recent years and its resilience toadverse shocks, said the IMF in its regular assessment of Latin America’s fourthlargest economy.“Colombia has maintained sound macroeconomic performance, weathering well the bouts ofglobal economic and financial stress of recent years. A strong and competently-managedpolicy framework—anchored by an inflation-targeting regime, a flexible exchange rate,effective financial supervision and regulation, and a prudent medium-term fiscal framework—has allowed the authorities to respond adequately to shocks, using their policy tools tostabilize growth.” said the IMF’s mission chief for Colombia, Valerie Cerra.Economic growth accelerated during the course of 2013, lifted by supportive monetarypolicy and fiscal measures that stimulated activity in construction and civil works, withannual GDP growth estimated at about 4 percent. Unemployment continued to decline,averaging 9.7 percent, the lowest level since the 1990s, and labor market formalizationimproved. Inflation was subdued at 1.9 percent, as temporary supply shocks loweredfood and electricity prices late in the year. The central bank took advantage of buoyantcapital inflows, mainly from foreign direct investment, to further bolster its foreignexchange reserve buffers. Economic prospects are favorable in 2014, with growth expected to be about 4.3percent and inflation to remain within the 2-4 percent target band. As inflation graduallyrises toward the 3 percent mid-point of the target range as one-off factors disappear,IMF staff considers that the policy rate could be increased toward its neutral level. Thecombined public sector deficit is expected to remain broadly unchanged, with the centralgovernment stance guided by the fiscal rule. External risks remain tilted to thedownside; thus, it is expected that the authorities will continue to use the flexibleexchange rate and monetary policy to cushion the impact of any external shocksColombia has a strong fiscal framework, with a commitment to reducing the centralgovernment structural deficit and public debt over the coming years. To achieve thisdesirable goal, while also providing fiscal space for outlays to reduce poverty and overcome

3Colombia’s infrastructure deficit, the authorities will need strong efforts to expand non-oilfiscal revenues.2. Main Aspects of Colombian EconomyColombia has placed itself as one of the highest growing economies in the region.ColombiaVenezuelaPeruChileGDP, Inflation and Unemployment rate 2002 – 2018p(%)

4Growth of Exports (2000-2013).USD Million.FOB Value of total exports (2012-2013)USD Million.

5Top Exports destination countries (2013)Exports by destination countriesPercentage participation of FOB value by destination country.January – December 2013

6Growth of Imports (2000-2013).USD Million.Top Imports country of origin (2013)Source: Dane – Dirección de síntesis y cuentas nacionales

7Inter annual behavior of the GDPThird Trimester 2012 – Third Trimester 2013GDP Annual Behavior by contry (2012-2013)Source: Statistics offices in the respective countries

83. Foreign InvestmentAny investment made from abroad into Colombian territory, including Free Trade Zones, by personswho do not reside in Colombia is considered as Foreign Investment.Principles of the Foreign Investment Regime:Equality: Foreign investment must receive the same treatment as local investments,thus the imposition of discriminatory or more favorable treatments or conditions is notpermitted.Universality: Foreign Investment is permitted and actually welcome in any sector ofthe economy, except for the following cases: 1. National Defense and Security; 2.Processing, disposal and dumping of toxic, hazardous or radioactive waste producedoutside the country; and 3. Private surveillance and security.Automaticity: No authorization is required to carry out a Foreign Investment, exceptunder special regimes governing mining, oil and gas, insurance, television, portfolioinvestments and the financial sector.Stability: Conditions and regulations regarding investment, the remittance of profitsand reimbursement that were enforceable on the date of the investment’s registrationcannot be modified, with very few exceptions, in a way it negatively affects theinvestor.Types of Foreign Investment:1. Direct Foreign Investment:Acquisition of equity participation, shares, corporate interests, mandatory convertiblebonds or any representative interest in a company’s capital.Acquisition of rights in autonomous patrimonies created by a mercantile trustagreement as a means to develop an enterprise or for the purpose of purchasing,selling or administrating shares in a company that is not registered in the NationalRegistry of Securities and Issuers.Acquisition of real estate property, participation titles in processes of securitization orinvestments through real estate funds by means of private or public offers.Acts or contracts when the same do not represent equity participation in a companyand the income generated by the investment depends on the company’s profits. I.E.:Technology transfer contracts, collaboration, cooperation, concession, serviceadministration and licensing contracts.In investments in assigned capital or as supplementary assigned capital in branchesestablished in Colombia by foreign companies.Acquisition of participation interests in private equity funds.

92. Portfolio Investments:It is done through foreign equity funds in shares, bonds and other titles registered inthe National Registry of Security and Issuers.It is mandatory for a purpose of carrying out investments in the public stock Exchangeto be present.There must be both an international administrator and a local one.These investor funds may be institutional (registered in a country outside ofColombia); only needing an authorization from the Colombian FinancialSuperintendence and a NIT (Fiscal Identification Number) or individual when theinvestment is meant to cannel treasury excess, the latter do not need any form ofauthorization.Investment Methods:1. Transfer of foreign currencies through the Exchange market so as to contribute directly to acompany’s capital or to acquire rights or shares from third parties in already existingsocieties.2. In kind, directly with the delivery or transfer of a tangible or an intangible asset; or indirectlyby means of a capitalization in favor of the investor.3. By means of resources in local currency originating in local credit operations that will beused in the acquisition of shares through the public stock market.4. The contribution in kind of intangible assets to the capital of a company, such astechnological contributions, trademarks, susceptible of depreciation according to Colombianaccountancy standards.5. By means of resources in local currency entitled to be dispatched to the investor of capitalabroad, that come from operations that has to be channeled through the currency exchangemarket.Treatment standards for investors.It is materialized in obligations that are a development of the principle of equality. The maincommitments are:National Treatment: It consists in treating foreign investments in a manner that is notless favorable than the one given to national investments.Most favored nation treatment: Colombia grants the same advantages, which havebeen agreed upon in another multilateral investment agreement, to foreign investorsthat are resident in another particular state.

10Minimum level of treatment: Colombia must grant to the foreign investors a minimumof guarantees and protection to their investments. Said minimum follows the rules ofinternational customary law, meaning the minimum level of treatment generally givenby other states to foreign investments, with the full conviction that such is the minimumthey are obliged to respect. The minimum level of treatment is composed by thecommitments to give a “fair and just” treatment, therefore complying with due process,justice, protection and full security to investments.Registry of Foreign Investments.The registry of Foreign Investment is administered by the Central Bank (Banco de la República) andto comply with the rules of registration is a necessary condition that has to be fulfilled by each andevery investor for them to have access to the exchange rights granted by law.The registration process can be conducted by the foreign investor or his representative in one of thefollowing ways:1. Directly through the Central Bank.2. Through an authorized market intermediary.3. By means of a current compensation account.The registry is done automatically by filing the international investment exchange declaration (FormN. 4 of the Central Bank) with the exchange market intermediary or by means of an account depositand subsequent filing of the exchange declaration.Each year, within the given time periods and following the procedures stated by the Central Bank,the foreign investments must be updated using Form N. 15 for companies or subsidiaries in generalor using Form N. 13 for branches of foreign companies of the special regime.Foreign exchange rightsTo remit abroad net profits generated by the investments.To reinvest profits or retain them in the surplus of undistributed profits with right oftransfer.To capitalize sums with right of transfer, resulting from obligations derived from theinvestments.To remit abroad, in freely convertible currency, the sums received either from thetransfer of the investment inside the country, from the liquidation of the company or theportfolio, or from a decrease in the capital of the company or the portfolio

11Colombia is ranked sixth in the world and first in Latin America in matters referring toprotection of investors:Colombia is the second most attractive country to invest in, in Latin America, for the nextthree (3) yearsIf you were supposed to invest in Latin America over thenext three years ¿Where would you?

12Principal Investor countries 2000-2013 (III Trim)Law 9 of 1991 is the frame law for exchange matters in Colombia (general guidelines for Colombianauthorities). With the restructuring of the market and the country’s economic openness, this lawcompletely modified the exchange regime creating two (2) separate currency markets:1. Regulated Exchange Market: Currency operations that necessarily must be channeledthrough the exchange market intermediaries or the established mechanisms (compensationaccounts).Regulated exchange market operations:Imports and exports of goods. For services, the operation is carried out through theopen market, unless the national reserves are inferior to three months of exports.Foreign debt operations conducted by Colombian residents, as well as financial costsinherent in the same.Foreign capital investments as well as the returns linked to them.Colombian capital investments abroad as well as the returns linked to them.

13Financial investment or investments in assets abroad, unless made in currencies thatdo not have to be channeled through the exchange market.Guarantees and surety agreements in foreign currencies.Derivatives operations.2. Open Market: Operations in currencies that do not have to be channeled through theexchange market.Exchange aspects are currently regulated by frame laws, issued by the Colombian Congress,however, the Central Bank is the maximum exchange authority entitled of developing the applicableregime in accordance with the Constitution.3. Colombian Commercial relationships:a. Export percentages for each productb. Growth graphicsi. Exportsii. Importsc. Commercial treatiesIncentives for investors:The applicable tax, customs and foreign trade regimes give a more favorable treatment toenterprises that carry out their activities in free trade zones, created by law.In essence, whenever, when a company is based inside one of these Free Trade Zones, eventhough it is still considered part of Colombian territory, the regime grants certain benefits as:The applicable income tax rate is only 15% on the company’s duly depurated income,as opposed to the standard rate of 25%.No V.A.T. is generated when importing goods from abroad into the free trade zone;however, V.A.T. is incurred as soon as these goods are permanently introduced toColombia for their distribution.Types:The Permanent Free Trade Zone is an area in which multiple companies are based,benefitting from the special tax and customs treatment, administered by an operatinguser (as defined in the Law).Special Permanent Free Trade Zones are, as the name implies, a type of free tradezones in which a company obtains a special recognition as a free trade zone,whenever it aims to develop an investment project that is especially relevanteconomically and socially for the entire country.

14“Uniempresarial” Goods Free Trade Zone: These are special types of free trade zonesin which, a single company requests the classification of free trade zone to the areawhere it wants to be based. Agro industrial projects can be installed in these zoneswhenever they comply with the following requirements:a) Invest a sum of USD$ 38,62 million.b) Generate 150 direct and formal jobs. This requirement can be diminished by 15 forevery USD$ 5 million added to the investment amount. Nonetheless, the minimumjobs to be generated are 50.Imports of capital goods exempt from custom duties – “Plan Vallejo”: The “Plan Vallejo”system for imports basically implies that the person requesting the plan can importcapital goods without being subject to custom duties and deferring payment for theV.A.T. In order to apply the following must be complied with:a) The good to be imported must be one of the listed in Resolution 1148 of 2002issued by the Colombian Ministry of Commerce.b) The person requesting the application of the plan must export 1.5 times the FOBvalue of the capital goods to be imported.c) The request must be addressed to the National Tax and Customs Authority – DIAN.Imports of Raw Materials exempt from V.A.T. and custom duties: Another modality of“Plan Vallejo” in which a person can request the plan to import raw materials for theirproductive process, without being subject to V.A.T. or custom duties, as long as, atleast, 60% of the final product is exported.4. Incentives by sectorHotel ServicesA special tax treatment is in effect in Colombia for hotel services rendered in newhotels that are built between the years 2002 and 2017. The income generated in therendering of said services is exempt from income tax for a term of thirty (30) years.A special tax treatment is in effect in Colombia for hotel services rendered in hotelsthat have been remodeled between the years 2002 and 2017. The income generatedin the rendering of said services, proportional to the expenses incurred in theremodeling, is exempt from income tax for a term of thirty (30) years.Presently 80% of the imported goods for the hotel sector are imported from the UnitedStates. Since the signing of the Free Trade Agreement between both countries, theprogressive reduction of custom duties will greatly benefit the import prices of theaforementioned goods.Currently there are numerous tax and custom benefits for capital goods utilized intourism exports.Cacao and long term plantations

15Exempt income: In Colombia is in effect a very relevant tax incentive regarding longterm plantations (oil palm, cacao and fruits). In accordance with the latter, incomegenerated in these types of plantations, that initiate their activity between January 1 st2003 up to December 31 st 2014, is exempt from taxation for a period of ten (10) yearscounted from the start of the production.Productive alliances: This refers to a special program that looks to link the smallproducers with the industrial sector (processers and distributors) for the jointdevelopment of middle to long term projects accompanied by a supply agreement. Toachieve said goal, every one of the aforementioned projects receives a subsidy of upto 30% of the value of the project.Support and benefits granted to producers:a) Structuring and follow up of sustainable and profitable initiatives.b) Assistance with implementation of value chains like suppliers (commercial allies).c) Increase in their income (the base income is equal to 2 minimum monthly wages).d) Financial sustainability – Revolving Fund.e) Employment generation (2,6 jobs generated per involved beneficiary).Support and benefits granted to the private and corporate sector:a) Production insurance (quality, opportunity, planning, customer loyalty and stability).Support and benefits for public and private institutions:Lumber and forestrya) Proven platform on sustainable and profitable initiativesb) Change in the assistance cultureInternal return rates between 11% and 16.6%. According to the study “Global Timberinvestments, Wood costs, regulation and risk” 2010, in Colombia it is easily achievableto obtain return rates, in real terms (without including inflation) before taxation, ofamounts equal to the 11.2% in Pinus Patula, 14.7% in Pinus Maximinoi, 15.5% inPinus Tecunumanii and 16.6% in E. spp.; attractive rates in comparison to ourcompetitors like Chile 13.1% P. radiata for pulp and 15.6% in P. radiata for lumbering.Permanent income tax exemption: The profiting of new forestry plantations, after theclassification done by the Autonomous Regional Corporation (CAR in Spanish), will beexempt from income taxation. Furthermore the investment in new sawmills is alsoexempt from income tax if the saw mill is directly linked to the profiting of theaforementioned plantations. This exemption is not limited in time.Requirements for new plantations:

16a) Registration of the new plantation before the Autonomous Regional Corporation –CAR.b) Lease agreement or document that proves the ownership or right of exploitation ofthe plantation.c) Certificate issued by the CAR classifying it as a new plantation.d) Certificate issued by the Fiscal Auditor or accountant in which the sources ofincome are discriminated, indicating the income linked to the plantation andseparating it from other income.Requirements for new Sawmills:a) Invoices demonstrating the acquisition of the new sawmill, as well as the acquisitionof the complimentary machinery after January 1 st 2003.b) Supply contract between the plantation and the sawmill.c) Certificate issued by the Fiscal Auditor or accountant in which the sources ofincome are discriminated, indicating the income linked to the plantation andseparating it from other income.Certificate of Forestry Incentive (CIF in Spanish): This certificate is a monetarysubsidy, given by the Ministry of Agriculture and Rural Development, which recognizes50% of the costs for establishing and maintaining a forestry plantation up to its fifth (5 th )year. This certificate is not compatible with other tax benefits or any other subsidiesgranted by the Colombian Government.EnergyIncome received solely by companies dedicated to power generation, as a result of thesale of electricity generated using wind power, biomass or agricultural residue isexempt from income tax for a period of fifteen (15) years, as long as the following arecomplied with:Technologya) Obtain and sell carbon bonds in accordance with the Kyoto Protocolb) At least 50% of the income received from the sales of the carbon bonds must beinvested in socially beneficial projects in the region where the electric generationcompany is located.Income generated from the exploitation of Software that is developed in Colombia andduly registered before the national copyrights authority is benefitted with an income taxexemption for five (5) years counted from January 1 st 2013. However the softwaremust contain a high level of national scientific and technological research, certified bythe national science institution – COLCIENCIAS.Oil and GasAs a general rule, transactions between Colombian residents are not consideredexchange operations and therefore must be paid in local Colombian currency, even if

17they can be agreed upon in foreign currencies. However, the oil and gas sector issubject to the Special Exchange Regime, only applicable to branches of foreigncompanies that are dedicated to:a) Exploration and exploitation of oil, carbon, gas, ferronickel and uranium.b) Rendering of services that are inherent to the oil and gas sector.Under this special regime all the monetary resources must be transferred through aspecial supplementary investment to assigned capital account (ISCA from its acronymin Spanish) since no access to the foreign exchange market is granted. Accordingly thesums resulting from the sales of the companies benefitted by this regime do not haveto be channeled through the exchange market.Currencies are kept in the ISCA account.Supplementary diminishing of the assigned capital is every amount that the branchsends to its offshore holding company directly. This is one of the true benefits of thisregime, since no obligation exists to channel the amounts through the exchangemarket.Companies that benefit from this regime can request to be excluded from it; howeverthe exclusion must be for a minimum of ten (10) years.5. Colombian tax regime:INCOME TAXFirst and foremost, in accordance with article 12 of the National Tax Statute, any andall companies located (both domicile and effective place of management criteria areapplied) in Colombia are considered Colombian residents for tax purposes andtherefore are taxed on their national and foreign sourced income. Furthermore, eachyear they must file a tax return for the annual income tax.Regarding individuals, residence is acquired after spending 183 days or more inColombian territory, over a consecutive 365 day period. Foreigners are taxed on theirlocal and worldwide income as soon as they acquire fiscal residency in Colombia.According to article 24 of the National Tax Statute, income generated in Colombianterritory is to be considered as Colombian sourced income and therefore subject toColombian tax rules. In Colombia, corporations are taxed on their annual income at a fixed rate of 25%applied on the taxable base determined as indicated below. Individuals are taxedprogressively in accordance with their income.When determining the taxable base, in accordance with article 26 of the same TaxStatute, certain sums, namely specific costs and deductions determined by law and

18that have a direct relation with the taxable income, are deductible, reducing theeffective income amount subject to the tax.Furthermore, in accordance with article 254 of the Tax Statute, tax credits can bededucted from the effective tax to be paid. Said credits can only be deducted if the taxpaid abroad does not exceed the amount to be paid in Colombia for the same income.Depending on the activity carried out, various rates of withholding tax are applicable,ranging from 0.1% to 11% when dealing with other Colombian residents.It should be noted that payments, made from Colombia to a non Colombian resident,be they royalties, interests, commissions, leases, payment for personal services,professional fees and the like, have to be withheld at a fixed rate of 33%. Theexceptions to the latter, though few, are clearly defined in the Tax Statute, specificallyregarding dividends as explained below.Dividends to be paid to a foreign investor in Colombia can be subject to withholdingtax. The effective rate is to be applied solely on the portion of said dividends that is notconsidered tax exempt. To determine said portion the rules stated in articles 48 and 49of the same Tax Statute have to be applied, basically the amount to be distributed asdividends to the shareholders has to be compared versus the taxes already paid by thecompany, and if the former surpasses the latter then that amount is to be subject toincome tax, payable by the shareholders. Regarding windfall taxes and occasional income the applicable rate is 10%.Occasional income in Colombia can only occur in the following scenarios: 1. Incomegenerated as a result of inheritances, legacies, bequests or donations; 2. Incomegenerated as a result of the sales of fixed assets that were owned for more than two(2) years by the taxpayer; 3. Income generated in the dissolution and liquidation of acompany; and 4. Income for lotteries, gambles, prizes and the like.Additionally, in accordance to article 188 of the National Tax Statute, in Colombia apresumptive income tax system must be applied by taxpayers. Said system constitutesan alternate method for determining the income tax, so as to ensure that the taxablebase is not lower than 3% of the taxpayer’s assets as of December 31 of the year priorto the current taxable year. In other words, presumptive income is the minimumestimated amount of profitability of a taxpayer based on which the law expects toquantify and collect the income tax.The return for income tax must be filed annually, depending on the dates determinedby the Colombian Government and the last digit of the taxpayer’s identification number.The tax returns for withholding taxes must be filed monthly.Law 1429 of 2010 implemented a progressive system regarding income tax for smalland medium companies. To apply the company must comply with the following:a) The company’s total assets must be valued under 5.000 monthly legal wages,roughly USD$ 1.574.166.00.

19VALUE ADDED TAXb) The company must not have over fifty (50) employeesIn Colombia, most sales of taxed goods or the rendering of taxed services generate a16% V.A.T. There are special rates; namely a 5% and a 20% rate for special goods orservices.Every two months a tax return must be filedFor the rendering of services by restaurants, coffee shops, bakeries, etc.; the sales ofdomestically manufactured goods and mobile telephony no V.A.T. is incurred, howevera tax on consumption must be applied at a rate of 8% or 4%.Returns for the V.A.T. must be filed every two months.GMF – TAX ON FINANCIAL TRANSACTIONS In Colombia every financial transaction is taxed at a standard rate of four (4)Colombian Pesos per every thousand involved in the transaction, thus the applicablerate is 0.4% on the value of the transaction. Nonetheless, after the last tax reform therate will be gradually diminished, up to the point that for the year 2018 it will bereduced to 0. There is no need for the taxpayer to file a return for the GMF; thefinancial institution withholds the amount from each transaction.MUNICIPAL TAXESICA – INDUSTRY AND COMMERCE TAXThis tax is levied on industrial, commercial or service activities carried out within thejurisdiction of a municipality or district by a taxpayer with or without a businessestablishment, and it is collected and managed by the municipality or district where theactivity is carried out. Actual rates range between 2 per thousand (0,2%) and 10 perthousand (1%) applied on the gross income of the taxpayer. A tax return must be filed,for taxpayers located in Bogotá, every two months.PROPERTY TAXThis tax is levied annually on the ownership, usufruct or possession of real estateproperty located in Colombia, and it is collected and managed by the municipalitywhere the property is located. The rate of said tax ranges between 1 per thousand(0,1%) and 16 per thousand (1.6%) applied on the value of the property.REGISTRY TAXFor the registration of some documents before Colombian authorities, a registry tax isincurred. The applicable rates range from 0.7% to 1% on the value contained in theregistered document.

20TRANSFER PRICING RULESThe Colombian Tax Authority, over the last decade, has been enforcing, on linkedforeign business partners, the obligation of preparing and presenting documentation incompliance with transfer pricing rules. Transfer pricing rules that closely follow theOECD guidelines and the arm’s length principle fully apply in Colombia.CREE – FAIRNESS INCOME TAXWith the last tax reform, Law 1607 of 2012, the new fairness tax was introduced.Specifically it is a tax on corporate income in benefit of social investment andemployment generation. The applicable rate for this tax is 9% for the years 2013, 2014and 2015; from there on the rate will be 8% on the taxable base. Regarding thedetermination of the taxable base, according to article 22 of Law 1607 of 2012, fromthe taxpayers’ net income, costs, expenses and exempt income amounts must bededucted. Nonetheless the taxable base cannot be inferior to 3% of the taxpayer’sassets as of December 31 st of the year prior to the current taxable year.The fairness income tax replaces the amounts that used to be levied from thecompany’s payroll at a rate of 9%. Thus, companies no longer need to contribute withthe formerly known parafiscal contributions and are only taxed on their income.TAXATION OF EMPLOYEESOnce again, the last tax reform implemented a special taxation regime for employeesin Colombia that should be taken into account. According to article 329 an employee isthe individual that receives at least 80% of his income from a labor contract. Now, inaccordance with article 330 of the same Statute, if any employee, that is a Colombianresident for tax purposes, has a yearly gross income equal or superior than 4700 UVTs(Tax value units), roughly USD$ 66.400, they must determine their income taxaccording to ordinary income tax procedure. Furthermore, the taxable base,determined by the taxpayer, cannot be inferior to the IMAN (National MinimumAlternative Tax), a presumptive taxable base and therefore the tax to be paid cannotbe lower than the one established by law.PERMANENT ESTABLISHMENTFurthermore, after the last tax reform, Colombia adopted new criteria so as todetermine the source of income for non Colombian residents, specifically; the conceptof “Permanent Establishment” was recently introduced into our legislation inaccordance with the OECD definition.DECREE 2193 OF 2013 – TAX HAVENSWith this recently issued Decree, the Colombian Government has compiled the list ofcountries that are to be considered tax havens. This qualification by the nationalGovernment has a direct impact on any and all businesses that have relation with a

216. Labor Matterscountry regarded as a tax haven. Specifically, if revenues are to be transferred to oneof the countries considered as a tax haven, the amount necessarily is to be subject to awithholding tax at the maximum rate of 33%. Furthermore, transfer pricing rules are tobe applied, regardless of the link between the contracting parties. Since the mentionedDecree is very recent, further development can be expected by the National TaxAuthority.Five things an investor should know about labor matters in Colombia:Employment agreements that are executed in Colombia, regardless of the nationalityof the parties, are governed by local law.At the end of each year, the Government sets up establishes the current minimummonthly legal salary.Under Colombian labor law, all payments made as a direct retribution of theemployees’ work will be considered to constitute salary without exception and thereforeany contractual term that attempts to exclude any such payments from the employees’base salary will be invalidated.Both nationals’ citizen and aliens non-citizen employees are obliged required to joinaffiliate and contribute to the social security system.In addition to the employee's monthly salary, that employers and employees maydefine in the labor employment contract agreement several sums or payments whichare deemed to be excluded from the employee’s base salary base, but such paymentsthat may not exceed 40% of the employee’s base salary.General MattersIn Colombia, a labor contract is an agreement whereby a person agrees to render to another (anindividual or a company) his/her personal services under a continued subordination and receivesperiodical compensation which remunerates the work performed.a) Formal requirementsColombian labor legislation assumes that every personal work relationship is governed by anemployment contract. Thus, for the purposes of declaring that a valid contract has been formed, thefollowing elements must be set forth in such contract:(i)The personal activity of the employee;(ii) continued subordination or dependency of the employee with respect to the employer,granting the employer the authority to give orders and instructions at any time concerning mode,time, or quantity of work; and

22(iii)A salary that compensates the employee for the services rendered.Once these requirements have been met, it is deemed that an employment contract exists,regardless of the name assigned to it. This means that in Colombia there are no special formalities,aside from the exceptions provided by law.Labor ContractsLabor contracts may be classified according to their duration, as follows:LaboragreementIndefinite TemFixed TermCharacteristicsThe duration of this type of agreement depends on the subsistence of the causesthat originated the relationship and the scope of the work to be performed.All verbal contracts are considered to be indefinite term agreements, regardless ofthe fact that the parties may have agreed otherwise.The parties establish a term for the duration of the contract, which may not exceedthree years. There are two types of fixed-term labor contracts: those of less than ayear and those of between one and three years. This type of contract ischaracterized by a special formality, as it must in writing; otherwise it will beunderstood as an indefinite-term agreement.The fixed term labor contracts with a term of less than one year can only berenewed for three equal or lesser terms. If a new renewal is desired, the term maynot be less than one year. If the term is between one to three years, it may berenewed indefinitely. However, fixed-term labor contracts between one and threeyears, may be renewed indefinitely, but will never turn into indefinite-term laborcontracts.Since labor law establishes the automatic renewal of fixed-term labor contracts withan equal period to the one initially agreed, in the event that a further renewal is notdesired, prior notice of at least 30 calendar days must be given to the other party,before the expiration date of the contract.For the timethat theperformanceof the workmay lastOccasional,accidental ortransitoryThe duration of the duty or the hired work is not defined by the parties. Rather, itdepends directly on the period of time the duty lasts, or the work that has beencontracted. In that sense, it does not permit any renewals.The necessity to describe in a detailed way the duty or work objective of theagreement means that the contract must be in writing.This type of contract is appropriate for the fulfillment of duties that vary from thenormal activities of the Company and its duration is less than one month.Probationary Period

23During the probationary period, the employer has the opportunity to evaluate the employee’sperformance, and, simultaneously, the employee may evaluate the work environment. During suchperiod, which should be stated in writing, either party may terminate the employment contractwithout prior notice or incurrence of indemnification payments. The probationary period is related tothe duration of the employment contract agreed, but it may not exceed two months.Foreign EmployeesForeign nationals have the same rights and obligations as Colombian employees. However, when aforeign national enters into an employment agreement in Colombia, both the employer and thepotential foreign national employee must meet additional requirements in connection with theadministrative procedures at Ministry of Foreign Affairs for the physical entry of the foreign workerinto Colombia and supervision during such foreign national’s stay in Colombia.Payments derived from a labor relationshipSalaryThe salary is the employee’s primary type of compensation for services rendered for the employer’sbenefit. Thus, the following elements should be considered in order to determine if the amountsgranted by the employer to its employees are deemed salary:(i)(ii)(iii)Rewarding character: it is of the essence of a salary nature payment to reward arendered service, disregarding the form or the name given to the payment.Non gratuity character: opposed to the rewarding character, the amounts granted by theemployer to its employees occasionally, by gratuity and by its own free will, shall not bedeemed as salary.Personal income character: salary nature payments have the purpose of enriching theemployee. Thus working tools, transportation aid and any other benefit granted to theemployee to perform his/her duties, shall not be considered as salary.Types of Salary1. Regular Salary: A regular salary compensates the employee recipient for services rendered, andit may be fixed or variable. In addition to the regular salary, the following must be added: (i) anyadditional compensation for overtime work, (ii) surcharges, (iii) percentage on sales andcommissions, (iv) additional salaries and regular bonuses, (v) permanent travel expenses foremployee’s meal and lodging, and in general, any payment made as direct compensation of theemployees’ work.It is important to bear in mind that in Colombia, no employee can earn a salary lower than themonthly minimum legal salary, that is, COP$ 616.000 (Approx. USD315) 1 monthly for 2014.1 1USD = COP 1.950

242. Integrated Salary: The integrated salary differs from the regular salary, as it constitutes the onlypayment that in addition to the compensation of the personal service, remunerates beforehand thevalue of surcharges, benefits and legal fringe benefits, such as severances, severance’s interests,service bonuses, and generally all fringe benefits; except vacations. In conclusion, the employeeonly receives one monthly salary payment is not entitled to any additional payments for any legalfringe benefits.An integrated salary arrangement must be stated in writing in the text of the employmentagreement, or as an additional clause, or through crossed letters between the parties, indicating thefactors included in such stipulation. Additionally, an integrated salary is only permissible for thoseemployees that earn more than ten monthly minimum legal salaries plus a fringe benefit factor of atleast 30%.For year 2014, the minimum integrated salary is COP 8.008.000 (Approx.USD4.106). 2Extralegal BenefitsThe specific determination of the payments that constitute salary is the most important issue for thepurposes of liquidation of fringe benefits, vacations, indemnities and contributions to the socialsecurity systems, and payroll fees. Labor law provides that employers and employees may define inthe labor contract which sums or payments are deemed to be excluded from the employee’s salarybase. This is an advisable formula for any company, because it reduces the value of its fringebenefit obligations.Notwithstanding the above, it is important to bear in mind that all payments made as a directretribution of the employees’ work will be deemed to constitute salary without exception andtherefore the contractual definition that attempts to exclude such payments from the employees’base salary will be invalidated. Payments or benefits that are excluded from the base salary cannotexceed 40% of the base salary the total amount must have proportionality to the salary of the 40%.Travel Expenses (Per Diem)Travel expenses include both travel costs, as the outlays for meals, and other expenses when theemployee is traveling for the benefit of the employer to perform a particular task. Travel expenseswhen paid on a regular basis are deemed to constitute salary when destined for meals and housing(excluding those destined for transportation and expenses of representation). Any agreementregarding travel allowances when paid on a regular basis destined to subsistence and housing, asto not be considered salary, would have no legal effects whatsoever and would be null.Fringe BenefitsUnder Colombian labor law, every employer has the obligation to grant all of its employees certainbenefits, in addition to their salaries, which are known as legal fringe benefits. However, anemployee earning integral salary (which is an all comprehensive salary), is not entitled to additionalfringe benefits.2 1USD = COP 1.950.

25The following are said benefits:ConceptPeriod ofPaymentDescriptionSeverance Annual Employers must make an annual direct deposit with aseverance fund on behalf of every employee, equivalent toone monthly salary for every year of service andproportionally for a fraction thereof. Said deposit must bemade before February 15 of each year. Upon terminationof the employment contract, the employer must pay theemployee the accrued severance until the date oftermination.The lack of timely payment generates a compensation ofone day's salary for each day of delay until payment isverified during the term of employment.Interest on Severance Annual Equivalent to 12% per annum on the balance of eachyear’s severance owed to the employee as of December31 of the preceding year, which must be paid no later thanJanuary 31st of each year.Service BonusSemi-AnnualEqual to one monthly salary for each year of service and50% must be paid in June and the remaining 50% inDecember of each year.Transportation aid Monthly Employer must reimburse each employee whose salary isno more than two times the SMLMV a monthly paymentfor transportation expenses for 2014, it is of COP$72.000(Approx. USD37).Footwear and dress aid Every fourmonthsIt is an endowment of one pair of shoes and one labordress that has to be provided three times a year to everyemployee, in accordance with the task to be performed.Employees entitled to this benefit are those that earn up totwice the minimum legal salary and that have beenemployed for at least three months (no later than April 30,31 August, and 20 December of each year).Family allowance Monthly It is a sum of money in-kind payments and services,provided and paid for by the government’s familycompensation bureau. Any employee whose pay does notexceed four SMLMV is entitled to this benefit.Social SecurityEvery employer must affiliate its employees to the General Social Security System, and makemonthly contributions in accordance with the employees’ monthly salaries. Employees mayvoluntarily choose the entities regarding General Pensions System and the General Health SocialSecurity, and the employer will be the one choosing the General Professional Risks System entity.Contributions’ amount is calculated as follows:

26SystemContributions (% of salary)Employee EmployerPension 4% 12%Health 4% 8.5%Risks -Between 0.348% and 8.7%(varies in accordance with the exposed risk)Pursuant to Law 797 of 2003, employees earning more than four SMLMV must make additionalcontributions to the Pension System which varies between 1% and 2% of the employee’s salary 3 .Vacations and working hoursa. VacationsAll employees have the right to enjoy 15 vacation days of remunerated rest for every year of serviceand proportionally for any fractions thereof, which vacation days can only be accumulated for up totwo years, and in special circumstances such vacation days can be accumulated for up to fouryears.b. Working HoursLabor hours are limited to 48 hours per week, distributed in a maximum of six days per week.However, with the proper authorization, granted by the Ministry of Social Protection (Ministerio de laProtección Social), an employee is entitled to work up to 12 hours of overtime per week, this is twoextra hours per day. Employees in positions of management and confidence are not subject to saidrestrictions.In any case, it is possible to arrange that the daily working hours are increased in up to two hoursdaily, with the only purpose of permitting the employees to rest during Saturday. This increase inthe working hours does not constitute overtime, thus no surcharges have to be paid.The work performed between 6:00 a.m. and 10:00 p.m. is considered daytime work; and thedaytime overtime will be compensated with an additional 25% surcharge over the daytime hour.On the other hand, work performed between 10:00 p.m. and 6:00 p.m. is considered nighttime work,and it has an additional 35% surcharge over the daytime hour, only for being nighttime work.Additionally, nighttime overtime is paid with an additional 75% surcharge over the daytime hour.c. Mandatory Remunerated Rest on Sundays and Holidays 43 The additional contributions will be as follow: up to 4 SMLMV: 16%; between 4 and 16: 17%; between 16 and17: 17.2%; between 17 and 18: 17.4%; between 18 and 19: 17.6%; between 19 and 20: 17.8%; more than 20:18%4 National holidays in Colombia are observed on January 1st and 6 th ,March 19 th , May 1 st ,June 29 th , July 20 th ,August 7 and 15 th , October 12 th , November 1 st and 11 th and December 8 th and 25 th, .Additionally, there are fivereligious holidays on dates specified by the Catholic Church.

27Sundays and national holidays are considered by Colombian labor law as mandatory periods ofpaid rest. This implies that, as a general rule, the employee is not obliged to render services onthese days but is still entitled to receive the relevant salary. In Colombia there are 13 nationalholidays and five religious holidays. Where employees have to render services on Sundays ornational holidays they are entitled to special surcharges calculated according to the following rules:(i) If work on Sundays is regular or habitual (i.e. three or more Sundays in one month), theemployee is entitled to an additional surcharge of 75% over the ordinary hourly rates, plusone day of compensatory rest in the following week.(ii) If work on Sundays is occasional (i.e. two Sundays or less in one month), the employee isentitled to one of the following benefits of his/her choice: one day’s compensatory rest inthe following week, or an overtime payment of 75% over the ordinary daytime hourly rate.Termination of the Employment AgreementGenerally, employment agreements may be terminated without prior notice by any of the parties. Ifthe contract is terminated by the employer, the effects of the termination will vary depending on thetype of contract and whether the contract is terminated with or without just cause.IndemnificationIndemnification payments become payable in the event of the employer’s failure to comply withany legal or contractual obligations, or for the failure to comply with any obligations that thelabor law imposes on employers. The most common types of indemnifications include thefollowing:Indemnification for the termination of the employment agreement without cause (Severance):Type ofEmploymentAgreementFixed termFor the timethat theperformanceof the workmay lastIndefiniteTermSeveranceThe salary payable for the time period remaining until the completion of the term.The salary corresponding to the term determined by the duration of the duty or thecontracted work, in which event the indemnification will not be less than 15 days ofsalary.Employees with salaries less than ten times the minimum legal monthly wage:For employment relationships of one year or less, thirty days of salary; plus twentyadditional days for each subsequent year and proportionally for fractions thereof.Employees with salaries that are equal to or exceed ten minimum legal monthly

28wage:For employment relationships of one year or less, twenty days of salary; plusfifteen additional days for each subsequent year and proportionally for fractionsthereof.Employees with ten years or more of services as of December 27, 2002: forty-fivedays of salary for the first year, plus forty additional days for each subsequent yearand proportionally for fractions thereof.Employees with ten or more years of services as of January 1 st , 1991, have theright to be restored to their position, and in the event of a termination without justcause, the employer must pay an indemnification of forty-five days of salary for thefirst year and thirty days of salary for any additional years; without prejudice thatthe employee may initiate a labor law suit seeking restitution to such employee’soriginal work place.Default IndemnityIf the employer at the time of termination of the employment agreement does not pay the employeethe sums owed for salary or additional benefits in due time and form, the employer will be requiredto pay a default indemnity corresponding to one day of the employee’s last salary for every day ofdelay in the payment, during a period of time of two years from the day in which the right wasaccrued. From the month 25 on, the employer would have to pay current banking interests, until theday in which the payment is effectively completed.Reinforced StabilityIn accordance with the Constitution, there are certain types of employees that cannot be dismissedwithout a previous authorization of a labor authority, such as: (i) pregnant women, or on maternityleave; (ii) certain unionized employees, (iii) employees with disabilities, and (iv) employees withreinstatement right, among others.Collective dismissalsAn employer who wishes to collectively dismiss its employees will require authorization from theMinistry of Social Protection to do so. The event of a collective dismissal is determined by theproportion of employees dismissed, starting with 30% of the employees within a six month period, incompanies with 11 to 49 employees, and down to 5% of the employees within a six month period, incompanies with 1000 employees or more.Notwithstanding the above, if the employees are dismissed with just cause, or their termination isdone by mutual consent between the parties, such events will not be considered to determine acollective dismissal.

29Collective RightsDuring the course of a collective work conflict, collective law rules (i) the relationships betweenthe employer and union organizations, (ii) collective contracting and (iii) the defense of commoninterests, both of employers as well as of employees.There is not a strong labor union culture in Colombia. Less than 8% of the total labor force of thecountry belongs to labor unions. The largest and most influential unions in the country are controlledby public employees, particularly in the state-owned oil industry, health and education sector.However, it is important to bear in mind that the right to constitute labor unions is protected both bythe Labor Code and by the Political Constitution, and the officials of the unions have special legalprotection that prevents them from being dismissed and, in some cases, allow them to devote mostof their time to union issues while being paid by the employer.a) UnionsUnions are employee organizations lawfully constituted for the purpose of obtaining, improving andconsolidating common rights vis-à-vis their employers. It is also the association of employees aimedat the union member’s defense of their individual and collective interests. Pursuant to ColombianLabor Law, any group of 25 or more employees, regardless of whether they are employees of thesame company or not, may constitute a labor union.b) Collective Bargaining and Collective AgreementsThe right of collective bargaining to rule labor relations is guaranteed and protected both by theColombian constitution and by the Labor Code, for both unionized and non-unionized employees.The collective agreement is entered with the unionized employees and the collective accords areentered between employers and non-unionized workers only in cases where the union membershipis not more than one third of the employees.c) StrikeA strike is defined as the collective, temporary and peaceful suspension of work, carried out by theemployees in a company or establishment, with the aim to effectuate change regarding certaineconomic and professional matters proposed to their employers, after compliance with certainprocedures. Its exercise is only lawful and possible within the collective bargaining process as anoption to employees, provided that they work for an employer in the private sector who does notcarry out activities classified by law as public services.Sub-contracting and temporary work undertakingsAlthough Colombian labor law permits companies to execute agreements with independentcontractors (individuals), temporary employment agencies and outsourcing companies, in order toavoid any misunderstanding as to the nature of this type of contract, it is important to be certain thatthe relationship between the company and the party rendering the service (individual or legal entity)does not create any dependence or subordination, and that the service provider is truly independentand autonomous in the performance of his/her services. Additionally, in the absence of complete

30compliance with all the legal requirements, the contracting party may be deemed to be the realemployer of the personnel provided, and therefore responsible for all the labor payments.a) Temporary employment agencies (TEAS)A company may decide to enter a service agreement with a temporary employment agency, whichis a company that provides personnel, and temporarily assists with the development of a usercompany’s activities. The user company benefits from the services rendered, through ‘missionemployees’, which are hired directly by the TEAS.Under this arrangement, for all legal purposes, the TEAS will be the true and only employer of theindividuals and therefore responsible for all legal labor obligations. The company will reimburse allpayments completed by the TEAS and will pay a percentage of such amount as fees for theservices of the TEAS.The commercial agreement executed will be a service agreement, whereby the TEAS will supplythe personnel required by the company. The agreement must be in writing and the TEAS mustcommit to abide by Colombian labor legislation in respect of individuals’ salaries, fringe benefits,vacations, social security, payroll fees and overtime regime. Likewise, the TEAS must purchase aninsurance policy to guarantee the fulfillment of all labor obligations towards the individual. TheTEAS must also ascertain the way in which occupational hazards must be dealt with when theindividual is engaged in risky activities.User companies may enter service agreements with TEAS only in the following cases:(i)(ii)(iii)To attend occasional and temporary jobs. Such relationships should not last longerthan a month, and should not be related to the regular activities of the company;to replace personnel on vacation or leave of absence or who are unable to work due toillness or maternity; orTo address increases in production, transport, sales, harvest periods and in therendering of services.In these three cases, the relationship between the user company and a mission employee may notlast for more than six months. The relevant period can be renewed, but not for longer than theoriginal period. If the necessity of the particular service continues on the expiration of the relevantperiod, the user company may not enter a new agreement with the same TEA, nor with a differentone.A further legal obligation is that within the first 10 days of every month, the TEAS should report tothe user company regarding its affiliation and payments to the social security system of the missionemployees who have rendered services to them in the previous month.b) Outsourcing companiesCompanies may receive personal services from employees by means of outsourcing. Where this isthe case, the relevant company and the company to which the services are outsourced will be

31linked by means of a service agreement. For all legal purposes, the company which carries out theoutsourced services will be the sole employer, and therefore responsible for all legal laborobligations with the employees that render their services. Labor law provides that the company towhich the services are outsourced must have technical and administrative autonomy in renderingthe outsourced services. This implies that the contracting party (the company, in this case) is notallowed to give orders relating to the mode, time, or quantity of the work either to the company towhich the services are outsourced, or to its employees.c) Independent contractorsA company may decide to execute a service agreement with an individual performing as anindependent contractor. However, this agreement may only be arranged for intellectual or artisticoccupations and, in such case, it must be clearly established that the performance of the contractwill be carried out with technical and administrative autonomy, under the account and risk of thecontractor, and therefore without a relationship of dependence or subordination to the hiringcompany.Unemployment National Rate (2013)Colombia is one of the countries in the region with the highest annual growth in labor force.Source: Departamento Administrativo Nacional de Estadística – DANE-.COLO 0605 0851 54391/HBE/KSB4290210346557

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Doing Business in Costa RicaThe purpose of this presentation is to provide information to investorswho are evaluating Costa Rica as a potential location for their business.Attorneys

General FactsThe Republic of Costa Rica is a country in Central America, borderedby Nicaragua to the north, Panama to the east and south, the PacificOcean to the west and south and the Caribbean to the east.The country has a total area of 51,100 km2, and a population of 4.7million.Attorneys

Government structureThe Costa Rican state comprises three powers: executive responsibilitiesare vested in a president, legislative power is vested in a president,legislative power is vested in the Legislative Assembly, and judicial poweris vested in the Supreme Court.Attorneys

Investing in Costa RicaCosta Rica´ s value proposition focuses on five major key areas:Proven Track Record: Around 250 high- tech multinational companiesare operating in Costa Rica and in 2012, 40 new high technologyinvestment projects confirmed their decision to establish their operationsin the country. Out of the total annual inflows of FDI in Costa Rica,over50 % is reinvestment from established multinational companies. In theFree Trade Zone Regime, 2/3 of the annual inflow of FDI comes fromreinvestment.Qualified Workforce: Costa Rica has an exceptionally talented andbilingual young workforce. Approximately 95 % of employees inmultinational companies are local.Attorneys

Investing in Costa RicaStrategic Location: Preferential access platform to 2.5 billion people(34 % of the world´ s population), and more than 64% of worlwideGDP. 87 % of exports of goods covered by Free Trade Agreements.Excellent Business Climate: The country enjoys an excellent businessclimate based on a renowned democratic tradition, economic andpolitical stability.Solid Infrastructure: More than 90 % of energy is renewable. The countryhas redundant telecommunications access.Quality of Life in Costa Rica is high: Safest country in Latin Americaand one of the top 5 environmental performers of the world.Attorneys

To ensure wide market access, Costa Rica has signed several freetrade agreements with 18 countries, which are:El SalvadorGuatemalaHondurasNicaraguaMexicoChileDominican RepublicCanadaTrinidad & TobagoGuyanaBarbadosBelizePanamaUnited StatesChinaPeruSingaporeEuropean Union

Investment IncentivesThe Free Zone Regime is the mainstay of Costa Rica´ s export andinvestment promotion strategy. The Free Zone Regime is a set ofincentives and benefits granted by the Costa Rican governmentfor companies making new investments in the country, as stated in thethe Free Zone Regime Act # 7210, Act # 8794, and in its Bylaws.Free Zones are primary areas for offshore tax and customs operations.They are restricted zones with no resident population, authorized toserve as such by the Governmentś Executive Branch. These facilitiesare intended to accommodate operations engaging in input and rawmaterial imports, manufacturing and assembly or marketing ofexport goods and provision of export- related services.Attorneys

Free Trade Zone Incentives:Export processing industries engaged in processing or assemblingraw materials to produce export / re- export finished goods.Export trade companies (not producers) engaged in handling, repacking,or redistributing non- traditional export / re- export products and merchandise.Service industries or companies exporting to natural or artificial peopleabroad or serving to Free Zone companies, as long as these servicesare directly linked to those companies production processes. Banking,financial, or insurance companies inside Free Zones will not be allowedto benefit from the Regime.Attorneys

Park- managing companies engaging in installing companies underthe Free Zone Regime and to park management and maintenance.Companies or organizations engaged in scientific research to enhancetechnology levels of industry or agribusiness activities and Costa Rica´ sforeign trade.Companies operating shipyards and dry docks to build, repair, or serviceships.Manufacturing firms which can export or not (minimum export level is notrequired).Attorneys

Our ServiceOur objective is to provide our clients located in Costa Rica and abroadwith integral specialized legal services.ARA LAW offers a service focused on providing integral legal advice toestablish your company, in accordance with your needs and businessgoals, preparing the pertaining documentation, performing the actsnecessary before the respective authorities, and providing corporate-legalsupport to your company.Please, contact us by email at info@aralaw.cr or by phone (506)22918844Attorneys

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DOING BUSINESS IN GERMANYJuly 2014Heidelberg │ Frankfurt │ Stuttgart │ Dresden │ Chemnitz │ Erfurt │ Jena │ www.tiefenbacher.de

Table of ContentsTable of Contents ................................................................................................................... 2A. Introduction .................................................................................................................. 4B. General Information .................................................................................................... 41. Area ..................................................................................................................................... 42. Population ........................................................................................................................... 53. Politics ................................................................................................................................. 54. Work and Residence Permits .............................................................................................. 64.1. EU Citizens (including Iceland, Liechtenstein, Norway and Switzerland) ............... 64.2 Non-EU Citizens ....................................................................................................... 7C. German Economy ........................................................................................................ 9D. German Business Practices ....................................................................................... 9E. Business Infrastructure ............................................................................................ 10F. Establishing a new Business in Germany .............................................................. 111. Limited Liabiltiy Corporation Company (GmbH) ............................................................... 112. Mini-Limited Liabiltiy Corporation Company (Unternehmergesellschafthaftungsbeschränkt, UG) .................................................................................................. 163. Stock Company (Aktiengesellschaft, AG) .......................................................................... 174. Partnership limited by shares (Kommanditgesellschaft auf Aktien, KGaA) ...................... 205. European Public Limited Company (Societas Europaea, SE) ............................................ 206. Partnerships ...................................................................................................................... 217. The Advantages of a Partnership compared to a corporate structure ............................. 238. Other ................................................................................................................................. 23G. Taxation ...................................................................................................................... 241. General information ......................................................................................................... 242. Corporate Income Tax ...................................................................................................... 243. Personal Income Tax ......................................................................................................... 244. Trade Tax .......................................................................................................................... 25H. German Labour Law .................................................................................................. 251. Collective agreements ...................................................................................................... 262. Workers council ................................................................................................................ 262

3. Principle of Equal Treatment ............................................................................................ 264. Employment Contract ....................................................................................................... 264.1 Interview ............................................................................................................ 275.2 Employment Contract Contents ........................................................................ 275.2.1 General Business Terms ..................................................................................... 275.2.2 Working Hours ................................................................................................... 275.2.3 Probationary Time ............................................................................................. 285.2.4 Limited-Term ..................................................................................................... 285.2.5 Part.Time ........................................................................................................... 285.2.6 Salary ................................................................................................................. 285.2.7 Paid Leave .......................................................................................................... 295.2.8 Sick Leave .......................................................................................................... 295.2.9 Industrial Accident ............................................................................................. 295.2.10 Maternity Leave ........................................................................................... 305.2.11 Parental Leave ................................................................................................... 305.3 Termination of Employment ............................................................................. 305.3.1 Limited-Term Employment Contract ................................................................. 305.3.2 Dismissal with the Option of Altered Conditions of Employment(Änderungskündigung) ...................................................................................... 305.3.3 Cancellation Agreement (Aufhebungsvertrag) ................................................. 305.3.4 Termination of the Employment Contract by giving Notice ............................. 315.3.5 General dismissal protection ............................................................................. 325.3.6 Particular Dismissal Protection .......................................................................... 325.3.7 Employment Reference Letter .......................................................................... 325. Labour Law Suits ............................................................................................................... 336. Taxes and Social Insurance Contributions ........................................................................ 337. Ostensible Self-Employment (Scheinselbständigkeit) ...................................................... 333

A. IntroductionThe Federal Republic of Germany is not only the largest European economy and thefourth-largest economy in the world but also ranks amongst the world’s top exporters. Ittherefore represents an attractive place with great prospects for foreign businesses.However, if you are considering doing business in another country it is essential to fullyknow and understand the local business environment, which might differ from the oneyou are used to. Against this background, this brochure aims to provide an explanatoryguideline for foreigners on how to do business in Germany as well as to point out relevantGerman legislations. Nevertheless, due to the diversity of options and complexity of Europeanand German legislations this can only be a general overview. On that score, Tiefenbacherspecialises in business law across the broad range of areas essential to companiesand investors doing business in Germany. With more than 40 professional staff,including certified public accountants and tax consultants in several locations in Germany,we have the capacity to deliver promptly efficient and targeted advice where it is required.Hence, if you have any further questions after reading this brochure, please do nothesitate to contact us. It will be our pleasure to assist you.B. General Information1. AreaThe Federal Republic of Germany consists of sixteendifferent states and is located in Westernand Central Europe. It covers an area of 357, 021km2, which is dominated by a temperate seasonalclimate. The bordering nations are Denmark,Poland, the Czech Republic, Austria, Switzerland,France, Luxembourg, Belgium and the Netherlands.The capital of Germany is Berlin.4

2. PopulationWith approximately 80.8 million inhabitants,Germany is the mostpopulous member state of the EuropeanUnion. Moreover, its populationis characterised by a certaincultural diversity due to the factthat almost 20 % of the inhabitantsare people with an immigrationbackground. The largest of theseforeign nation groups are the Turkishfollowed by the Polish and theRussians.However, Christianity represents the most prevailing religion in Germany with 62.8 millionadherents. The second largest religion after that is Islam with an estimated 4.3 millionsadherents, followed by Buddhism (300.000 adherents) and Judaism (100.000 adherents).Although German is the official language in Germany, English is spoken by a wide rangeof people.3. PoliticsGermany is a federal, parliamentary, representative democratic republic. The currentFederal Chancellor is Angela Merkel. She therefore heads the executive branch of government.Joachim Gauck whose responsibilities are mainly of a more representative matteris currently the President of Germany.The German legislative power is divided between the Bundestag and Bundesrat. Whilethe Bundestag is directly elected by the German citizens the Bundesrat represents the 16different federal states of Germany. The Bundestag, that is more powerful in practice, iselected for a four year term and consists of 631 members. 299 of those members areelected in single-seat constituencies according to first-past-the-post. The other members5

are allocated from statewide party lists put up by the parties themselves in order toachieve a proportional distribution.In this context Germany’s party system is dominated by the Christian Democratic Union(CDU/CSU), the Social Democratic Party (SPD), the Left (Die Linken) and Alliance 90 /the greens (Bündnis 90/ die Grünen). At present, the governing Parties are CDU/ CSUand SPD (Grand Coalition)Germany has a civil law system. A so-called ordinary judicial branch, consisting of fourlevels up to the Bundesgerichtshof, focuses on civil and criminal cases. However, thereare separate judicial branches for administrative, labour, finance and social security issueseach with their own hierarchies. In addition to that, Germany has a powerful FederalConstitutional Court (Bundesverfassungsgericht) responsible for constitutional matters,with power of judicial review.4. Work and Residence Permits4.1. EU Citizens (including Iceland, Liechtenstein, Norway and Switzerland)Due to the EU rules on the free movement of workers, citizens of EU Member States aswell as those of the EEA and Switzerland have the right to live and work in Germany forthree months as long as they hold a valid passport or a photo identity card. Therefore, novisa or work permit is required. Nevertheless, every new citizen must register with the police(polizeiliche Anmeldung) and the local residency office (Einwohnermeldeamt) of thelocal town hall if he or she is staying longer than two months. This registration has to becompleted within two weeks moving in into a permanent accommodation. The followingdocuments are required for the registration in question: A valid passport or a nationalidentity card, a copy of lease or rental agreement and a completed registration form. Afterhaving made this registration a registration card will be issued. EU citizens are able to residein a Member State for more than three months if they are entitled to freedom ofmovement. In principle, EU citizens are entitled to freedom of movement, especially forEU citizens who want to reside as workers in Germany seeking employment.6

4.2 Non-EU CitizensNon-EU citizens who intend to stay in Germany for less than 90 days must apply for a visa.But some citizens of certain states don´t need to have a visa. You can check the listof the countries whose citizens require a visa for entry into Germany athttp://www.auswaertigesamt.de/DE/EinreiseUndAufenthalt/StaatenlisteVisumpflicht_node.html.However, if they plan to stay for more than 90 days they must obtain a German residencepermit. This can be made in conjunction with the above-mentioned visa application. Although,citizens of the United States, Australia, Canada, Israel, Japan, New Zealand andSouth Korea may apply for the needed residence permit after their arrival in Germany.Pursuant to the new German Immigration Act from 1 January 2005 this residence permitalso gives foreigners the right to work in Germany (instead of separate residence andwork permits). Nevertheless, after their arrival in Germany, non- EU citizens have to gothrough the same police registration procedure as described above.Overall, it is to say that immigration to Germany for non-EU citizens is still limited toskilled workers (individuals with either a polytechnic or university degree or at least threeyears of training together with job experience) and students and their near relations.However, there are four different types of residency permit: the limited resident permit(Aufenthaltsgenehmigung), the unlimited settlement permits (Niederlassungserlaubnis),the permission for permanent EU-residence (Erlaubnis zum Daueraufenthalt EU) and theBlue Card EU (Blaue Karte EU).Limited resident permit: Once the registration process is completed a limited residencepermit must be applied for within 90 days after the arrival in Germany. The local authorityfor foreigners (Ausländerbehörde) is the appropriate authority in this matter. The followingdocuments are required for the application: Passport, two recent passport photographs,employment contract or student enrolment, evidence of financial support (student grant,bank statement etc.), proof of health insurance and a police registration form. Dependingon individual circumstances (for example nationality, duration of employment contract orperiod of study) the validity of the limited resident permit can vary. Non EU citizens areonly allowed to work if this is expressly noted on the limited resident permit.7

Unlimited settlement permit: The unlimited settlement permit is an unrestricted permit forpermanent residency. It is usually granted once a person has spent a certain period oftime in Germany. However, occasionally it is granted immediately on arrival. This can bethe case because of political reasons or because of the specific high qualifications of thecitizen who contributes to the German labour market. An unlimited settlement permitusually requires the following criteria:• having held a five year’s residence permit• Proof of being employed for at least five years and having paid the relevantsocial contributions• Proof of ongoing financial support• Proof of appropriate accommodation for the applicant and his family• Adequate knowledge of the German language• Basic knowledge of the German legal and social systemsSpouses are normally granted unlimited settlement permit on the basis of their partner livingin Germany already (family reunification visa).Whereas children are usually grantedthe permit after they have been residents for at least five years.Permission for permanent EU-residence: This is also a permanent residence permit. Thispermit entitles the non EU citizens to work. The conditions are similar to that for the unlimitedsettlement permit. Furthermore the permission for permanent EU-residence allowsmobility within the EU. But not both – unlimited settlement permit and permission forpermanent EU-residence - can be obtained for one person. Also foreigners with “refugeestatus”are not able to get this permission.Blue Card EU: The Blue Card EU is a temporary residence (four years) but only for nonEU citizens with university degree or a comparable degree to find a job in keeping withtheir qualifications. An additional condition is the poof of an employment with a minimumannual salary of at least 47.600 Euro. EU Blue Card Holders who are working more than33 months and who are paying premiums for pension get a permanent permit.8

C. German EconomyThe Euro, which is divided into 100 Cent, has been the officialcurrency in Germany since 2002. The foreign exchange referencerates are published by the European Central Bank(ECB).Manufacturing is the backbone of Germany’s economy. Thecountry is a member of the G-8 Group and therefore belongsto the richest nations in the world. One of Germany’s most important industrial regions isthe Ruhr which is an area of coal mines and steel mills along the Ruhr River. Other importantindustrial areas are located in Bavaria, Dresden and Hamburg.Machine and vehicle construction as well as the chemical industry belong to Germany’smost important industries. In this context, Germany’s industries not only include the mostfamous cars, namely BMW, Volkswagen, and Mercedes-Benz but also worldwide exportingcompanies like Bayer, BASF and Hoechst. In addition to that, electrical engineering,electronics, and office equipment are growing industries in Germany.Germany’s economic success is mainly due to foreign trade. It exports a large amount ofmotor vehicles, chemical products, engineering articles as well as electrical engineeringproducts. Nevertheless, most of the energy resources and raw materials for the Germanindustries are imported, based on the fact that the country has only small amounts ofnatural resources. Other main imports are food, drinks, tobacco, and petroleum products.In 2013 Germany’s GDP was approximately 2.735,80 billion Euro (equals 3,593 billionUS-Dollar).D. German Business PracticesThe normal working hours are from 9am to 5pm. However, the retail opening hours dependon the respective state and might vary. Nevertheless, 24h shopping on Sundays isonly available on certain gas stations and at other sites relevant to travel.In Germany the standard added tax rate is 19 %. However, there is a reduced tax rate ofonly 7 % that mainly relates to food and agricultural products. VAT is imposed on assets9

and services in Germany and on imports into Germany. Overseas exports are exceptfrom VAT.In comparison with other countries wages in Germany rank not only amongst the highestin Europe but also worldwide. In 2005 the average industry wages were 27,90 Euro in thewestern part of Germany and 17,40 Euro in the eastern part. Though, the quality of Germanlabour and its efficiency is well-known throughout the world. Furthermore, in 2015statutory minimum wages of 8,50 Euro will be introduced.Average working hours are 37,5 hours per week and the annual leave varies between 20and 30 working days. It has to be noted, that workers in Germany are protected by stronglabour laws which entitle them to many different rights. For example the ordinary dismissalof workers must be proceeded by notice, which depends on the duration of the timethe employee stayed with the company (it varies between 1-7 months.) In addition to that,unions are powerful and large in Germany. Social Security and Health Care costs areequally split up between the employee and the employer. (Please refer to the respectivechapter “German Labour Law”)E. Business InfrastructureGermany’s infrastructure belongs to the most developed ones in the world. Especiallywith regard to EU requirements the German transport and communication utilities havebeen liberalized. The result is an efficient network of motorways, railways and waterwaysconnecting Germany with major hubs in the world.Germany has not only the third largest motorway network worldwide in length but also awell established network of high-speed trains. The InterCityExpress of the DeutscheBahn AG (the national railroad carrier) serves major German cities and destinations inbordering countriesAll together there are 40 airports in Germany. The biggest and busiest of them is theRhein-Main airport near Frankfurt am Main (FraPort). However, other major airports withfrequent air traffic are in Munich, Cologne-Bonn, Berlin-Tegel, Düsseldorf and Hamburg.Germany also has a very well developed marine transport with major sea- and inlandports. In this context, the main sea ports include Kiel, Rostock and Lübeck on the Baltic10

Sea and Emden, Bremen, Bermerhaven and Hamburg (the biggest of all ports in Germany)on the North Sea. Relevant river ports on the other hand are in Duisburg Cologne,Bonn, Mannheim and Karlsruhe on the river Rhine, in Magdeburg and Dresden on theriver Elbe and in Kiel on the Kiel Canal which provides an important connection betweenthe Baltic and the North Sea.F. Establishing a new Business in GermanyGermany offers a broad variety of different legal forms for running a business. However,which of these legal forms a foreign investors should choose will depend on mainly individualfactors such as functioning, capitalization, liability, accounting issues, and tax considerations.There are three major forms of corporations under the German law:• the Limited Liability Corportaion Company (Gesellschaft mit beschränkter Haftung-GmbH),• the AG (Aktiengesellschaft) and• the KGaA ( Kommanditgesellschaft auf Aktien).1. Limited Liabiltiy Corporation Company (GmbH)The GmbH is the German business entity most commonly used by foreign investors. Onereason for this is the fact that German law provides great potential, flexibility and freedomfor adapting a GmbH to the individual needs of its shareholders. Therefore, the GmbH isespecially suitable for small- and medium-sized businesses.General InformationA GmbH is a company with legal personality. It therefore can sue and be sued as well ashold and dispose of rights. Its legislation is the Limited Liability Companies Act. When itcomes to naming a GmbH there are no restrictions apart from the fact that confusionswith existing companies have to be avoided and the name must contain a reference to itslimited liability by use of the abbreviation “GmbH” at the end of the name.11

A GmbH can be formed for any rightful purpose. From a legal point of view it makes nodifference if a GmbH is registered in a specific German state due to the fact that theGerman corporation law is federal law. However, tax rates may vary from location to location.(Please refer to the respective chapter “Taxation”).FormationThe first step on the road to form a GmbH is the notarization of a Deed of Formation andArticles of Association. This is usually be done by the founding shareholders. However, arepresentative of the founding shareholder(s) acting under power of attorney may concludethe notarized agreements.Immediately after the above-mentioned notarization a bank account has to be opened bythe company and cash contributions to the share capital must be deposited. Only afterthis has been done the company can be registered with the Commercial Register (Handelsregister).By doing so the Managing Directors must certify to the Commercial Registerthat the cash contribution is still at the company’s account and at their disposal at thetime of filling in the applications. This registration for application has to be signed by allmanaging directors in person before a notary who not only certifies their signature but alsoinstructs them about their duties as Managing Directors. This formation process usuallytakes between 3 - 12 weeks.Company in Formation (Vor- GmbH)After having completed the first step of formation (notarization of the deed of formationand articles of association) the company already exists as a company in formation (Vor-GmbH). Although the company only becomes a separate legal entity after the registrationwith the Commercial Register it may start its business operations even at this stage.Rights or liabilities which arise from those activities done prior to registration are legallythe rights and liabilities of the company in formation. However, upon registration the mentionedrights and liabilities acquired before the registration are assigned by law to theGmbH. It is important to note that the company’s net asset prior to registration must notbe less than the amount of the registered share capital. If this is the case, the shareholderswill be liable for the difference between the amount of the registered share capital andthe net asset.12

The Articles of AssociationThe Articles of Association can be phrased in different ways depending on the degree offlexibility desired by the shareholders. Therefore, the Articles of Association may be formulatedrather short only setting out mandatory provisions such as name, registered office,duration, registered share capital, purpose, initial contributions of the shareholders,representation and management of the corporation. Nevertheless, the Articles of Associationcan as well be a detailed description of the shareholder’s rights and obligations,classes of shares and restriction on the transfer of sharesRegistered Share CapitalThe minimum share capital for a GmbH is 25.000 Euro.A GmbH is not obliged to issue share certificates or to keep formal records of share ownership.Instead of that, the ownership of each share is recorded only in the corporationdeed. However, later transfers of share will be documented in transfer deeds attested bya notary. After each of those transfers of shares an up-dated shareholders’ list must besubmitted to the Commercial Register by the Managing Directors. Nevertheless thoselists have mainly an informational function and do not provide evidence of the ownershipof shares.(1) How to transfer sharesThe transfer of shares requires a notarized transfer deed. In addition to that, prior consentof the company is needed if only a part of a share shall be transferred. However, theArticles of Association may provide additional requirements which also have to be met bythe transfer action (such as the consent of other shareholders).(2) ContributionThe contribution to the share can be in cash as well as in kind.In the event of the contribution being in kind, the Articles of Association must provide aspecific form of the contribution and the exact amount of the corresponding share capital.The contribution must be worth at least as much as the above-mentioned correspondingshare capital. Otherwise the shareholder is obliged to pay the respective difference incash. Furthermore, the shareholders must hand in a report on the valuation of the contributionin kind. If the contribution in kind is another business, the financial results of thelast two years have to be submitted too.13

A cash contribution on the contrary requires that 50 % or 12.500 Euro (depending onwhich of these are greater) are paid up at the time of submitting the application for thecompany’s registration. In the case of the company only having one shareholder additionalsecurity must be provided for any unpaid amount of the capital. If the contribution isin kind, this contribution must be submitted in full.Furthermore, it is important to note that a GmbH is not allowed to make payments to theshareholder which might reduce the net asset below the amount of its registered sharecapital.Managing Director(s)Any person with a full legal capacity can be appointed a Managing Director. The ManagingDirector belongs to the mandatory bodies of a GmbH. Nevertheless, a Managing Directorneither needs to be a shareholder of the company nor a German resident. In thecase of only one Managing Director being appointed she or he is the sole representativeof the GmbH. Nevertheless, if more than one Managing Director is appointed they usuallyrepresent the company jointly (Furthermore, the shareholders may grant one or severalManaging Directors to represent the company individually or represent the GmbH jointlywith one or more other Managing Directors or with an authorized officer).It should be notedthat the German law distinguishes between the appointment and removal of the ManagingDirector(s) on the one hand and his Service Contract (Dienstvertrag) on the otherhand. These two issues are dealt with separately by the law.The company’s business is managed by the Managing Director(s) who apply the standardsof a prudent business person to their dealings. However, additional obligations andduties of the Managing Director(s) may be constituted by the Articles of Association orthe service contract. If the Managing Director(s) do not comply with their duties they arejointly and severally liable to the company. In detail this means Managing Directors mustnot disclose trade secrets of the company, they must ensure that the company keepsproper records, they must declare bankruptcy in the event of the company being overdeptand if half of the share capital is lost, he must call a Shareholder’s Meeting.Shareholder’s MeetingThe Sharholder’s Meeting which also belongs to the mandatory bodies of a GmbH is notonly entitled to approve Managing Directors but also to remove them. It therefore hascontrol over the management. In addition to that, the Shareholder’s Meeting adopts annualfinancial statements as well as appropriates and distributes profits.14

Supervisory BoardIn principle, a Supervisory Board is not necessary (unless otherwise agreed in the Articlesof Association). However, if the company has more than 500 employees, a SupervisoryBoard becomes compulsory. In this case, a third of its members have to be employee’srepresentatives. Only if the company counts more than 2000 employees half of themembers of the supervisory board have to be employee’s representatives.The main function of a Supervisory Board is the supervision of the company’s management.Other possible tasks are the appointment or removal of the Managing Directorsand the adoption of the annual financial statement meetings.ShareholdersNatural as well as legal persons can be shareholders of a GmbH. Shareholders are notonly entitled to many rights but they also have duties. The rights include the right to vote,the right to obtain information and the right to any surplus upon liquidation. The shareholderswield their power by approving resolutions during the General Meeting. Usuallythe shareholders receive one vote for every 50 Euro of the share capital they own. However,this can be differently directed by the Articles of Association.All shareholders must be treated equally in order to ensure that no shareholder is subjectedto unequal treatment or by the company or any other shareholder without his orher approval.Another sharholder’s right is the right to inspect the company’s books and records and tobe informed of the matters of the GmbH. Additionally, a shareholder has a claim to theprofits stated in the annual financial statement unless the Articles of Association stateotherwise. A shareholder’s duty however includes locality not only to the company but alsoto other shareholders which limits the extent to which the shareholder can pursue hisor her own interests.LiabilitiesThe GmbH’s liability is limited to the amount of its registered share capital. Therefore,shareholders are not subject to any personal liability or obligations and piercing the corporateveil only takes place in very rare cases. (for example: fraudulent actions).Accounting and Disclosure15

Every GmbH has to keep accounting records and prepare annual financial statementspursuant to the regulations of the German Commercial Code (Handelsgesetzbuch; HGB).These regulations lay down detailed requirements concerning the form and content of thestatements. In addition to that, large and medium-sized companies must have an auditingfor their annual financial statements. However, the statements must be lodged with theCommercial Register within twelve months of the end of each financial year.CostsThe formation of GmbH always involves costs. This is necessary in order to prevent theparticipants from inconsiderate behaviour. Therefore, the additional costs have a warningfunction. However, the costs depend on the share capital which means that the costs forformation are not fixed but vary from each individual formation to the other. In addition tothat, the costs are higher for a GmbH that includes only one person (Ein-Personen-GmbH) than for a GmbH that consists of more people.General overview of the GmbH’s advantagesIn summary, a GmbH includes the following advantages for foreign investors:First of all, a GmbH’s formation is quite simple and does not include many difficulties. Inaddition to that, the Articles of Association can easily be adapted to the shareholders requirementsand there are not as many legislative regulations concerning a GmbH as toother business entities (eg. AG or SE). And ultimately, the shareholders are able to influencethe management directly due to the fact that they are entitled to issue binding instructionsto the Managing Directors. Therefore, a GmbH is an easily formed and flexiblebusiness entity.2. Mini-Limited Liabiltiy Corporation Company (Unternehmergesellschafthaftungsbeschränkt, UG)As of November 01, 2008, German has established the so-called Mini-Limited LiabiltiyCorporation Company (Unternehmergesellschaft haftungsbeschränkt, UG) as a responseto the UK Limited. The quintessential feature of the UG is the waiver of the traditionalGerman minimum capital requirement. This is also the main demarcation line betweenthe UG and the “regular” GmbH, for which the MoMiG retains the minimum capital requirementof 25.000 Euro.Yet, the UG is not an entirely new form of company, but actually only a new kind of subtypeof the well-tried GmbH. The UG is subject to the same rules and regulations which16

are applicable to the “regular” GmbH. Thus, the UG will make it possible to “start small”and then gradually expand the business to a “full-grown” GmbH without the need for reregistration.But as long as the registered capital stays below the threshold value of25.000 Euro for a GmbH, the UG must trade under the designation “Unternehmergesellschaft(haftungsbeschränkt)” and must pay up the entire amount of the registered share capitalbefore registration. In addition, a UG will be required to set up a reserve equal to a quarterof the annual surplus minus the accumulated deficit of the preceding year3. Stock Company (Aktiengesellschaft, AG)The AG is usually used by larger companies. This is also due to the fact that its legislation,the Stock Corporation Act (Aktiengesetz), provides less flexibility and most of its legislationsare mandatory which can only be modified by the Articles of Association if this isexplicitly permitted by the Stock Corporation Act. Therefore, an adaption to the shareholder’srequirements is not possible offhand. However, the advantage of an AG in comparisonwith a GmbH is the fact that shares can be transferred easily and the AG can belisted at a stock exchange and is therefore able to equity capital from the public.FormationIn order to form an AG one or more shareholders are needed. First of all a notarization ofthe Articles of Association is required. After that the founding shareholders must appointthe first Supervisory Board and the Statutory Auditor. These appointments must be notarised.The Supervisory Board then appoints the first management. Subsequently, thefounding shareholders must prepare a written formation report, including all relevant detailsof the establishment of the AG. The Management Board and the Supervisory Boardwill then scrutinise the formation report. (In some cases an auditing of the formation reportby an independent auditor might be required). Following this procedure the formationof the AG has to be registered with the Commercial Register. The application for registrationhas to be signed before a notary public and by all founding shareholders and the initialmembers of the Managing Board and the Supervisory Board.LiabilityUpon registration stockholders are not personally liable to the AG. Instead of that, theirduties are limited to paying the contributions owed. However, the AG only becomes a legalperson on registration. People acting for and on behalf of the AG prior to registrationwill be liable for any debts incurred.17

Share Capital and SharesThe registered share capital must not be less than 50.000 Euro and is divided intoshares. These shares can be par value or without a par value. However, the German lawdistinguishes even further between bearer shares (name of the owner is not registered)and registered shares (the name of the owner has been registered in the AG’s share register).The Articles of Association must specify the types of shares that are issued. Bearershares my not be issued until they are fully paid. Contributions to share capital can be eitherin cash or, if permitted by the Article of Association, in kind. In the latter case, contributionmust be fully made upon registration. Shares are transferred easily within an AG.In comparison to a GmbH the transfer does not need a notarized transfer deed.Articles of AssociationThe minimum content of the Article of Association is determinated by the German StockCorporation Act. It includes:• The company’s name and information about it’ s registered seat• Amount and division of the company’s share capital• Types of shares• Number of the members of the Management board• Object of the companyIn addition to that, the Articles of Association may determine other aspects. However, itmust be noted that this is only possible where it is explicit allowed by the German StockCorporation Act.Management BoardThe Management Board not only manages the AG but also represents it in and out ofcourt. Contrary to the GmbH neither the shareholders nor the Supervisory Board is allowedto issue binding regulation to the Management Board concerning the AG’s management.The members of the Management Board are appointed for a maximum term offive years. Furthermore, it is necessary that the members are stockholders. However,German nationality or residency is not required. The members are appointed by the SupervisoryBoard. AG’s with a registered share capital of more than 3 million Euro musthave a Management Board of at least two people (unless the Articles of Associationstates otherwise).18

The members need to apply the standard of a prudent business person to their dealings.If they breach their duties the members of the Management Board are jointly and severallyliable to the AG. In this context the burden of proof lies with members who must thenproof that they complied with their duties. However, the Management Board is not liable ifthey can reasonably assume that they acted in the company’s best interest.Supervisory BoardThe Supervisory Board is the controlling body of the AG. Its main task is it to superviseand advise the Management Board. The Supervisory Board is appointed by a simple majorityvote of the shareholders (unless the Articles of Association provide that a specificshareholder shall appoint one or more members of the supervisory board.) The membersare appointed for a term of five years.The main functions of a Supervisory Board are:- the appointment and dismissal of the Members of the Management Board- Representation of the AG’s during its dealing with the Management Board- Supervision of the Management Board- Review and approval of the annual financial statementsGeneral MeetingThe shareholder’s power is exercised by passing resolutions in General Meetings. Duringsuch meetings the shareholders appoint the members of the Supervisory Board and theauditors. The General Shareholders’ Meeting also approves of the balance sheet profitand decides on amendments of the Articles of Association and on the handling of thecompany profits (dividend payment). A simple majority of the votes is usually enough formost corporate decisions. However, decisions involving major changes such as amendmentof the Articles of Association must be taken by a qualified majority of at least threefourthsof the share capital represented at the meeting. In making their decisions theshareholders have a duty of loyalty to the company but not to other shareholders.Accounting and DisclosureThe AG has to keep financial records and must provide annual financial statements pursuantto the legislations of the German Commercial Code. In addition to that, mediumsized and large corporations must have their annual financial statements audited. These19

financial statements have to be handed in to Commercial Register within the twelvemonths of each financial year.4. Partnership limited by shares (Kommanditgesellschaft auf Aktien,KGaA)A KGaA is rarely used in Germany. It combines the structures of a limited partnershipand an AG. A KGaA can be formed by setting up a new corporation or by converting anexisting business entity into a KGaA. It is basically a limited partnership in which the partnersreceive shares instead of contributions. Besides this, the shareholders are organisedin a way which is comparable to a Stock Company with a Shareholders’ Meeting andSupervisory Board. Nevertheless, the shareholder’s rights are not as extensive as thosein a Stock Company. Furthermore, at least one general partner is needed, who then ispersonal liable for debts and liabilities of the KGaA. A partnership limited by shares hasthe same accounting and disclosure obligations like an AG. However, it should be takenin consideration that this rarely used business entity causes additional incorporation costsand higher costs for tax compliance. Consequently, a KGaA should only be consideredas the appropriate business entity if the KGaA is the right form to achieve a preferred taxtreatment or if investors shall be attracted but the control rights of shareholders comparableto an AG shall be avoided.5. European Public Limited Company (Societas Europaea, SE)The determinating provisions which regulate a SE are based on an EU regulation whichgot implemented by German law. The structure of a SE is quite similar to an AG. EverySE in Germany must have a link to at least two member states of the European Union.As a result of that, sheer German business operations can not be carried out through anSE.Altogether, there are four possibilities in order to form a SE :• at least two already existing corporations from different EU member states form aholding SE• at least two already existing corporations from different EU member states form ajoint subsidiary SE• an already existing stock corporation (having a subsidiary in another member statefor at least two years) is being converted into a SE20

• Merger of two or more already existing stock corporations.The SE must be registered with the Commercial Register with minimum share capital of120.000 Euro. Shareholders are not subject to any personal liability for the SE and theirduties are limited to paying the contributions owed. A SE in Germany can choose betweentwo different ways of structure: It may either opt for the English single board systemor the German dualistic system (management board and supervisory board). Therefore,a SE with its headquarters in Germany may opt for the English board system.However, what is also special about a SE is the fact that it is entitled to relocate its principleplace of management and its registered office to another EU member state. As a resultof that, a SE provides high flexibility for future developments and allows companiesto unify their structures across European boundaries. It is therefore especially suitable forbusinesses with operations in multiple EU countries.6. PartnershipsThere are two types of Partnerships:• Limited partnership (Kommaditgesellschaft, KG)• General Commercial Partnership (Offene Handelsgesellschaft, oHG)The main difference between these two forms of partnerships is in the liability of its partners.oGeneral Commercial Partnership (Offene Handelsgesellschaft oHG)An oHG is a typical business entity for small and medium sized companies.Even though an oHG does not have a legal personality it is treated as an independententity to the extent that it can acquire rights, enter into engagements and appear in courtproceedings. In order to found an oHG two or more people have to conclude a partnershipagreement (a one-man oHG is not permitted.) The oHG has to be registered withthe Commercial Register and the local trade office. Furthermore, the General CommercialPartnership arises upon signing of the partnership agreement by the partners andstart of business activity. As a result, its formation does not directly depend on the registrationas such. All partners are jointly and severally liable for the oHG's debts and liabilities.oLimited Partnership (Kommaditgesellschaft, KG)21

The partners of a KG are divided into two groups: At least one partner (the General Manager)is liable personally without limit while the other limited partners are only liable withtheir registered partnership contribution. The formation process of a KG is quite similar tothe one of an oHG: A partnership agreement hast to be concluded and the KG has to beregistered with the Commercial Register. The KG exists legally with the signing of thepartnership agreement unless otherwise provided. As a result, the legal existence occursindependently of the time of registration with the trade registry. In this context it is importantto note that there indeed is a risk of a liability gap: the limited partners are fullyand personally liable for all liabilities of the KG until it has been registered.oGmbH & Co. KGA GmbH & Co. KG is a special form of a limited partnership (KG) in which a corporationparticipates as a general partner. As a result of that, a GmbH & Co. KG is a partnershipin which no natural person is liable for the KG’s obligations. Since the GmbH & Co. KGbasically consists of two companies (the Limited Partnership itself (KG) and the LimitedLiability Company (GmbH)) its formation is governed by the regulations for the establishmentof a GmbH and a KG. The GmbH as well as the KG have to be registered with theCommercial Register. As mentioned above the general partner is subject to unlimited liabilityfor obligations of the KG. However, as the general partner is a GmbH, its liability isgenerally limited to its registered share capital. The limited partner on the contrary is onlysubject to liability with respect to its initial contribution in the KG.The accounting and disclosure requirements for a GmbH & Co KG are close to those of acorporation. A GmbH & Co KG is therefore required to deposit its financial statementswith the district court administering and the trade registry. Furthermore, the financialstatements also have to the submitted to the electronically-maintained Federal Gazette.oLimited & Co. KG / UG & Co. KGA Limited & Co. KG/ UG & Co. KG is also a special form of a limited partnership, which iscomparable to the GmbH & Co. KG. However, in this case a UK-based Limited / a UGparticipates as general partner. In the event of a Limited & Co. KG / UG & Co. KG beingformed no natural person is liable for the KG's obligations.22

7. The Advantages of a Partnership compared to a corporate structureThe following points are usually invoked concerning the advantages of a partnership andshould therefore be taken into consideration when choosing a specific form of businessentity.A partnership distinguishes itself due to:• the direct management by the general partners• the fewer publication requirements• the easy way of dissolving a partnership and distributing its capital to the partners• the greater flexibility in adapting the internal affairs to the partner’s needs.• beneficial gift and tax treatment8. OtheroBranchCarrying on business in Germany by registering as a branch is especially suitable forcompanies not yet sure about the sustainability of their commitment in Germany. Thebranch has to be registered with the Commercial Register and the Trade office.However, a branch has no legal entity status within Germany. This leads to the result thatthe branch is regarded as an integral part of a foreign company. The foreign company istherefore still liable for all commitments and debts arising from the branch’s business operations.Nevertheless, it must be taken in consideration that a branch establishes jurisdictionfor the respective company in Germany.oSole TradershipEspecially for individuals the sole trader (Einzelkaufmann) represents the easiest way ofstarting a business in Germany. The registration with the Commercial Register and a notificationto the local trade office (Gewerbeamt) are the only requirements for startingsuch a business (unless a special regulated business is carried out). However, in someindustries special approvals and permissions are compulsory. Furthermore, the soletrader is also the sole proprietor of all assets. He or she is therefore personally liable forall liabilities and debts arising from the business.23

G. Taxation1. General informationGermany does not provide one consistent nationwide tax rate for all companies. Insteadof that, it has to be distinguished between corporations (such as the GmbH and AG)which are subject to corporate income tax (Körperschaftssteuer) and partnerships whichare subject to personal income tax (Einkommenssteuer). Both of these taxes are leviedby the German government. In addition to that, all German business operations (corporationsand partnerships) are subject to the trade tax (Gewerbesteuer). This tax is levied bylocal municipals such as the city where the company is based.2. Corporate Income TaxCorporate companies based in Germany or with an executive board in Germany are notonly subject to German income tax on the profits they make in Germany but also on theirworldwide generated income. However, other corporate companies are only liable to incometax on the income generated inside Germany.The tax base for Corporate Income Tax is formed by the taxable income (annual businessprofit). In Germany this is being calculated according to accrual basis accountingmethod which is recorded in the annual financial statement.The Corporate Income Tax rate currently amounts to 15 % of the taxable income. In addition,a Solidarity Surcharge is added on top of this Corporate Income Tax. This solidaritysurcharge is 5.5 % of the 15 % corporate income; creating a total of 0.825 % of taxableincome. As a result, Corporate Income Tax and Solidarity Surcharge add up to a total of15.825 %.3. Personal Income TaxPartnerships are associations of partners. Therefore the partners themselves are subjectto all rights and obligations. Consequently, the tax rate is applicable to the individual incomeof the shareholders. Currently, the Personal Income Tax adds up to 14 % (2014)for an annual income exceeding the tax-free allowance of 8.354 Euro. Depending on therespective income it can however rise to a maximum income tax rate of 42 % which isapplicable to an annual income of 52.882 Euro or more. Furthermore a tax rate of 45 % isapplicable in excess of earnings of 250.731 Euro per year.24

In addition, the Solidarity Surcharge which amounts to 5.5 % of the individual income taxrate of every partner is also added to Personal Income Tax (This means if an individualincome rate is 30 % the total amount of tax will be 31.65 % of the individual income.)4. Trade TaxThe Trade Tax has to be paid by all commercial business operations in Germany regardlessof the legal form. Due to the fact, that the Trade Tax Rate is set by local authorities itcan vary from one German location to another. However, the Trade Tax Rate generallyvaries between 7 and 17 %. Nevertheless, partnerships have an annual tax free allowancefor trade tax of 24.500 Euro. The Solidarity Surcharge is not added to the Trade TaxRate.H. German Labour LawThe German labour and employment law is based on a variety of labour and employmentacts. There is no unified German labour and employment act. The German CivilCode (Bürgerliches Gesetzbuch – BGB) contains general rules for labour and employmentrelationships, which are complemented and specified by numerous acts providingregulations for particular situations, for example:• Protection Against Unjust Dismissals Acts (Kündigungsschutzgesetz - KSchG)• General Equal Treatment Act (Allgemeines Gleichbehandlungsgsetz - AGG)• Social Security Code (Sozialgesetzbuch – SGB)• Maternity Protection Act (Mutterschutzgesetz – MuSchG)• Part-Time and Limited Term Employment Act (Teilzeitbefristungsgesetz – TzBfG)• Federal Paid Leave Act (Bundesurlaubsgesetz – BurlG)• Working Time Act (Arbeitszeitgesetz – ArbZG)Labour disputes are settled in front of a labour court. The Labour Court Act (Arbeitsgerichtsgesetz– ArbGG) regulates the labour law suits, including all disputes betweenemployers and employees and also trade union disputes.As Germany is a member of the European Union, labour law is strongly influenced byEU legislation and case law as well.25

1. Collective agreementsIn some branches, there are also collective labour agreements (Tarifvereinbarungen),based on the Act on Collective Agreements (Tarifvertragsgesetz – TVG). These collectiveagreements are concluded between Unions of the employees and employer’s associationsand are usually only binding for the contracting parties. Though, non-memberparties can refer to a collective agreement. However, it is possible, that collectiveagreements are binding all employees of a branch, regardless of whether the employeesor employers are a member of the Union (so called: branch- level collective agreement/allgemeinverbindlicherTarifvertrag). There are for example branch- level collectiveagreements for the branches of catering industry, hotel business and construction.These collective agreements normally contain terms of paying, working conditions andworking hours. They apply automatically to the employment contract. Therefore notwithstandingregulations are hardly possible.2. Workers councilIn companies with at least five employees, the Work Constitution Act (Betriebsverfassungsgesetz– BetrVG) authorizes the employees to elect workers council (Betriebsrat).The workers council is representing the needs and interests of the employees. Thereforeit negotiates and agrees with the employer on so called agreements of work (Betriebsvereinbarungen).These often contain modalities of participation of the workerscouncil, on termination and working hours. Agreements of work are binding the employerbut are only applicable for the employees within the establishment. Workers council alsoneed to be involved in case of giving notice to an employee, though its decision is notbinding for the employer.3. Principle of Equal TreatmentAs the employer is obliged by the General Equal Treatment Act to treat all employeesthe same way, the latter do have a right of the same treatment if they are treated unequallyand there is no objective reason for that.4. Employment ContractThe written employment contract between the employee and the employer must containthe key aspects of the employment relationship, such as contracting parties, work to perform,gross salary and benefits, vacation, starting date of employment, notice periods,extra hours. If the employer will be represented for example by a human resourcesmanager, it is recommendable for the employer to point that out to the employee and26

that the representative is entitled to take measures against the employee, such as termination.Even though if the employment treaty turns out to be reviewable or invalid but is administered(employee starts working), there will be a so called factual employment contract(faktisches Arbeitsverhältnis) with the content of the originally intended as far as valid.As a consequence the employer is obliged to pay salary and the employee to work.4.1 InterviewIf the employer advertises a job, he has to make sure that no discriminations are containedwithin. Otherwise there is the possibility of compensation and indemnity (§ 15 ofthe General Equal Treatment Act). In case of a personal job interview the employer hasto be aware of that only questions related to the job function are allowed. Therefore,questions on health situation and previous convictions can be permissible. Also permissibleis the question for disability because this leads to legal consequences for the employer.If permissible questions are answered wrongly, the employment contract is appealableor can be terminated. However, the employee has the right to avoid answeringimpermissible question and also is not obliged to answering them truthfully.4.2 Employment Contract Contents4.2.1 General Business TermsUsually the employer dedicates the terms and conditions of the work contract to a largenumbers of employees without negotiating them with the employee (so called: AllgemeineGeschäftsbedingungen). Because of the weak position of the employee the Germanlaw provides regulations (§§ 305 ff. German Civil Code (BGB)) which are protectingthe employee. If there are passages in the employment contract which are not permissibleby German law, they are deemed invalid but usually the rest of the contract remainsvalid. Furthermore, clauses are invalid if there are unclear.4.2.2 Working HoursGerman employees normally work from Monday to Friday (five-day-week). Saturday andholidays are none working days. The average working under a five day week time is between35 and 40 hours, the daily productive working time may not exceed eight hours(breaks not included). However, it is possible to exceed the daily working time up to tenhours over a period of six months as far as the average daily working time does not exceedeight hours. Working on Sundays and public holidays is generally prohibited, butthere are several exceptions in the Working Time Act (Arbeitszeitgesetz – ArbZG). There27

are special regulations for female (MuSchG) and underaged workers (Young WorkerProtection Act – Jugendarbeitsschutzgesetz – JarbSchG).4.2.3 Probationary TimeThe contracting parties often agree on a probationary time up to six months. During thisperiod both, the employee and the employer can terminate the contract with a notice periodof only two weeks (§ 622 Abs. 3 BGB).4.2.4 Limited-TermThe requirements for limited-term employment contracts are covered by the Act on Part-Time and Limited Term Employment Act (Teilzeit- und Befristungsgesetz TzBfG). Generallylimited term employment contracts are only permissible in writing and in case of anobjective reason for the limitation, such as the temporary replacement in case of pregnancy,parental leave or illness. Without any grounds a limited-term contract is permissiblefor a maximum period of two years (or four limited-term contracts altogether notlonger than two years). However, the contract may not follow any other contract with thesame employer. It is also permissible if the employee is at the age of 52 years or more. Ifthe employee claims the ineffectiveness of a limitation he/she enters into an unlimitedemployment contract.4.2.5 Part.TimeThe Act on Part-Time and Limited-term Employment Relationship provides also rules forpart-time work. Part-time work describes an employee who works fewer hours than theweekly hours worked by full-time workers, which is in Germany between 35 to 40 hoursin a 5-day-week. After working as a full-time employee for at least six months, every employeecan request to work part-time (§ 8 TzBfG). The employer can only deny the requestif he has to fear bad impacts on his company. A part-time worker who wants towork full-time must be given preference in case of a vacant full-time post.4.2.6 SalaryGenerally the contracting parties are free in the negotiation of the salary if there are nocollective agreements. However, the law changed in Germany: from January 1 st 2015there will be a minimum wage in Germany at the level of 8.50 Euro per hour. This minimumwage affects almost every industry. Collective agreements containing a minimumwage below that level can only subsist until the end of the year 2016.The Working Time Act (Arbeitszeitengesetz – ArbZG) contains provisions for the regulationof overtime, night and holiday working.28

Additional payments such as Christmas benefits are not required by law. Often collectiveagreements provide for such payments, though. If the employer is not obliged to suchpayments, he needs to be aware of that a duty can arise because of customary law.4.2.7 Paid LeaveThe Federal Paid Leave Act (Bundesurlaubsgesetz – BUrlG) guarantees at least 20days paid vacation per calendar year to the employees who work a five day week. However,it is common for an employee to receive between 25 and 30 days of vacation.There are special regulations for disabled and adolescents who receive longer vacationentitlements.The full vacation entitlement requires that the employee has been working at least for sixmonths. Before the expiration of the six months period, he/she will only receive proportionalvacation.If there are objective reasons, the employer can refuse the employees right to take hisvacation as a whole. He/She also has to choose in respect of social criteria if severalemployees request vacation for the same time.Generally, vacation has to be taken for the current calendar year. If it’s not possible forthe employee to take all his/her vacation, he/she is allowed to transfer it into the followingyear when he/she meets the legal requirements (§ 7 BUrlG). As far as German lawdetermines, that after a period of three months of the next year the vacation of the precedingyear expires this is not corresponding with the EU law. However, an expiry after15 months is in accordance with EU law.After terminating the employment relationships the right of vacation can turn into compensationif the legal requirements are met (§ 7 BUrlG).4.2.8 Sick Leave§ 3 of the Continuation of Remuneration Act (Entgeltfortzahlungsgesetz – EFZG) statutes,that in case of illness the employer has to continue payment of full salary for a periodof six weeks, and under certain circumstances up to twelve weeks. Afterwards thehealth insurance makes sick payment (§ 48 V SGB V). The EFZG is only applicable ifthe employee has been working for four weeks.4.2.9 Industrial AccidentWhen it comes to interior industrial accidents, there is a particular liability scale in Germany.If the accident is caused by an employee, the employer can be liable for the dam-29

ages. This is because the employee usually has a much lower income and also the employeris benefiting much more and bears a less risk. In case of intentionally damages ofcourse, the employee himself/herself is responsible and has to recompense the loss ofthe employer.4.2.10 Maternity LeaveFemale employees are entitled to full paid maternity leave. The maternity leave normallystarts six weeks before the expected due date and ending eight weeks after childbirth.Afterwards part-time working can be requested. The payments are made partly by thestatutory health insurance provider and partly by the employer. During pregnancy andmaternity leave there is also a special dismissal protection.4.2.11 Parental LeaveParental leave is regulated in the Federal Act on Payment of Child Rising Benefit andChild Rising Leave (Bundeselterngeld- und Elternzeitgesetz). Both parents can take parentalleave up to three years, but not at the same time. During this period the employeris not obliged to make any payments, but also not to terminate the employee. Employeesare allowed to work part-time (up to 30 hours a week) during parental leave. If theywant to work for a third party agreement of the employer is needed. Parents must givenotice to the employer that they will be on parental leave at least six weeks before. Duringparental leave there is a particular dismissal protection.4.3 Termination of Employment4.3.1 Limited-Term Employment ContractA limited-term contract ends automatically by expiration of the term. There is no terminationnotice needed and it is also not permissible if the contracting parties haven’t agreedon it.4.3.2 Dismissal with the Option of Altered Conditions of Employment (Änderungskündigung)There is the possibility of a dismissal with the option of altered employment conditions.Here the employer terminates the existing employment contract and simultaneouslymakes an offer for a new employment contract with altered conditions. However, suchdismissal is not admissible to reduce the salary of the employee only.4.3.3 Cancellation Agreement (Aufhebungsvertrag)Also common is a cancellation agreement (Aufhebungsvertrag). Here the employer andemployee make a (written) contract about the ending of the existing empoloyment con-30

tract. Advantages of this way of ending an employment contract is that no period of terminationhas to be considered and the employee is usually not causing any further problems(employment lawsuits). However, in most cases the employee is not entitled to unemploymentbenefits for twelve weeks as he is reliable for his unemployment by signinga cancellation agreement. Therefore employers offer sufficient financial compensation orother benefits.4.3.4 Termination of the Employment Contract by giving NoticeBoth, the employee and the employer do have the right of terminating the employmentcontract, but the latter has to meet higher legal requirements in case of unilateral termination.There are two kinds of termination in German labour law: ordinary and extraordinarytermination. In both cases a written notice of termination is necessary (§ 623 BGB).Verbal notices are invalid and have to be redone. If a notice is given by a representativeof the employer, he/she has to assure that proof of power for this measure is presentedto the employee.An ordinary termination leads to the ending of the employment relationship after the applicablenotice period expires. The notice period is determined by law (§ 622 BGB) andtakes at least four weeks and may be up to seven months, depending upon the length ofthe employment. The employer and the employee can agree on a longer notice period,however, a shorter period is invalid. If there is a worker´s council the employer has toconsult it before giving notice of termination to the employee. However, the work´s councilopinion is not binding (§ 102 BetrVG). Termination without proper hearing of theworks council is invalid.There is no notice period to be obtained in case of an extraordinary termination (§ 626BGB). The employment relationship ends immediately. For an extraordinary terminationserious reasons are needed which make it, in good faith, unacceptable to continue theemployment relationship until the end of the notice period. It is only permissible within 14days after knowledge of the facts of the serious reason.If a labour court holds a termination notice invalid, the employer must pay the employee´ssalary for the entire duration of the proceedings. Furthermore, the employer isobliged to reemploy the employee.31

4.3.5 General dismissal protectionAs the German labour law tends to protect the employee, there are various regulationsdealing with dismissal protection.General dismissal protection is provided mainly by the Protection Against Unjust DismissalsAct (Kündigungsschutzgesetz – KSchG). If applicable, ordinary termination is onlylegitimate if the requirements are met (§ 1 KSchG). The Protection Against Unjust DismissalsAct is applicable to employees working in a company for more than six monthsand which has employed more than 10 employees (apprentices do not count). If the actis applicable, the employee may only be terminated for three particular reasons whichare enumerated in the act. These are operational reasons (betriebsbedingt), behaviouralreasons (verhaltensbedingt) and reasons which are not based on a bad behaviour butthe person (personenbedingt). No matter of which reason the employee is noticed, theemployer always needs to prove the reason. He also has to prove in case of an operationalnotice, that there is no other possibility, e.g. another comparable job within thecompany plus that he regarded social criteria (age, seniority, family reasons, disability).In case of behavioural reasons, normally a warning letter (Abmahnung) is necessary beforegiving notice to an employee; otherwise the termination notice is unfair. If a dismissalfollows a warning letter, both have to base on the same misconduct.4.3.6 Particular Dismissal ProtectionBesides that, there is particular dismissal protection against ordinary and extraordinarydismissal for some groups of employees due to their individual circumstances. This includesfor example pregnant women, (§ 9 MutSchG), heavily disabled (§ 85 SGB IX)and members of worker´s council (§ 103 BetrVG, § 15 KSchG). In these cases, prior approvalof various German authorities is required for the termination of employment,which is usually very difficult to obtain.4.3.7 Employment Reference LetterAfter the ending of the employment relationship the employer is also obliged to draw upan employment reference letter in which he/she has to describe and appreciate the workof the employee and the employee himself. In case of legitimate interest, the employeeis entitled to ask for such a letter during the existing employment contract (so called interimperformance report).32

5. Labour Law SuitsThe Labour Court Act (Arbeitsgerichtsgesetz – ArbGG) establishes special labourcourts, consisting of three instances: the Labour Court, the State Labour court and theFederal Labour Court. The jurisdiction of the labour courts covers most issues with labourreferences (§ 2 ArbGG)There are some specifics about labour law cases compared to normal civil suits. Asusually, the party who loses the case has to pay the court fees and the legal expensesalso of the winning party. This is different in labour cases: in the first level each party hasto pay its own lawyer - regardless of which party wins or loses.There are also very short periods for filing suits. For example in case of the validity ofdismissals, there is only a three-week period for filing the dismissal suit (§ 4 KSchG).6. Taxes and Social Insurance ContributionsEmployees pay income tax on their income. Rates are between 15% and 42%. The employerhas to forward the income tax to the tax authorities. Any tax deductions have tobe made together with the employee’s tax declaration.The social security system is regulated by the Social Security Code (Sozialgesetzbuch –SGB). The mandatory Social Security System in Germany consists of health insurance,home care and nursing insurance, pension insurance and unemployment insurance. Thepremiums are paid half by the employers and half by the employees. The employer hasto pay dues to approximately 20% to 22% of the employee’s gross salary, depending onthe employee’s tax category.7. Ostensible Self-Employment (Scheinselbständigkeit)There is no obligation for such social security contributions for freelance workers whoare self-employed and therefore responsible for themselves. A freelance worker issomeone who is not bound by instruction. He is making his own decisions freely andbears his own entrepreneurial risk. In general he is working on his own behalf and expense.Also the provisions for dismissal protection do not apply.If someone is ostensible self-employer, he is appears to be a freelance worker, but infact he is an employee.The distinction between self-employment and ostensible self-employment isn’t alwayseasy. The latter is assumed if the “self-employee” is working only for one principal andgenerates the large part of his revenue out of this work. Further it is influential whether33

the performed work is typical work for an employee or if entrepreneurial thinking and decisionsare necessary. Eventually, this distinction is a matter of the individual case (§ 7SGB IV). Problems can occur for the principal, if the freelance worker turns out to be anostensible self-employee. This leads to the employers duty to pay social insurance contributionsin arrears for a period up to four years as the principal employed an employee.Additionally, fines can be imposed too. Furthermore, the ostensible self-employee is entitledto claim for a employment contract including dismissal protection, paid vacationand paid illness.Because of the legal consequences of a wrong classification, there is the possibility ofperforming a “procedure of qualification” (Statusfeststellungsverfahren) at the Clearingstellefür sozialversicherungsrechtliche Statusfragen, 10704 Berlin, which is an institutionby the German Pension Insurance.This presentation has been established for information purposes only. It may not be relied upon as legaladvice. This presentation cannot be reproduced or distributed without our prior written consent. Please donot hestitate to contact us for further information.Im Breitspiel 969126 HeidelbergGermanyTel. +49 (0)6221 3113.0international@tiefenbacher.deKey contacts:Dr. Gero Schneider M.C.L.g.schneider@tiefenbacher.deMarcello Di Stefanodistefano@tiefenbacher.de34

Doing Business In GhanaThe World Bank Doing Business Report 2013 ranks Ghana among the top six (6) in Africa in doing business inAfrica index. Even though Ghana dropped one (1) place (compared to the 2012 rankings) its rating on the index forgetting credit appreciated by 15%. On the political front, Ghana’s 5 th successive successful democratic election washeld in December, 2012 and has obviously helped the country become an attractive investment destination.THE LEGAL MARKETGhana’s legal and regulatory framework continues to see significant changes:Oil & GasThe Petroleum Commission which has the mandate to regulate and manage the utilization of petroleum resource hasstarted work in earnest. Significantly, the Act is intended to promote increased local participation in petroleumactivities. Consequently the Legislative Instrument to give legal backing to the Local Content Policy framework isbefore parliament and expected to become law by the end of 2012. The regulations provide for the establishment ofa Local Content Committee at the Petroleum Commission which will be responsible for ensuring compliance withthe requirements. The submission at a Local Content Plans is now a mandatory part of the Plan of Development foroil and gas production. It would appear that the oversight of Local Content function at the Petroleum Commission(instead of the Ministry of Energy), is designated to give the function a technocratic and not a Political leaning. Themanner in which the Local Content Plan of the Jubilee Partners is handled will serve as a test case.Another significant development in the Oil & Gas sector is the establishment of the Ghana National Gas CompanyLimited (GNCC) incorporated in July, 2011 to add value and commercialize the nation’s gas resources. The GNCCis to build, own and operate infrastructure required to gather, process, transport and market natural gas resources forthe domestic and export market. It is also charged with the responsibility to promote the development ofpetrochemical industries; substantially reduce and/or eliminate flaring of gas; and develop Western Region ofGhana.TourismThe Tourism Act was passed in 2012 to enhance the development of the tourism sector in Ghana. These reformsinclude the establishment of a Tourism Authority mandated to license and register tourism enterprises – touroperators, guest houses, hotels, restaurants. The law also establishes the Tourism Fund to finance industry projectsand programmes.PensionsThe implementation of the Pensions Act will see greater mobilization of financial resources from fund managers.There are mandatory requirements regarding how funds may be invested. This is expected to lead to increasedactivity in the capital market because Trustees and Fund Managers shall be seeking avenues to invest employeecontributions under voluntary and mandatory options.

PROPOSED LEGISLATIVE REFORMSReal Estate Investment TrustThe Securities and Exchange Commission (SEC) is embarking on a plan to pass a regulatory framework to lead tothe establishment of Real Estate Investment Trusts by 2013. The proposed reforms are intended to ease the taxburden and funding constraints of the real estate sector which is a very booming sector in Ghana and the margins areseverally known to be high. A framework for REIT is expected to make the sector even more attractiveEstablishment of EnterprisesIn GeneralAn investor who is desirous of establishing a for-profit enterprise in Ghana has three options: to register a soleproprietorship, which is an individual operating under the name and style of a registered business name; to register apartnership with a minimum of two to a maximum of 20 individuals carrying on business jointly for the purpose ofmaking profits; or to register an external company (i.e., the Ghana branch of a company incorporated outside Ghana)or incorporate a public or private Ghanaian company, limited or unlimited by shares. It is important to note that soleproprietorships and partnerships are restricted to Ghanaians.Joint Stock CompanyA company registered with shares must meet the requisite eligibility and capitalization requirements prescribedunder the Companies Act and the Ghana Investment Promotion Center Act (GIPC Act), respectively. Capitalizationrequirements depend on the nationality of the shareholders and the nature of business of the company.When the enterprise is owned jointly with a Ghanaian, the minimum capitalization required is US $10,000. When itis wholly foreign owned, the minimum capitalization requirement is US $50,000. A company that is engaged inretailing or trading must have a minimum capitalization of US $300,000. There are specified capitalizationprescriptions for companies operating in some regulated sectors such as banking, finance, and capital markets.Limited-Liability CompanyA limited liability company is a company having the liability of its members limited to the amount, if any, unpaid onthe shares held by them. Shares are of no par value, and the value of the shares is determinable at the time ofpurchase or sale.Under the Companies Act, a limited-liability company is characterized as private if the company’s regulationsrestrict the company’s right to transfer its shares, if any; limit the total number of its members and debenture holdersto 50; and prohibit the company from making any invitation to the public to acquire its shares or debentures or todeposit money for fixed periods, whether bearing interest or not. Any other company that can invite the public toacquire shares or debentures as regulated by the Securities and Exchange Commission (SEC) is a public company.

Acquisition of EnterprisesIn GeneralDepending on the industry or sector in which the parties operate, they may require the approval of the regulator inorder to transfer or acquire an undertaking. Also, the approval of the SEC must be obtained when the acquiring oracquired company is listed on the Ghana Stock Exchange (GSE).Acquisitions may have tax implications, depending on the extent of the acquisition. Capital gains tax at 15 per centis payable on any amounts accruing to a company from a merger, amalgamation, or reorganization of the companywhen there is continuity of underlying ownership in the asset of at least 25 per cent.Banking IndustryThe Bank of Ghana must approve any agreement or arrangement that would result in a change in the control of abank or its holding company; for the sale, disposal, or transfer of the whole or part of the business of a bank; for theamalgamation or merger of a bank with another bank or institution; or for the restructuring of a bank.The acquisition or sale of significant shareholdings in a bank requires three months’ notice to, and the writtenapproval of, the Bank of Ghana. A significant shareholding is an indirect holding of a director that represents 10 percent or more of the capital or voting rights or makes it possible to exercise a significant influence over themanagement of the bank.The Bank of Ghana may refuse to approve a proposed transfer of shares in the interest of sound and prudentmanagement, if in its opinion the transaction will be detrimental to that bank.Mining IndustryThe Minister of Mines and the Minerals Commission regulate the transfer or acquisition of shares in miningcompanies. The Minister may, by notice in writing to a mining company, require the company to issue to theRepublic of Ghana a special share for no consideration. These shares will constitute a separate class of shares andwill have such rights as will be mutually agreed between the Minister and the mining company.No person may become a controller of a mining company unless he has notified the Minister of his intentions andthe Minister has notified him that he has no objection. A controller is a person who, either alone or with an associateor associates, is entitled to exercise or control the exercise of more than 20 per cent of the voting power at anygeneral meeting of the mining company or of another company of which it is a subsidiary.The no-objection notice given by the Minister will be void if the person fails to acquire the controlling interestwithin one year from the date of the notice. The Minister may object if he considers that the public interest will beprejudiced by the person becoming a controller of the mining company.A person who ceases to be a controller of a mining company must give prior written notice or must, within 14 days,notify the Minister of that fact. The company also must notify the Minister of the fact that a person has ceased to bea controller of the company.

Petroleum IndustryA contractor or subcontractor may not transfer any share or shares in its incorporated company in Ghana to a thirdparty without the written approval of the Minister responsible for petroleum, if the effect of such transfer would givethe third party control of the company or would enable the third party to take over the interests of a shareholder whoowns 5 per cent or more of the shares in the company.Communications IndustryThe National Communications Authority (NCA) must approve the transfer of shares in a licensee company if thetransfer would result in a change of control of that company and cause that company to breach license terms relatingto its ownership structure. Failing any change in control or any breaches, mere notification to the Authority willsuffice.TaxationCorporate TaxThere are a number of direct and indirect tax obligations on corporate entities in Ghana, under various laws. Underthe Internal Revenue Act, as amended, a company is resident for tax purposes if it is incorporated in Ghana or has itsmanagement and control exercised in Ghana at any time during the year of assessment.Generally, the income of an incorporated company is subject to a corporate tax of 25 per cent on its annual profit.However, the rate of corporate tax in Ghana also is dependent on the specific industry that the corporate entity isengaged in, the location of the corporate entity, and the investment incentives prescribed under the GIPC Act andthe Free Zones Act. For example, there are tax exemptions for free zone enterprises on the payment of income taxon profits for the first 10 years from the date of commencement of the operations, with a subsequent income tax of 8per cent; exemption from the payment of withholding taxes by shareholders on dividends; and exemption frompayment of customs duties.The chargeable income of a person for an assessment year is the total of that person's assessable income for the yearfrom each business, employment, and investment, less the total amount of deductions allowed to that person for theyear. A company is allowed to deduct from its income all outgoings and expenses wholly, exclusively, andnecessarily incurred during that period, as well as any deductions prescribed by regulations. The deductions allowedinclude: Contributions made by a person to a charitable institution or fund approved by the government or donations tocharity; Interest on loans used in the production of income; Rent on land or building occupied by a person to the extent that the land or building is occupied for purposes ofproducing income; Repairs/alterations/renewal of plant, machinery, fixtures, and other infrastructure employed in the production ofincome;

Rent received and included as income in respect of property rates, and mortgage interest; Bad debts incurred in the normal course of business and which cannot be recovered; and Foreign currency losses incurred in respect of a debt claim, obligation, or foreign currency holding of thecompany, when the Commissioner has been notified of the debt obligation.Withholding TaxesUnder Ghanaian law, a resident person who pays interest to another resident person is required to withhold 10 percent on the gross amount of the payment. This is not applicable to interest paid by an individual and interest that isexempt from tax. Table 1 shows withholding taxes payable by residents and non-residents and Table 2 shows thewithholding taxes payable by countries with which Ghana has a double taxation treaty.Table I: Withholding Taxes PayableWithholding Tax Final On AccountPayable by ResidentsInterest 8%Dividends 8%Fees to part-time teachers, lecturers, exams 10% 10%invigilators, and supervisorsFees, emoluments paid to directors, board10%members, managers, and othersCommissions to insurance, sales, or canvassing10%agentsEndorsement fees 10%Commission to lotto receivers or agents 5%Payment for the supply of goods or use of5%property or services exceeding GHC 500Payable by Non-ResidentsPremiums paid to non-resident insurers 5%Dividends and interests 8%Royalties, natural resource payments, rent 10%Fees for management and financial services 15%Endorsement fees 15%

Table 2Type of Income Germany South Belgium Italy Netherlands United France SwitzerlandAfricaKingdomTechnical/Management fees 8 10 10 10 8 10 10 8Interest 10 10 10 10 8 12.5 10 10%Royalties 8 10 10 10 8 12.5 10 8%Dividends;Capitalization of profits isdeemed to be a distributionof dividends but does notapply to a company duringthe first five years ofcommencement ofbusiness.555557.57.5Companieswhich holdmore than10% of theshares of acompany-5%All other cases1515151510151515%Tax Payable by EmployeesThe income tax rate for employees who are residents ranges from 0 per cent to 25 per cent on a graduated incomescale. Employees are taxed on the income accruing from their employment. An individual who spends more than183 days in Ghana in any year of assessment is deemed to be resident for tax purposes.Income tax is deducted at source by the employer and paid to the Ghana Revenue Authority (GRA) according towhat is commonly referred to as the Pay As You Earn (PAYE) system. Each registered company is issued with aTax Identification Number, for the purpose of identifying taxpayers.Property TaxProperty tax is payable by the owner of premises to the local authority, based on the ratable value of the premises.The obligation of the owner to pay the property tax may be assigned to the tenant/lessee by contract.Value-Added Tax/National Health Insurance LevyThere is currently a 12.5 per cent value-added tax (VAT) and 2.5 per cent National Health Insurance Levy (NHIL)on the supply of goods and services.

Capital Gains TaxCapital gains tax of 15 per cent is payable on any profit realized from the sale of a chargeable asset, which includespart of, or a right or an interest in, shares of a resident company, buildings of a permanent or temporal nature,business and business assets (including goodwill), and land situated in Ghana. A chargeable asset is treated as arealized asset when the asset is sold, exchanged, surrendered, or distributed by the owner. Exemptions from thepayment of capital gains tax under the law include: Capital gains up to a total of 50 currency points per year of assessment on capital gains realized by a person; Capital gains accruing to or derived by a company arising out of a merger, amalgamation, or reorganization of thecompany, when there is continuity of underlying ownership in the asset of at least 25 per cent; and Capital gains when the amount received or realized is, within one year of realization, used to acquire a chargeableasset of the same nature.National Social Security Scheme ContributionA company must deduct an amount equal to 5.5 per cent from each employee’s basic monthly salary and contributean amount equal to 13 per cent of the basic monthly salary to the mandatory social security scheme. This must bedone within 14 days from the end of each month.Capital AllowanceThe tax laws of Ghana provide for capital allowance instead of depreciation for a company’s depreciable assets. Theasset must be in the nature of the company’s capital, owned by the company, and used for the production of itsincome. The GRA must be notified in writing within one month after the asset has been put to use. Table II sets outthe categories of depreciable assets, their classes, and applicable rates.Table II: Depreciable Assets – Categories, Classes, and RatesClass Items Applicable Rates1 Computers and data-handling equipment 40%2 Automobiles and manufacturing plant and machinery 30%Assets in respect of long-term crop planting costs of acapital nature3 Mineral and petroleum exploration and productionrights80%/5%/50%Buildings, structures, and works of a permanentnature used in mineral and petroleum prospecting,exploration, and development, which are likely to beof no value when the rights are exhausted or when theprospecting, exploration, or development ends

4 Railroad cars, locomotives, and equipment; water 20%transportation equipment; aircraft; specialized publicutility equipment; office furniture, fixtures, andequipment; any depreciable asset not included inanother class5 Buildings, structures, and works of a permanent 10%nature other than those mentioned in Class 36 Intellectual property Rates not applicable; depreciableover useful life spanTax ConcessionsIndustry, Activity, and LocationTable III displays the available tax concessions for certain industries and activities. Table IV features locationincentives for the manufacturing and agro-processing businesses.Table III: Tax Concessions Based on Industry and ActivityType of Industry Activity Tax ConcessionFarming Tree crops Income exempt for 10 years, commencingfrom year of first harvestFarming Cocoa IndefiniteLivestock and cash crops Livestock (other thancattle), fish, or cash cropsIncome exempt for five years ofassessment from commencement ofbusinessCattle Cattle farming Income exempt for 10 years ofassessment from commencement ofbusinessAgro-processing established inGhana in or after 2004Agro-processingCompanies engaged in both agroprocessingand farmingReal estate developmentRecycling businessConverting agro productsinto edible canned orpackaged productsProducing cocoa byproductsfrom standardcocoa beans, husks, andother cocoa wasteNilConstruction for sale orleasing of low-cost,affordable residentialpremisesProcessing of waste foragricultural or commercialpurposesIncome exempt for a period of five yearsfrom commencement of commercialproductionFive years from commencement ofcommercial productionElect to be treated as agro-processingbusiness or farming business and claimeligible exemptionIncome exempt for five years ofassessment from the commencement ofoperationsSeven years from commencement ofcommercial production

Hospitality (hotels) Nil 20% corporate taxExport of non-traditional goods Nil8% corporate tax(horticultural products, processedand raw agricultural productsgrown in Ghana (other than cocoabeans)Rural banking Nil 10 years tax holiday and 8% corporate taxafter tax holidayCompanies listed on the GSE Nil 22%Table IV: Location Incentives for Manufacturing and Agro-Processing BusinessesManufacturing BusinessesLocation Activity Corporate TaxAccra and Tema Nil 25%Regional capitals of Ghana (except Northern, Upper East, Nil 18.75%and West Regions)Located elsewhere in Ghana including Northern, Upper East, Nil 12.5%and West RegionsAgro-Processing BusinessesLocation Activity Corporate TaxAccra and Tema Nil 20%Regional capitals of Ghana (except Northern, Upper East, Nil 10%and West Regions)Outside other regional capitals, including Northern, UpperEast, and West RegionsNilNilFree Zone CompaniesA free zone company is exempt from payment of income tax for the first 10 years from the date of commencementof business. After the expiration of the 10 years, the company must pay income tax at 8 per cent.Value-Added TaxA company with an annual turnover exceeding GHC 90,000 must be registered as a taxable entity with the GRA andcharge 12.5 per cent VAT, unless exempted by law. Other businesses with annual turnover up to GHC 90,000 mustoperate the VAT flat rate scheme, charging tax at 3 per cent.Customs Duties and TaxesA company is liable to pay import duties on its imports into Ghana, except on imports that are specificallyexempted, such as agricultural inputs. If any goods are lost or destroyed before they are delivered to or removedfrom a factory or warehouse or in removing them from a factory or warehouse, any duties due on them may beremitted by the appropriate tax authority if they have not been used or consumed in Ghana. In addition, goods and

services exported or shipped as stores on vessels and aircraft leaving Ghana are exempt from payment of importduties.Generally, items produced for consumption attract VAT. Similar items imported into Ghana attract import VAT atthe rate of 12.5 per cent on the value of the imported item. Excise duty also is payable on all locally manufactured orproduced goods, unless the goods are exempt.This duty is calculated on the ex-factory price of goods. Items subject to excise duty include tobacco products suchas cigarettes. On application to the relevant tax authority and subject to such conditions as may be imposed, noexcise duty will be payable on any goods manufactured in Ghana and shipped as stores for consumption outsideGhana on a ship or aircraft proceeding to a place outside Ghana, on goods exported by their manufacturer, or ongoods permitted to be used free of duty and so used.However, excise duty becomes due and must be paid by the manufacturer to the Commissioner before the goods aredelivered from the factory or warehouse. The Commissioner may permit some goods to be warehoused withoutpayment of duties on them or before they are used by the manufacturer in his factory or warehouse for any purpose.This provision is currently applicable to cocoa and petroleum products.For customs purposes, in computing the value of goods to be exported, the cost of the goods must include freightcharges incurred for transport up to the port or place of exportation, harbor dues, loading charges, and all other costs,profits, charges, and expenses and duties accruing up to the point where the goods are deposited on board theexporting vessel, aircraft, or vehicle at the place of departure from Ghana.In addition, the value of imported goods is their transaction value (i.e., the price actually paid or payable for thegoods when sold in the country of origin for export into Ghana). If the transaction value cannot be obtained, thecustoms value may be based on: The transaction value of similar goods sold for export into Ghana and exported at or around the same time as thegoods being valued; When the imported goods or identical or similar imported goods are sold in the country in the condition asimported, the unit price at which the goods are sold; or Computed valuation.Computed valuation includes the cost or value of materials and fabrication or other processing employed inproducing the imported goods; an amount of profit and general expenses equal to that usually reflected in sales ofgoods of the same class or kind as the goods being valued which are made by producers in the country ofexportation for export to the country of importation; and the cost or value of other expenses necessary to reflect thevaluation.In computing the duties and taxes on imported goods, three factors must be taken into consideration: cost, insurance,and freight (CIF) value; rate of customs duty; and the quantity (i.e., weight, number, measurement, and similarphysical attributes).When the goods attract duty, the rate of duty may take one of three forms: ad valorem, which is according to value(per cent applied to the value); specific rate, which is the rate applied to the physical attributes (such as per liter, perkilogram, per ton, per square meter); and alternative rate, which is either ad valorem or a specific rate, whicheverwill attract the higher or lower duty as stated by the tariff. When the rate is ad valorem, the duty is calculated on a

percentage of the CIF value; when the rate is specific, the quantity upon which duty is to be calculated must bedeclared in addition to the CIF value.Currency Regulation, Capital and Profit Transfer, and Investment IncentivesCurrency RegulationGhana’s foreign exchange regime is governed by the Foreign Exchange Act. The Central Bank (Bank of Ghana,BoG) regulates foreign exchange business and transfers between residents and non-residents. The law prohibits aperson from engaging in foreign exchange business without the requisite license from the BoG.Payments to or from Ghana between residents and/or non-residents must be made through a bank. Transfers to orfrom Ghana must be made through a bank, a dealer, or a person licensed to carry out the business of moneytransfers. If the BoG has reason to believe that a payment or transfer will contravene the laws of Ghana, it mayrequire the paying or transferor bank to obtain prior permission before effecting the payment or transfer.Foreign Currency AccountsResidents and non-residents are allowed to maintain foreign currency accounts. Balances in these accounts cannotbe transferred without the necessary documentation supporting the transaction. Residents are, however, allowed totransfer up to US $10,000 per annum from this account without documentation to meet obligations abroad.Foreign Exchange AccountsResidents are permitted to maintain foreign exchange accounts into which foreign exchange earnings that are notconverted into cedi balances can be credited. Residents are allowed to transfer up to US $10,000 per annum fromthis account without documentation to meet obligations abroad. Also, importers are allowed to import, throughdirect transfer from such accounts, up to US $25,000 per transaction without initial documentation.Financial Intelligence CenterPursuant to the Anti-Money Laundering Act, the Financial Intelligence Center (FIC) has been established as a unitwithin the BoG to provide assistance in the identification of proceeds of unlawful activities and to combat moneylaundering in Ghana. A person who brings into or out of Ghana foreign exchange of more than US $10,000 mustdeclare the particulars of the currency and the amount to the BoG or its authorized agent at the port of entry or exit.On receipt of the declaration, the authorized person must immediately send a copy to the FIC. In addition, theinstitution through which the money is transferred or received must notify the FIC within 24 hours of thetransaction.Failure to notify the FIC or failure to report to the FIC any transaction involving foreign currency exceeding theBoG’s approved limit constitutes an offense that is punishable by imprisonment of not more than three years, inaddition to 500 or 1,000 penalty units, respectively, depending on whether or not the offender is a body corporate.The BoG periodically issues directives on restrictions on the importation or exportation of foreign currency.Similarly, when the Governor of the BoG determines the country is experiencing or has experienced a severedeterioration in its balance of payments, the Governor, in consultation with the Minister of Finance and EconomicPlanning, makes rules for the temporary restriction of foreign currency transfers. These rules are valid for amaximum of three months, after which the time may be extended.

Capital and Profit TransferInvestments registered with the Ghana Investment Promotion Center (GIPC) and the Free Zones Board (FZB) areguaranteed unconditional transfer of dividends or net profits, payments in servicing foreign loans, fees and chargesarising from technology transfer agreements, and proceeds from the sale or liquidation of the whole or part of theinvestments.Investment IncentivesThe GIPC Act and the Free Zones Act set up the GIPC and FZB, respectively, to encourage and promote economicdevelopment and regulate the activities of investors in the country. The GIPC Act applies to businesses with foreignshareholding.An enterprise may be registered with the FZB either as a free zone developer or as a free zone enterprise. A freezone developer is licensed to develop and/or manage a free zone. A free zone enterprise is a company that exports atleast 70 per cent of its products.The incentives common to GIPC- and FZB-registered companies are in the areas of profit transfer, disputesettlement, and guarantee against expropriation. Companies have the right to transfer unconditionally, in freeconvertible currency, dividends and net profits attributable to investment, payments for servicing foreign loans, andfees and charges in respect of transfer agreements.Furthermore, if a dispute arises between the investor and the government, the parties are required to employ allefforts through mutual discussions to reach an amicable settlement. Failing this, either party may submit the disputeto arbitration in accordance with the agreement of the parties, the arbitration rules of the United NationsCommission of International Trade Law, and any bilateral or multilateral agreement on investment protectionbetween the government and the investor’s home country.Investors also are guaranteed protection against expropriation. In the unlikely event that expropriation occurs, thestate must pay fair and adequate compensation. Investors have access to the High Court to determine their rights andthe compensation payable, and (where applicable) the courts may make orders for repatriation of compensation.The incentives peculiar to each type of investment are discussed in turn.Free Zones CompaniesA free zone company is exempt from direct and indirect taxes. The company is exempt from income tax on itsprofits for the first 10 years from the date of commencement of operations, after which tax at 8 per cent is charged.Shareholders of these companies are exempt from tax on dividends.Companies Registered with the Ghana Investment Promotion CenterRegistration with the GIPC entitles the investor to an automatic immigrant quota, depending on the amount ofinvestment made. An investment of more than US $10,000 but less than US $100,000 entitles the investor to animmigrant quota of one person, and an investment of between US $100,000 and US $500,000 entitles the investor to

an immigrant quota of two persons. When the investment is more than US $500,000, the investor is permitted animmigrant quota of four persons.Competition LawIn GeneralGhana has no competition law, although the Competition and Fair Trade Practices Bill has been under considerationfor several years. However, there are a number of legislative instruments that deal with consumer protection issuesand there are groups of public institutions mandated to oversee particular areas of consumer protection.Protection Against Unfair Competition ActThe foremost legislation that deals with consumer protection issues is the Protection Against Unfair CompetitionAct, which was passed in order to provide protection against unfair competition. This Act provides safeguardsagainst dishonest business practices in Ghana. In summary, it protects businesses against: Confusing imitation of a product or service; Damage to another’s goodwill or reputation, which includes prohibiting a person from making untrue allegationsabout another’s product or service so as to divert public interest; Use of secret information without the consent of the rightful owner; and Unfair advantages for foreigners.Confusing imitation of a product or service could be with respect to a trade mark (whether registered or not), tradename, presentation of a product or service, or using a celebrity or well-known character. It is irrelevant whether ornot the product has been registered; an act that causes consumers to think it is the product of another is prohibited bylaw.Foreigners have an unfair advantage when a foreign business receives subsidies or other preferential treatment inanother country where it produces its goods. Foreign businesses are prohibited from taking an unfair advantage overbusinesses in Ghana.Apart from the listed protection it provides, the Protection Against Unfair Competition Act generally prohibits anyact or practice in the course of industrial or commercial activities that is contrary to honest practices. The breach ofany provision of this Act is an offense, and an aggrieved party may seek civil remedies.Intellectual Property ProtectionLegislative FrameworkGhana has a wide range of intellectual property laws that provide the legal framework for the registration andprotection of IP-related rights against unauthorized use and exploitation. Additionally, there are other statutes thatregulate the pertinent issues of technology transfer and electronic transactions. Ghana is a member of the World

Intellectual Property Organization (WIPO) and a signatory to most of the WIPO-administered treaties, including butnot limited to: The Singapore Treaty on the Law of Trade Marks; The Patent Law Treaty; The WIPO Copyright Treaty; The Paris Convention for the Protection of Industrial Property; The Washington Treaty on Intellectual Property in Respect of Integrated Circuits; The Hague Agreement concerning the International Deposit of Industrial Designs; The Protocol Relating to the Madrid Agreement concerning the International Registration of Marks; and The WIPO Performance and Phonograms Treaty.The principal Intellectual Property laws in Ghana are summarized in turn.Geographical Indications ActThe Geographical Indications Act provides for the protection of geographical indications. Any violation under theAct is punishable by a fine not exceeding 2,000 penalty units or up to two years’ imprisonment, or both.The High Court, may order that any goods related to any offense under the Geographical Indications Act should beforfeited to the state. The Registrar of Companies (Registrar) supervises the operation of this law.Trade Marks ActThe Trade Marks Act governs the registration and protection of trade marks in Ghana. Rights conferred byregistration under this Act include the exclusive use of the mark and the right to initiate an action in court againstany person who infringes the mark or performs acts likely to cause an infringement.Whoever infringes a registered mark commits an offense and is liable on summary conviction to a fine notexceeding 250 penalty units or to a term of imprisonment not exceeding two years, or to both.Copyright ActThe Copyright Act provides protection for a bundle of rights, the enjoyment of which prevents the unauthorized useor exploitation of a person’s creative works. Rights accruing to creators exist in two forms: economic rights andmoral rights. Economic rights enable the author to reap the financial benefit of his creative efforts for a reasonableperiod of time; moral rights protect the personality or reputation of the author and exist in perpetuity. A person whocommits an offense under the Copyright Act is liable on summary conviction to to a fine of not more than 1,000penalty units or to a term of imprisonment of not more than three years, or to both.The Copyright Act also provides for civil remedies and entitles a person whose rights are in imminent danger ofbeing infringed to initiate proceedings in court for an injunction, for an order requiring the Customs, Excise, andPreventive Service (CEPS) to detain the infringing goods, and/or for recovery of damages for infringement.

Industrial Designs ActThe Industrial Designs Act stipulates two basic requirements for the registration of industrial designs: novelty andoriginality. Registration confers the exclusive right to make, sell, or import or export, for commercial purpose,articles embodying a design.The Industrial Designs Act entitles an IP right holder to institute an action in court for an injunction to prevent aninfringement, an action for an award of damages, and an action for any other remedies. Any person who infringes anindustrial design is liable on summary conviction to a fine not exceeding 2,000 penalty units or to a term ofimprisonment not exceeding two years, or to both.Patent ActThe Patent Act regulates the registration and protection of patents. Registration of a patent confers a right on theholder for protection for a period of 20 years. The Act empowers right holders to initiate an action in court for thegrant of injunctions, an award of damages, and any other forms of relief provided in law. The making, importation,exportation, sale, or use of registered products or processes without the consent of the owner constitutes aninfringement. A person found guilty of such infringement is liable to a fine not exceeding 2,000 penalty units or to aterm of imprisonment not exceeding two years.Layout-Designs (Topographies) of Integrated Circuits ActThe Layout-Designs (Topographies) of Integrated Circuits Act, also known as the Layout-Design Act, provides forthe protection of layout designs (topographies) of integrated circuits and related matters. Under the Act, protectionbegins on the date of first commercial exploitation of the layout design anywhere in the world, or (with the consentof the right holder) as long as an application for protection is filed in Ghana within the first two years, or on the dateof filing the application for protection, if the layout design has not been previously exploited commerciallyanywhere else in the world. The term of protection in Ghana is 10 years.Violations under the Layout-Design Act are punishable by a fine not exceeding 2,000 penalty units or two years’imprisonment, or both. The court has the discretion to order seizure, forfeiture, and destruction of the layout designsor articles used in the commission of the offense.Protection against Unfair Competition ActThe Protection against Unfair Competition Act sets out the various practices that are deemed unfair competition,defines these practices, and outlines the extent of protection provided under Ghanaian law and other related matters.Major practices considered unfair under the law include causing confusion with respect to another’s enterprise or itsactivities, damaging another person’s goodwill or reputation, misleading the public, discrediting another person’senterprise or its activities, unfair competition in respect of secret information, and unfair competition in respect ofnational and international obligations. Civil remedies are in the form of damages as compensation.The Protection against Unfair Competition Act has generally brought some relief to businesses whose reputation andgoodwill are exploited by persons who invade the Ghanaian business environment with products and services that

cause or are likely to ‘cause confusion with respect to another person’s enterprise or its activities, in particular theproducts or services offered by that enterprise’.Employment LawTypes of EmploymentPermanent EmploymentUnder the Labor Act, the employment of a worker for a period of six months or more, or for a number of workingdays equivalent to six months or more, within a year is deemed to be permanent employment. Such employment hasto be secured by a written contract, not later than two months following the commencement of employment.Temporary/Casual EmploymentUnder the Labor Act, a casual worker is a person engaged on a seasonal/intermittent basis for a period of less thansix months. According to the labor law, a written contract is not required when an employee is engaged to work on aseasonal basis and remuneration is calculated on a daily basis. A temporary worker, on the other hand, is a personwho is employed continuously for a minimum of one month, but is neither a permanent worker nor a seasonalworker.Trade UnionsTrade unions are governed by the Labor Act. Ghana’s labor laws allow workers to form or join trade unions of theirchoice for the promotion and protection of their economic and social rights. However, workers in policy-making,decision-making, or managerial positions or in positions of trust, workers who perform duties that are highlyconfidential, and agents of shareholders of an undertaking may not form or join a trade union.Termination of EmploymentTermination of employment is governed by the Labor Act. There are stringent laws that govern the termination ofcontracts of employment. Any termination that is not conducted in accordance with the stipulations of the contractor in consonance with the Labor Act may be seen as an unfair termination, and the worker concerned may seekredress at the National Labor Commission or in the law courts.The Labor Act restricts the exercise of an employer’s discretion in the termination of employment, and the onus ofproof of the fairness of the termination is on the employer. Generally, a worker must be given a fair hearing beforehe can be legally terminated, regardless of how serious his offense may be.Working ConditionsUnder the Factories, Offices, and Shops Act, an employer is required to provide a healthy and safe workingenvironment and is required to report any accident, dangerous occurrences, and industrial diseases to the DistrictLabor Officer.

Workman’s Compensation LawThe Workman’s Compensation Law primarily regulates compensation awarded to employees for personal injuriesarising out of and in the course of their employment. It governs, inter alia, the employer’s liability in such cases, thecriteria for the computation of compensation for injuries, and liability in the event of an employee’s death.Employment of ChildrenThe Children’s Act prohibits the engagement of children in any form of employment that deprives them of theirhealth, education, or development. The minimum age of employment for a child is 15 years. A child who is 13 yearsof age may be engaged in light work, but for hazardous work the child must be 18 years of age.According to the Children’s Act, work is hazardous when it poses a danger to the health, safety, or morals of aperson. Light work is defined as work that is not likely to be harmful to the child’s health or development and thatdoes not affect the child’s attendance at school or the child’s capacity to benefit from schoolwork.Employment of Foreign NationalsThe employment of foreign nationals is governed by law. Application for an immigrant quota may be submitted by acompany that is registered with the GIPC. Such applications will be dealt with by the GIPC in consultation with theImmigration Service. The number of automatic immigrants allowed by the law is dependent on the capitalinvestment made by the company. A capital investment of between US $10,000 and US $100,000 entitles thecompany to one immigrant employee. A capital investment of between US $100,000 and US $500,000 entitles acompany to two automatic immigrant visas. A capital investment of more than US $500,000 entitles a company tofour immigrant employees.Free zone companies are required to submit their work and residence permit applications to the FZB, for onwardtransmission to the Ghana Immigration Service for approval. Work permits must be submitted to the Board twomonths prior to the date of commencement of the intended employment. Resident permits may not exceed twoyears.National Labor CommissionThe Labor Act established the National Labor Commission (NLC) as the lead agency for the resolution of all labordisputes and related matters. The NLC maintains a database of qualified persons to serve as mediators andarbitrators in the resolution of all labor-related disputes.In the performance of its functions, the NLC enjoys privileges and immunities as if it were a High Court. It has thepower to enforce the attendance of witnesses and examine them on oath, to compel parties and witnesses to producedocuments, and to issue requests to examine witnesses overseas.Pension PaymentsThe National Pensions Act provides for a contributory three-tier pension scheme for employees in Ghana.Employers are required to contribute 13 per cent and the employee contributes an amount equal to 5.5 per cent(deducted at source by the employer) of his basic salary to the Social Security and National Insurance Trust(SSNIT), and this money is invested (in trust) for the employee’s pension.

Tier 1 is a mandatory basic social security scheme. The existence of any employee pension or superannuationscheme does not relieve a company of its statutory obligations under the Tier 1 scheme. Tier 2 is a mandatory fullyfunded and privately managed scheme. Tier 3 is a privately funded voluntary scheme. Social security contributionsare portable — that is, they can be transferred from one social security scheme in one country to that in anothercountry and must be paid in respect of both local and expatriate staff.Banking LawBanking SectorGhana’s banking sector is dominated by foreign-owned banks. There are approximately 26 commercial banks, ofwhich 15 are subsidiaries of foreign banks, with an estimated market share of 51 per cent of bank assets. Britishbanks dominate, but the combined share of banks from the African region, particularly from Nigeria, is larger. Thedomestic component of the banking system is dominated by state-owned banks (SoBs). The state has a controllinginterest in five banks, through direct and indirect shareholding by the government, the BoG, and the state-controlledSSNIT. The SoBs account for 29 per cent of the banking system assets — one of the highest in sub-Saharan Africa.The BoG is the regulator of the banking industry. To this end, the BoG promotes effective banking systems anddeals with all unlawful or improper practices of banks. The BoG also proposes and considers reforms of the lawsrelated to the banking industry. Presently, the minimum capitalization for the grant of a license for the operation of alocal commercial bank is GHC 60,000,000.Licensing RequirementsOnly corporate bodies registered in Ghana are granted licenses to set up commercial banks. Operating a bankingbusiness in Ghana without a license is an offense. The BoG receives applications for licenses and deals with allmatters relating to the issuance or refusal of licenses. Such applications must be accompanied by: The regulations of the corporate applicant; Details of persons, including their corporate affiliates, who will hold significant shares in the proposed bank andtheir certified financial positions; Particulars of the directors and key management personnel of the bank; and Feasibility reports, including a business plan and financial projections for the first five years of operations, as wellas evidence of the initial capitalization.The BoG is the custodian of state funds and generally operates as the government’s banker, managing the publicdebt and serving as the government’s adviser on fiscal matters.Legislative FrameworkForeign Exchange ActThe Foreign Exchange Act authorizes the BoG to license and regulate the foreign exchange business in Ghana. TheBoG thus nominates and grants licenses to banks, corporate bodies, or persons that it considers competent to engagein the foreign exchange business.

An application for a license is granted within 60 days of its submission. A license so granted is renewable every 12months and is non-transferable. The BoG has the power to suspend or revoke licenses issued in accordance with theForeign Exchange Act when the licensee violates the terms of the license or any regulation governing the usage ofthe license.Payment Systems ActThe Payment Systems Act mandates the BoG to establish, operate, promote, and supervise payments and fundstransfer and to oversee the clearing and settlement systems in Ghana. The BoG also may designate any otherpayments, funds transfer, and clearing and settlement systems operating in the country that it considers to be in thepublic interest for the Bank to supervise.The BoG exercises overall responsibility over the operations of all payment systems in the country. Records of alloperations and transactions of any payment system must be retained for a minimum period of six years.Anti-Money Laundering ActThe Anti-Money Laundering Act established the FIC, which aims to assist in the identification of proceeds ofunlawful activity and combat money laundering activities.The FIC also provides information to investigating authorities, the intelligence agencies, and the revenue agencies,to facilitate the administration and enforcement of the laws of Ghana and exchange information with similar bodiesin other countries in relation to money laundering activities and similar offenses.Borrowers and Lenders ActThe Borrowers and Lenders Act provides a legal framework for credit, improves standards of information disclosedby borrowers and lenders, prohibits unfair credit practices, and promotes consistent enforcement mechanisms relatedto credit and related matters.The Act applies to credit agreements regardless of whether or not the lender is a resident or has its office in Ghana,or is a state institution, an entity controlled by a state institution, or an entity created by an enactment. The Actapplies to credit agreements even if a party to those agreements ceases to reside or have an office in Ghana.Non-Bank Financial Institution ActThe Non-Bank Financial Institutions Act regulates the operations of non-bank financial institutions and non-bankfinancial service providers. It does not apply to operators of microfinance services whose risk assets that do notexceed the amounts prescribed by the BoG and whose sources of funds do not include deposits from the public.A license is issued by the BoG prior to the commencement of operations; such a license is only issued to bodies thatare incorporated under the laws of Ghana with the sole objective of carrying on a non-bank financial service or tocredit unions that have satisfied the minimum capital requirement as set out by the BoG from time to time. The BoGmay revoke the license by a notice in writing to the licensee if the licensee conducts business in a mannerdetrimental to the interests of depositors or customers or for similar reasons.

Credit Reporting ActThe Credit Reporting Act provides the legal framework for the establishment of credit bureaus and related matters.The BoG is the supervisory institution under this Act. A license for the operation of a credit bureau is renewableannually and is non-transferable.The minimum paid-up capital to set up a credit bureau is GHC 500,000 and its investment in assets, as determinedby the BoG from time to time. The BoG may review the minimum paid-up capital at periodic intervals, whennecessary. A credit bureau may charge fees for its services or other services rendered under the authority of theCredit Reporting Act. Such fees are to be published in media with nationwide coverage.

I. ECONOMIC HIGHLIGHTSGuatemala has a population of over 15 million and is the country with the largesteconomic market in Central America. The 1996 Peace Accords, which ended 36years of civil war, resulted in an important legislative reform and macroeconomicstabilization creating the environment for foreign investment.The strength of the country's economy relies primarily on commerce, followed byagriculture, silviculture, hunting, fishing, manufacture and construction industryand tourism.The greatest markets for export are the United States, Central America and Mexico,and the key agricultural export includes coffee, corn, sugar cane, bananas, fruits,vegetables, meat and poultry products. The greatest imports are textiles andmanufacture, minerals, and chemicals from the United States, Central America andMexico. The products of major industry are food, beverages, textiles, shoes,clothing and metal products.Between the main countries that invest in Guatemala are the United States ofAmerica, México, and Spain with more than 200 companies established in thecountry.An important factor of the economy is Guatemala's large expatriate community inthe United States of America. The reception of family-remittances is a primarysource of foreign income equivalent to nearly two-thirds of exports. Guatemala isthe top remittance recipient in Central America.The national currency is the Quetzal and its exchange rate with respect to the USDollars is currently Q7.71 per US$1.00.According to the Central Bank (Banco de Guatemala), during 2013 the GrossDomestic Product (GDP) reached US$54,82 million, and the inflation in 2013 was4.39%.By the end of 2013 exports were up to US$10,030.10 million and the importsUS$17,515 million.The direct foreign investment in 2013 was of US$1,308.90 million.The eligible requirements to commence doing business in Guatemala are either:the organization of a Guatemalan corporation; the establishment of a branch of aforeign corporation; or foreign investment.II.CORPORATE STRUCTUREForeign investment is usually carried out by establishing a local company or abranch of a foreign company.

Creation of a local companyThe procedure for establishing a company is usually quick, taking approximately18 labour days to obtain a definitive registration at the Commercial Registry.To form a company, it shall be considered:• It is required a minimum of 2 persons (individual or corporate) to initiate acompany.• The Charter of Organization shall be authorized by a Notary Public;• The initial equity shall be of at least Q5,000 in cash (equivalent to US$648approximately);The Commerce Code (Decree 2-70) allows the formation of the following types ofcompanies:1. Stock Corporation (Sociedad Anónima). This is the type of company mostcommonly used. The equity is divided and represented in equal value shares andthe liability of each shareholder is limited to the shares held. The corporation musthave a Board of Directors or a Sole Administrator.2. General Partnership (Sociedad Colectiva). The partners are jointly andseverally liable to the full extent of their personal assets.3. Limited Liability Partnership (Sociedad de Responsabilidad Limitada). Eachpartner is personally liable up to the amount of equity paid in. The number ofpartners is restricted to a maximum of 20.4. Limited Partnership (Sociedad en Comandita Simple). Formed by two typesof partners. One or more general partners who direct business and are jointly andseverally liable for debts, and one or more limited partners whose liability islimited to the amount of equity paid in. The limited partners do not havemanagement voice in the operation.5. Special Limited Partnership (Sociedad en Comandita por Acciones). Thistype of company is the same as the Limited Partnership, but its equity isrepresented by shares.Establishing a branch of a foreign companyA company established in a country other than Guatemala can register a branchoffice in Guatemala. Any document sent from abroad shall be notarized andlegalized at the Guatemalan Consulate of the place of issuance, and translated toSpanish by a registered translator in Guatemala. The requirements are listedbelow.a) Certificate of organization from the country of origin (evidence that thecorporation is duly organized under the laws of the country where suchcorporation has been organized);b) Certified copy of the articles of incorporation, by-laws and amendments;c) The minutes of the company containing the company’s decision to operatein Guatemala and to initiate the registry process;d) Appointment in Guatemala of a legal representative, with both in court andout-of-court powers;

e) Allocate an amount of capital at a local bank for its operations in Guatemala,and execute a guarantee (a bond) of US$50,000 at maximum in favor of thirdparties to secure possible liabilities left by the foreign corporation aftertermination of business operations. This guarantee shall remain in effect for theduration of the company's operations in the country.f) A statement that neither the corporation nor its agents or employees mayclaim their rights as an foreigner, because they shall only have the rights grantedby the laws to Guatemalan citizens, and the means to exercise such rights.No registration of a foreign company is necessary for any of the followingoperations:a) Be a part of any proceeding or trial in Guatemala;b) Open and hold banking accounts in the country;c) Sell to or purchase from local independent trade agents;d) Manage orders through local agents which confirmation or acceptance takesplace out of the country;e) Grant loans or credits to companies established in the country;f) Issue, hold, endorse or protest credit instruments in the country;g) Acquire goods that are not part of a usual commercial activity and are notpart of a company assets;Limitations for foreign investorsNo general restrictions are placed on foreign participation, either for the formationof a company or for serving on a board of directors.However, there are few exceptions that should be taken into consideration, forexample:• There are some restrictions concerning concessions for open TV channels toforeigners;• Legal entities that provide public transport of passengers or freight shallhave at least 51% of Guatemalan share capital;• Only the following persons may be granted title to, rent, or use state-ownedlands in the Department of El Petén: (1) Guatemalans by birth who do not ownrural real estate anywhere in the country that exceeds 45 hectares; and (2)Guatemalans by birth who do not own industrial, mining or commercialenterprises. Enterprises owned 100 percent by Guatemalans by birth that meet therequirements set out in the preceding paragraph may be granted title to, rent, oruse state-owned lands in the Department of El Petén.• Only Guatemalans by birth and enterprises that are majority owned byGuatemalans by birth may take adverse possession of real estate.• Only Guatemalans by birth and enterprises 100 percent owned byGuatemalans by birth may own real property located within 15 kilometers of theborders. Foreign nationals may, however, own or possess urban real estate andreal estate for which rights were registered in the General Property Registry(Registro General de la Propiedad) before March 1, 1956 within the 15-kilometerarea.

• Only Guatemalans by birth or enterprises organized under Guatemalan lawmay exploit and renew forestry resources.• An enterprise organized under the laws of a foreign country that supplies aprofessional service that requires a legally recognized university degree,certificate, or diploma may not be established in Guatemala. However, such anenterprise may supply its services in Guatemala through a contract or otherrelationship with an enterprise established in Guatemala.• Prior authorization from the Shows Office (Dirección de Espectáculos) isrequired to contract with foreign groups, enterprises, or artists. In order forforeign artists or artist groups to perform in Guatemala, they must have a consentletter from any of the legally recognized non-governmental artist unions in thecountry. In mixed performances, made up of one or more films and variety shows,preference will be given to Guatemalans if the circumstances of the cast, schedule,and contract so allow.• Only Guatemalans by birth or nationals of a foreign country that areresidents in Guatemala may provide tour guide services in Guatemala.• In order to perform aeronautical duties on board foreign aircraft,individuals are required to have a certificate, license, or the equivalent, acceptedby the Civil Aviation Authority (Dirección General de Aeronáutica Civil), or issuedpursuant to an international agreement to which Guatemala is a party, underconditions of reciprocity.• In the operation of specialty air services by Guatemalan operators, allpersonnel performing aeronautical duties on board the aircraft must beGuatemalans by birth. However, the Authority may authorize foreign nationals toperform such duties for a period not to exceed three months, counting from thedate of authorization. The Authority may extend this period if it determines thatthere are no such trained personnel in Guatemala.• Only Guatemalans by birth or enterprises organized under Guatemalan lawmay operate commercial air transportation services in Guatemala. For greatercertainty, commercial air transportation services includes all domestic airtransport, including of passengers, mail orcargo. In order to supply such services, an enterprise must also meet the followingrequirements: (a) the enterprise must have its principal place of business inGuatemala; and(b) at least one-half, plus 1, of the directors, managers and individuals who haveresponsibility for management and control of the enterprise must be Guatemalansby birth or be a permanent resident of Guatemala.• To practice as a notary public, an individual must be a Guatemalan by birthdomiciled in Guatemala.III.TAX SYSTEMTaxationThe main business taxes are:1. Income Tax (Impuesto sobre la Renta -ISR-, Decree 10-2012)This is a tax levied on the Guatemalan-source financial income, i.e., anyincome resulting from productive activities in Guatemala. A Guatemalan-sourceincome is any income generated from capitals, goods, services, and rights invested

or used in the country, or originated from any activities developed in Guatemala,including foreign exchange earnings, of any nationality, domicile, or residence ofthe individuals or corporations engaged in the transactions, and the place ofexecution of the agreements.The fiscal year for Income Tax payment is January 1st through December31st, and must agree with the taxpayer’s fiscal year.Income Tax systems:a) Optional simplified regime for lucrative activities income: This system isautomatically applied, unless taxpayer chooses any other system. This paymentmay be made under the final withholding system, or directly to the Treasury, and iscomputed as follows: gross income minus exempted income, multiplied by 5% forincome up to Q.30,000.00, when it exceeds Q.30,000.00 the taxpayer must payQ.1,500.00 plus 7% for the amount that exceeds Q.30,000.00. It is important toemphasize that payroll workers are not eligible for this system.b) Regime on profits for lucrative activities: The regime is for individuals orcorporations engaged in business activities or otherwise. This tax 28% (25% from2015) is paid on a quarterly basis following the end of each quarter, and clearedevery year, by the following methods:• Quarterly partial balancing and settlements;• Paying one fourth of the tax in the previous final payment period;• It is based on a total taxable gross income obtained in the respective quarterand estimated at 5%, except for tax-exempt income and capital gains.2. Value Added Tax (Impuesto al Valor Agregado -IVA-, Decree 27-92)The purpose of the Value Added Tax (VAT) is to levy consumption, and,therefore, this tax is borne by the consumer rather than by the taxpayer. This tax islevied to each transfer payment and it is paid on a monthly basis, and therefore,Value Added Tax returns are filed every month. Taxable income is taxed at a rate of12% which, for sales, must be already included in the price of the transaction, andfor services, the price thereof.VAT’s Law also regulates tax credit refund. Under Article 15 thereof, taxcredit is a tax amount charged to a taxpayer for transactions subject to tax carriedout during the same tax period. A right to tax credit is valid under Article 16 of theVAT’s Law, for importation or acquisition of goods and for the use of servicesapplied to encumbered acts, or transactions subject to tax by the VAT’s Law. SuchSection provides: any taxpayers engaged in export activities and taxpayers sellingor providing services to individuals or corporations exempted in the domesticmarket, shall be entitled to tax credit refund when tax would have been created bythe importation, acquisition of goods or the use of services applied to encumberedacts or transactions subject to the VAT’s Law, associated with the productive ormarketing process of goods and services of taxpayer.3. Solidarity Tax (Impuesto de la Solidaridad -ISO-, Decree 73-2008)This tax is paid on a quarterly basis and is generated by business,agriculture and livestock activities with a gross margin above 4% of its grossincome. This tax levies whichever is greater that one fourth of the net assets, or

one fourth of the gross income. This taxable basis is multiplied by the rate of 1%.Companies are exempted of this tax the first year of operations. Taxpayers in the7% Income Tax system are also exempted of ISO tax. This tax may be credited toIncome Tax and the latter to the former.4. Documentary Stamp Law Tax (Ley del Impuesto de Timbres Fiscales y dePapel Sellado, Decree 37-92)This tax levies any documented act and agreement at a general rate of 3% ofthe transaction being documented, unless a specific fee applies. Therefore, thenonexistence of a document means the nonexistence of an obligation.Documentary Stamp Tax and Value Added Tax are mutually exclusive. This taxalso applies for the second an subsequent transactions of properties.5. Property Tax (Impuesto Único sobre Inmuebles -IUSI-, Decree 15-98)This tax levies property and is payable annually on a quarterly basis byowners. For tax purposes, the value of machinery and equipment, are not to becomputed within the taxable basis. Tax is computed by multiplying the value ofthe property by the following rates:Registered value of propertyUp to Q2,000 ExemptedQ2,000.01 - 20,000 0.2%Q20,000.01 - 70,000 0.6%Q70,000.01 and above 0.9%RateProperty value may be updated with any of the following options:• Self-appraisal by the taxpayer;• Appraisal conducted by the municipalities or by the Ministry of Finance;• The prices established in the notices issued by notaries for ownershiptransfers.Customs and Import DutiesCustoms and other import duties are imposed on goods that enter the country orservices delivered in the country. They include levies imposed for revenue orprotection purposes and determined on a specific or ad valorem basis.1. Agreement on the Central American Tariff and Custom Regime (Conveniosobre el Régimen Arancelario y Aduanero Centroamericano, Decree 123-84)The Central American Importation schedule is integrated by the CentralAmerican Schedule System (Sistema Arancelario Centroamericano -SAC-) and theImportation Schedule Rights (Derechos Arancelarios de la Importación -DAI-).The importation to any Central American country of products manufacturedoutside this region must pay the Value Added Tax and the Importations ScheduleRights (DAI). The importation of goods of origin within Central American countriesis only exempt of the payment of DAI.

2. Trade AgreementsGuatemala has signed the following Agreements:• Multilateral AgreementsWTO (GATT 1947)• Customs UnionCentral American Integration• Free Trade Agreementso Colombia - Northern Triangle (Colombia - Guatemala, El Salvador yHonduras)o Republic of China (Taiwan)o Panama (Central America-Panama)o Mexico - Northern Triangle (Mexico- Guatemala, El Salvador y Honduras)o Chile (Central America - Chile)o Dominican Republic (Central America - Dominican Republic)o The Dominican Republic – Central America Free Trade Agreement DR-CAFTA (United States - Costa Rica, El Salvador, Guatemala, Honduras, Nicaragua,and Dominican Republic)o Perú (Guatemala-Perú) pending entry into force• Partial Preferential AgreementsVenezuela, Colombia, Belize, Ecuador and Cuba• Bilateral Investment TreatiesArgentina, Austria, Belgium and Luxembourg, Chile, Czech Republic, Cuba,Finland, France, Germany, Israel, Italy, Republic of China (Taiwan), Republic ofKorea, Netherlands, Spain, Sweden, and SwitzerlandSocial Security contributionsThe employer’s contribution is the 12.67% of the salary of a payroll employee,which is integrated by the following rates: 10.67% contribution the Social Security(IGSS), 1% to the Employee’s Recreational Institute (IRTRA), and 1% to theTechnical Training Institute (INTECAP)The payroll employee’s contribution to the Social Security is of 4.83% of the salary.IV.FOREIGN INVESTMENTForeign investment is allowed by direct investment either by registering a branchof a foreign corporation or by forming a local company. These forms of investmentwere already developed in Section II.The Guatemalan State fosters and promotes investment, and has developed thefollowing regulation:1. Foreign Investment Law (Ley de Inversión Extranjera, Decree 9-98)This law is based on the principles that the national and foreign investmentmust be treated equally in the exercise of their economic activities, and that anydiscriminatory act is prohibited.

This regulation recognizes and guarantees private property rights fornational and foreigners; the right to participate in any lawful economic activity; fullprotection to the import and export of lawfully traded goods and services toensure the investments activities in the country; free access to foreign exchangeand the free convertibility of currency; the remittance of profits, earnings,dividends, and repatriation of capital with no restrictions except for applicabletaxes; prohibits confiscatory taxes and internal double or multiple taxation onforeign investment; and the State's submission to international arbitration in anyinvestment-related dispute that may arise.The Ministry of Economy Investment Office is the agency that ensures thecompliance of the investment regulation.2. Free Currency Negotiation Law (Ley de Libre Negociación de Divisas,Decree 94-2000)This law allows the using, holding, contracting, remitting, transferring,purchasing, selling, charging and paying of currency and in any currency. It is alsopermitted to hold and handle deposits and accounts on foreign currencies.3. Free-Trade Zones Law (Ley de Zonas Francas, Decree 65-89)This law promotes and regulates the establishment of Free-Trade Zones bysubjecting certain areas of land to a special custom regime, whether of public orprivate domain, and granting tax benefits to its operation such as exoneration oftaxes, tariffs and duties to importation, Income Tax and Value Added Tax.The activities developed at the Free-Trade Zone may be industrial (i.e.production or assembly of goods for exportation or re-exportation, research, andtechnical development), commercial (i.e. commercialization of merchandise to beexported or re-exported), and services (the delivery of services associated withinternational trade). By December 2013 there were 264 active registeredconsumers among the 16 private authorized Free-Trade Zones.In addition, the Organic Law of Santo Tomás de Castilla of Free- Zone ofCommerce and Industry (Ley Orgánica de la Zona Libre de Industria y ComercioSanto Tomás de Castilla, Decree 30-2008) creates ZOLIC which is the onlygovernment-owned free-trade zone. It is a logistics and operations center ofinternational trade since 1973, located next to Guatemala’s largest port on theAtlantic Coast.4. Promotion and Development of the Export and Drawdown Industry Law(Ley de Fomento y Desarrollo de la Actividad Exportadora y de Maquila, Decree29-89)This law intends to promote the manufacture of certain goods for theirexport to countries outside Central America, providing tax holidays such as thetemporary exemption from tariffs and Value Added Tax on imported rawmaterials, machinery, equipment, etc.

As a result of the application of the abovementioned laws, the application of the taxlaws that were already described in Section III is effective as follows:Promotion and Development of the Export and Drawdown Industry LawFree-Trade Zone LawIncome Tax Exempt on the earnings resulting only from exports. Sales income inthe national territory is subject to Income Tax, according to the current rates.Export income is Income-Tax exempted. Sales made in the nationalterritory are subject to such tax.Value Added Tax Temporary suspension Tax payment on: A) Raw materials(purchased both overseas and domestically. For raw materials acquired in thenational territory, the law provides the mechanism of Certificate of Acquisition ofLocal Commodities when purchased directly from the manufacturer. If acquiredfrom middlemen, the respective tax credit refund must be requested. Services andmaterials not directly linked to the productive process (including utilities such aspower, telephone, and bunker-fuels- are subject to VAT, and may be offset with theVAT collected in local sales or request a tax credit), semi-manufactured products,intermediate products, materials, containers, packages and labels necessary toexport or re-export goods manufactured in the country. Exempted is also thetransfer of goods among beneficiaries. In both events the parties executingagreements with the beneficiary must appear as co-exporters. B) Samples,engineering, instructive samples, patterns and models necessary for theproduction process or for research and instruction demonstrative purposes. C)Machinery, equipment, parts, components and accessories deemed necessary forthe productive process (whether new or used). Exemption on: A) Transfer ofgoods by and among foreign trade zones. B) Transactions carried out with theManaging Entity or with users of the Zone. C) Machinery, equipment, tools(whether new or used), raw materials (both purchased abroad and domestically),commodities, semi-manufactured products, containers, packages, components andgenerally goods used in the production of goods and in providing services. D) Thedispatch and delivery of goods by and between a qualified company under Decree29-89 and a foreign trade zone user.Solidarity Tax Exempted under the ISO Law Exempted under the ISOLawStamp Tax No exemption No exemption.Property Tax No exemption Free-Trade Zones shall be exempted fromProperty Tax, incumbent to the central government, during a 5-year period onproperty exclusively used for the development of the Zone.DAI Temporary suspension of payment of customs duties and import duties on:A) Raw materials, semi-manufactured products, intermediate products, materials,containers, packages and labels necessary for the export or re-export of goodsmanufactured in the country. B) Sample books, instructive engineering samples,patterns and models necessary for the manufacturing process or for research andinstruction exhibit purposes. C) Machinery, equipment, parts, components andaccessories necessary for the productive process (whether new or used). Not

subject to taxes, custom duties and charges applicable to imports to a Free-TradeZone of: machinery, equipment, tools (whether new or used), raw materials,commodities, semi-manufactured products, containers, packages, components andgenerally, any goods used in the production of goods and in providing services.Visas, work permit and residenceBusiness visas are granted by Guatemalan Consulates to foreigners that wish tovisit the country for legal business purposes.The work permits are granted by the Labor Ministry for the term of 1 yearrenewable for a second year only. Foreigners are also required to apply for theTemporary Residency during their first 2 years of stay in the country. Afterwards,foreigners are candidates for the Permanent Residency.The Labor Code requires that in each company at least 90% of its work force beGuatemalan employees, and collectively earn at least 85% of the total salaries paidby the employer. High-level positions such as general managers, directors,administrators, superintendents, and heads of the companies are excluded.V. LABOR REGULATIONIn accordance with the constitutional principles, the Labor Code (Decree No. 1441)develops the minimum guarantees, rights and obligations between employers andemployees and the dispute resolution process.There are relevant aspects of the labor regulation that should be considered:WagesThe wages can be agreed upon:1. Unit of time (month, 15-day period, week, day, or hour)2. Unit of work (piece, assignment, or fixed price)3. Profit sharing (Participation in utilities, sales, or collection on theemployer’s account)The minimum wage varies according to type of work and its rates are fixed everyyear by a multilateral commission. The minimum wage rates for year 2014 are:• For agricultural work: Q74.97 (US$9.72 approx.) per day on ordinaryworkday• For non-agricultural work: Q74.97 (US$9.72 approx.) per day on ordinaryworkday• For export and drawdown industry related works: Q68.91 (US$8.93approx.) per day on ordinary workdayWork periodsThe ordinary working hours are:1.1.

1. Daytime (between 6am and 6pm): May not exceed 8 hours per day and 44hours per week of effective work. The payment shall be equivalent to 48 hours perweek.2. Night time (between 6pm and 6am): May not exceed 6 hours per night and36 hours per week of effective work.3. Mixed hours: May not exceed 7 hours per day and 42 hours per week.The ordinary work period plus overtime shall not exceed 12 hours per day. Therate for overtime is 1.5 times the regular rate per hour.All employees are entitled to a paid day-off per week and to paid holidays. If workis performed in a holiday, such time must be computed as overtime. Officialholidays include: January 1st, Good Thursday, Good Friday and Easter Saturday,May 1st, June 30th, September 15th, October 20th, November 1st, December 24th(half day off after 12:00 p.m.), December 25th, December 31th (half day off after12:00 p.m.), the day of the local town's festivity (August 15th for Guatemala City).Other compensations and benefits• Productivity Incentive bonus (Bonificación Incentivo): Employee is entitledto Q250.00 (US$30.86 approx.) payable with its monthly salary.• Annual bonus: Employee is entitled to receive the equivalent of one-monthsalary each year payable in July, after a whole year of effective work.• Christmas bonus (Aguinaldo): Employee is entitled to receive the equivalentof one-month salary each year payable in December, after a whole year of effectivework.• Annual vacations: Employee has the benefit of 15 working days per year ofpaid vacations, after a complete year period of effective work. For agriculturalworkers the benefit is 10 working days.• Vested rights: The regular payment of certain compensations to theemployees beyond the minimum obligation creates rights to the employees andshall be taken into consideration for the calculation of the severance payment.• Severance payment: In case of unfair dismissal, the employee is entitled toreceive the equivalent to one month's salary (average of the last 6 months) foreach year of effective work, plus a 30% of the non-economical benefits that werepart of the salary (transportation, meals, etc.). This does not apply in case oftermination of a two-month probation period.

Why Ireland?A guide to doing business in IrelandDublin88 Harcourt Street, Dublin 2, Ireland Tel +353 1691 5000 Fax +353 1 691 5010Email dagnew@byrnewallace.com Dx 18 Dublinwww.byrnewallace.comNew York14th Floor, 415 Madison AvenueNew York, NY 10017, USAEmail dagnew@byrnewallace.com

ByrneWallace is one of Ireland’s largest law firms.Our clients are leading, innovative and growing publicand private enterprises active in all key industry sectors.Driven by client needsOver the years we have earneda reputation within Ireland andinternationally as a leading business lawfirm with an award-winning approach toclient service. We offer clients more thanexcellent transactional and specialistadvice. We want to be recognisedas “Your Legal Business Partners”,delivering the full benefits of a trustedlegal business partnership. This meansthat we challenge ourselves to find waysof adding business insight as well aslegal excellence.Delivering solutionsWe look to devise solutions anduncover opportunities, not just point toproblems. Our job is to understand ourclients, their markets and their businessgoals and objectives – and to tailorour services accordingly. In additionto first rate legal expertise, we applycommercial knowledge, insight and apractical understanding of the totality ofthe issues to all our client work.Resourced for successWith 35 partners and a total staff of 199people in our main offices in Dublin, wehave the scale and experience to ensurethat we deliver on our promisesin a timely, efficient and costefectivemanner. We are accessible,approachable and properly resourced todeliver the level of service you require.International reachFrom our New York office we can cater forthe legal needs of our US clients lookingto expand into Ireland and the rest ofthe EU. Through our association withleading Northern Ireland law firm MillsSelig, we meet the needs of our clientsthroughout the island of Ireland.Providing focused expertiseWe are a full service practice with ourservices divided into the following areas:• Banking and Financial Services• Capital Markets• Corporate• Corporate Restructuring andInsolvency• Data Protection• Dispute Resolution (litigation)• Employment Law• EU and Competition/Regulatory• Green Economy• Health Services• ICT, Software & Digital Media• Inward Investment• Life Sciences• Outsourcingwww.byrnewallace.com

ByrneWallace I Why Ireland? A guide to doing business in Ireland I 1ContentsWhy Ireland? 2Ireland’s tax advantages 5The investment vehicle 9Labour 10Real estate 14Intellectual property 17Technology 19Competition and antitrust 22Credit institutions and banking 25Investment funds 28Our inward investment expertise 30Our inward investment team 32

2 I Why Ireland? A guide to doing business in Ireland I ByrneWallaceWhy Ireland?Over severaldecades Irelandhas become amagnet for foreigndirect investment(FDI). Ireland isthe global base ofchoice for some ofthe world’s largestcorporations. FDIgenerates morejobs per capita inIreland than in anyother country.So what are theprincipal reasonswhy Ireland isso successfulin attractinginvestment?MARKET ACCESSIreland is a member of the EuropeanUnion (EU), with over 500 millionconsumers. Within Europe, Ireland is theonly English speaking country which usesthe euro, apart from Malta. TheEuropean mainland is readily accessiblethrough Ireland’s main ports and airports.Therefore more and more internationalcompanies use Ireland as their base toexpand into the rest of Europe, whileavailing of the benefits a leading foreigndirect investment location has to offer.12.5 % TAX RATEIreland offers one of the lowestcorporation tax rates in Europe. Irish taxresident companies benefit from acorporation tax rate of 12.5% on tradingprofits and certain distributions receivedfrom foreign trading subsidiaries. Thescope of activities which may beconsidered to be trading is quite broadand can include the development andexploitation of intellectual property. Acompany is tax resident in Ireland if it isincorporated in Ireland or if Ireland is theplace of central management and controlof the company. Irish tax law also containsextensive reliefs for expenditure in relationto intellectual property and research anddevelopment.FOREIGN TRADEThe 2014 Index of Economic Freedomrates Ireland as the European Union’smost economically free country.Information & communicationstechnology, chemical components andpharmaceutical products, medical andhealthcare devices are all key exports.Ireland is also beginning to emerge as aleading economy in the renewable energysector.The World Competitiveness Yearbook2014 ranked Ireland 15th out of 60countries worldwide for goods exportedas a percentage of GDP.US investment has been particularlyimportant to the growth andmodernisation of Ireland providing amultiplier effect with new technology,export capabilities, and employmentopportunities. As of 2013, the stock of USforeign direct investment in Ireland stoodat $190 billion. There are approximately700 US subsidiaries currently in Irelandemploying around 160,000 people andsupporting work for a further 275,000out of a working population of 2 millionspanning activities from manufactureof high-tech electronics, computerproducts, medical supplies, andpharmaceuticals to retailing, banking,finance, and other services. Ireland isalso an important European researchand development center for US firms inEurope.THE HOLDINGCOMPANY REGIMEThe principal benefits of locating aholding company in Ireland are theexemption from the charge to Irishcapital gains tax in respect of thedisposal of qualifying shareholdings insubsidiaries and the beneficial regimefor the taxation of foreign dividends.While there is no specific participationexemption, to the extent that dividendsare received from companies residentin the EU or in a tax treaty country suchas the US and are payable out of thetrading profits of such subsidiaries,those dividends are taxed in the handsof an Irish holding company at thelower 12.5% rate. Although Irelandimposes a dividend withholding tax andwithholding on interest payments (bothat 20%), domestic law provides for wideexemptions from these obligations,particularly for dividend payments.

ByrneWallace I Why Ireland? A guide to doing business in Ireland I 3“Ireland is home to9 of the top 10 global software companies,9 of the top 10 global pharmaceutical companies and15 of the top 20 global medical technology companies.“Source: IDA Ireland: Ireland Update Q4 2014

4 I Why Ireland? A guide to doing business in Ireland I ByrneWallaceRESEARCH ANDDEVELOPMENT (R&D)Over the last decade, Ireland hasemerged as one of the world’sleading lights in the area of Researchand Development. According tothe World Intellectual PropertyOrganisations Global Innovation 2014,Ireland is ranked 11th in the world forresearch and development.Ireland offers a very competitiveResearch and Development Tax Creditsystem. In 2012 50% of IDA Irelandsupported Foreign Direct Investmentwere in research and development,valued at over €517 million. Accordingto the latest IBM Global Trends report2010 Ireland is placed 9th globally forestimated total jobs in Research andDevelopment. Ireland offers a tax creditof 25% of incremental expenditure bya company, or group of companiesincurred wholly and exclusively onresearch and development.EXTENSIVE TAXTREATY NETWORKIreland has signed double taxationtreaties with 62 countries. New treatieswith Turkey, Serbia, Georgia andMoldova are in force since January 2011.New treaties were signed with HongKong, Singapore and the United ArabEmirates among others and will haveto be ratified. Updated treaties withGermany, Belgium and Switzerland willbe signed shortly.THE NATIONAL RECOVERY PLAN2011-2014The Irish Government’s NationalRecovery Plan 2011-2014 announced onthe 24th of November 2010 aims to dealwith Ireland’s current fiscal challengesbut will continue to improve Ireland’sattractiveness to overseas investors andhelp to sustain Ireland’s projected levelsof economic growth. Key measures inthe plan are aimed at overseas investors,supporting Research and Developmentand focusing on job creation.BUSINESS ENVIRONMENTIreland offers a pro business attitude,this is apparent when looking atsuccessive Governments policies,the approach taken by GovernmentAgencies and the working culture.Ireland has a stable constitution basedparliamentary democracy, an excellenttransport network and a very advancedtelecommunication network. Ireland wasranked fifth within the EU for its ease ofdoing business according to the WorldBank Doing Business 2014 Report.HIGHLY SKILLED WORK FORCEAlmost 50,000 graduates leave Irishcolleges every year. A large percentageof these with degrees in businessstudies, science and engineeringand most speak a second language.According to the most recent EurostatYearbook 2012 Ireland has the thirdhighest proportion of science, mathsand computer graduates in the 20-29age group within the EU. Also accordingto the IMD World CompetitivenessYearbook.Ireland ranks first regarding theavailability of skilled labour. This makesIreland a very attractive place to locate.COST COMPETITIVEOne of the few good things to come outof the global economic downturn hasbeen a pressure on costs. With rents,both office and private and salariesfalling dramatically in the last fewyears, Ireland has become increasinglycost competitive. As a consequenceIreland was ranked 10th worldwide forthe number of jobs created in businesssupport services, including call centers,shared services centers and businessoutsourcing in a study undertaken byIBM highlighting the role of foreigndirect Investment.IDA AND ENTERPRISE IRELANDIreland has recognised for a numberof years the need to assist foreigncompanies who wish to invest here.Several agencies were founded. Themain agencies today are the IDA andEnterprise Ireland. ByrneWallace has avery good working relationship with boththe IDA and Enterprise Ireland and canfacilitate relevant introductions.The IDA provides foreign companieswith help and guidance for setting upoperations in Ireland and can also helpcompanies who have already set upoperations here. Various grants andfinancial assistance to companies locatinghere are available and it is advisable toget into contact with the IDA from thestart of the planning process in order toavail of all possible assistance.The IDA’s strategy Horizon 2020 isfocused on employment intensiveservices and R&D. There may be capitalgrants available for example for sitedevelopment, or grants for training of thework force and the IDA also has a numberof business parks where companies canlocate.Enterprise Ireland is assisting Irishcompanies and foreign companies in thefood, drink and timber sector who wish toset up in Ireland.Ireland is a very attractive location forbusiness and we hope that this guidewill help you and your company to fullyappreciate Irelands offering. Any queries,we are happy to assist.

ByrneWallace I Why Ireland? A guide to doing business in Ireland I 5Ireland’stax advantagesThe favourable tax environment is a cornerstone of Ireland’sinward investment success. Utilising this advantage is a valuabletool for tax-efficient overseas investment and Ireland isincreasingly being chosen as the home of the low tax “principal”company in several significant international corporate structures.CORPORATION TAXThe scope of Irish corporation tax islargely dependent on the residencestatus of a company. Broadly speaking,an Irish tax resident company is liableto Irish corporation tax on its worldwideincome and gains, no matter whattheir source or nature, though specificexemptions do exist for certain types ofincome such as distributions from otherIrish resident companies and patentincome. A non-Irish resident companycan also come within the scope of Irishcorporation tax where it carries on activitiesin Ireland through a branch. Suchnon-resident companies are subject toIrish corporation tax on the profits ofthat branch. However, as Irish tax lawtreats a branch and its parent companyas one and the same entity for legalpurposes, no withholding taxes areimposed on the repatriation of branchprofits to its parent.In general, a company is tax resident inIreland if it is incorporated in Ireland,which is known as the place of incorporationtest. However, the general rule isnot followed in certain circumstances:• If the company is under the ultimatecontrol of a person resident in anEU Member State or in a countrywith which Ireland has a double taxtreaty, or which itself is, or is relatedto, a company whose principal classof shares is substantially and regularlytraded on a stock exchange inan EU country or treaty country• If the company carries on a trade inIreland or is related to a companythat carries on a trade in Ireland. Inthese circumstances, a company isdeemed to be tax resident whereits central management and controlresides. There is no statutory definitionof what constitutes managementand control and insteadcase law is relied upon to provideguidance. The available body ofcase law on the subject indicatesthat many factors need to be consideredbut the most important andoverriding of these are the placewhere the directors of the companyare resident and the place whereboard meetings are held.Rates of corporation taxThe rate of corporation tax charged isdependent on the nature of the profits.In general, trading profits and certaindistributions received from foreign tradingsubsidiaries are liable to corporationtax at 12.5%. All other income is liableto corporation tax at 25%.There is no definition provided in Irishtax law as to what constitutes tradingfor corporation tax purposes other thanto say that the following activities arespecifically excluded:• dealing in or developing land;• working minerals; and• petroleum activities.Profits from these activities are thereforeliable to corporation tax at 25%. Inaddition, despite pressure being exertedby other EU member states, the IrishGovernment, as part of the NationalRecovery Plan 2011-2014, reaffirmed itscommitment to maintaining the 12.5%corporation tax rate.What constitutes a trade?As mentioned above, under Irish taxlaw there is no guidance as to whatconstitutes trading profits for thepurposes of the 12.5% corporation taxrate. There are however a number ofother non-statutory sources of guidanceas to what constitutes a trade for thesepurposes:• a list of factors, known as the“badges of trade” and publishedby the UK Royal Commission on theTaxation of Profits in 1955, whichare generally accepted as beingindicative of trading activity;• available case law; and• guidance published by the Irish

6 I Why Ireland? A guide to doing business in Ireland I ByrneWallace“ The 2014 Index of Economic Freedomrates Ireland as the European Unionsmost economically free country andthe fifth in the world in this regard.”

ByrneWallace I Why Ireland? A guide to doing business in Ireland I 7Perhaps the most useful of thesesources is the guidance published bythe Revenue Commissioners. In thisguidance, as well as the more traditionalactivities which they deem to constitutetrading, the following are also included:• activities relating to thedevelopment and exploitation ofintellectual property rights;• corporate treasury functions;• investment management activities;• distribution activities; and• activities relating to the carrying outof research and development.HOLDING COMPANY REGIMEOne of the key facets of the favourabletax regime in Ireland is its attractivenessas a holding company location formultinational groups. This attractivenessis supported by a number of incentives:• exemption from the charge to Irishcapital gains tax in respect of thedisposal of qualifying shareholdingsin subsidiaries;• 12.5% rate of corporation tax ondividends received from companiesresident in the EU or in a countrywith which Ireland has a tax treatyand are payable out of the tradingprofits of such subsidiaries;• limited transfer pricing rules andno relevant thin capitalisation orcontrolled foreign corporation rulesfor foreign income;• significant exemptions fromwithholding tax on dividend andinterest payments made by an Irishholding company; and• an extensive and very favourablenetwork of 62 double taxationtreaties.INTELLECTUALPROPERTY REGIMEOver the past number of years Irelandhas emerged as the pre-eminentjurisdiction for multi-nationals tolocate their intellectual property andthe management and developmentactivities associated with it. This is notonly due to the favourable corporationtax rate for trading profits but also as aresult of a suite of other tax incentivessurrounding intellectual property andintangibles.Tax relief on acquisition cost ofintellectual property and intangiblesTax relief is available in respect of capitalexpenditure on the acquisition of awide range of intellectual property andintangible assets, including patents,trade marks, brand names, know how,domain names, scientific processes andgoodwill (to the extent that it is relatedto any of the above intangible assets).The tax deduction may be claimedeither in line with the accountingdepreciation charge included in thecompany’s financial statements or byelecting for a 15 year write down period.However, the deduction is restrictedsuch that it cannot exceed 80% of theprofits associated with the exploitationof the relevant intellectual property orintangibles for which the deduction isclaimed.Research and Development Tax CreditUnder Irish tax law, a tax credit isavailable to companies in relation tocertain expenditure on research anddevelopment (R&D) activities. The keyfeatures of the credit are as follows:• 25% credit for incrementalqualifying expenditure on R&D overthe amount of expenditure incurredin the “base year”, now 2003;• the credit is granted in addition tothe regular tax deduction availablefor R&D expenditure;• in order to qualify, expenditureon R&D activities must seek toachieve scientific or technologicaladvancement and involve theresolution of technologicaluncertainty;• expenditure incurred onsubcontracted R&D activitiesundertaken by a third party can alsoqualify for the credit to the extentthat:– the expenditure subcontracteddoes not exceed 10% of theoverall expenditure on R&D by thegroup; and– the subcontractor does not claima credit for the expenditure.• expenditure that is subcontractedto a qualifying third level institutioncan also qualify so long as it doesnot exceed 5% of the group’s overallexpenditure on R&D; and• the credit can also be refundable incertain circumstances where thereis an insufficient corporation taxliability to utilise the full credit forthe accounting period in which theexpenditure was incurred. In thissituation, the credit can be:– surrendered to other groupcompanies;– carried back for offset against thepreceding period corporation taxliability; or– claimed as a cash refund spreadover three years (subject to certainlimitations).For companies claiming the credit,net tax relief of 37.5% of the qualifyingspend can be available when the credit iscombined with the regular tax deductionavailable for the expenditure.

8 I Why Ireland? A guide to doing business in Ireland I ByrneWallaceAllowance for Expenditure onKnow-howExpenditure incurred in relation to theacquisition of know-how purchased froma third party and not as part of a tradeis tax deductible. However, unlike thededuction for expenditure on scientificresearch, a deduction for expenditureon know-how is not available where it isnot related to the trade being carried onby the company in question.Know-how purchased from a relatedparty or acquired as part of a purchaseof a trade may qualify for bookdepreciation treatment.Expenditure on Scientific ResearchA deduction is available for revenueand capital expenditure on scientificresearch. This deduction is availableeven where the expenditure on theresearch is not related to the trade ofthe company in question.A deduction against profits is alsoallowable for payments, whether capitalor revenue in nature, to a body carryingon scientific research that is approvedby the Minister of Finance or to an Irishuniversity in order to undertake scientificresearch.REGULATED FUND REGIMELeveraging its favourable tax andregulatory regimes, Ireland has emergedas a world leading location for theregulated funds industry.From a tax perspective regulated fundsare subject to what is known as a “grossroll-up” regime whereby income orgains are generally not taxedimmediately and instead tax (known asexit tax) only becomes chargeable onpayments or distributions out of thefund to investors. Furthermore, non-residentinvestors are exempt from anycharge to Irish tax (including exit tax) inrespect of an investment in an Irishregulated fund.STRUCTURED FINANCE REGIMEOver a number of years, Ireland’sstructured finance legislation has beensteadily enhanced such that Ireland isnow one of the pre-eminent locationsfor the establishment of vehicles used instructured finance transactions.Irish tax law ensures that structuredfinance vehicles established in Ireland(known as S.110 companies) sufferminimal Irish tax leakage in relationto their activities and also minimisewithholding tax on payments of interestto investors in the vehicles.In particular, Ireland has emerged as thelocation of choice for US life settlementssecuritisations due to our favourable taxtreaty network which can minimise taxleakage in relation to US exit taxes.TAX ON INDIVIDUALSIncome TaxIreland has a progressive system ofincome tax which is levied at two rates.As of 2014, an individual is subject toincome tax at 20% on their first €32,800of income, though this is typicallyamended each year by the Minister forFinance. This threshold is increasedwhen the individual is married. Anindividual is then liable to a rate of 41%on the balance of their income over andabove the threshold.In addition to income tax, individuals arealso subject to two social contributions,known as the Universal Social Charge(c. 7%) and PRSI (c. 4%), on their income.Scope of Income TaxIn order to be within the charge to Irishincome tax, a person must either beresident, ordinarily resident or domiciledin Ireland.A person will be deemed to be taxresident in Ireland if they spend:• a total of 183 days in Ireland in anytax year; or• a combined total of 280 days overtwo tax years (assuming a minimumof 30 days in each tax year).If a person is resident in Ireland for threeconsecutive tax years, they then becomeordinarily resident for tax purposes. Anindividual is deemed to be domiciledin the country in which they have theirpermanent home. Domicile is generallydetermined initially by an individual’sdomicile of origin (generally the countrywhere their father is domiciled whenthey are born) and will be regardedas domiciled in that country unless adomicile of choice is acquired.Influence of domicile and residenceAn Irish resident, ordinarily resident anddomiciled person is liable to Irish incometax on worldwide income. A resident anddomiciled, but not ordinarily resident,person is liable to Irish income tax on Irishsource income and on any other incometo the extent remitted. A resident but notdomiciled person is liable to Irish incometax on Irish source income and on anyother income to the extent remitted.

ByrneWallace I Why Ireland? A guide to doing business in Ireland I 9The investment vehicleBUSINESS STRUCTURESForeign direct investors may choosevarious legal entities to establisha presence in Ireland includingprivate limited companies, unlimitedcompanies, public limited companiesand branches. ByrneWallace canadvise on the suitability of each ofthese to the particular investor butthe most commonly used foreigndirect investment vehicle is the privatelimited company. Similar to the USCorporation, its chief advantage is thateach shareholder’s liability is limitedto the amount it agreed to pay for itsshares.INCORPORATIONThe incorporation process is generallyquick and inexpensive, taking between5-20 days and involving the filing ofcertain information with the CompaniesRegistration Office. The Memorandumand Articles of Association (similar tothe US Charter or Articles) set out thecompany’s parameters and regulationsand are filed with the incorporationpapers. ByrneWallace CorporateSecretaries Limited, our Firm’s companysecretarial division, provides a range ofcompany incorporation and secretarialservices to help make the incorporationand administrative process as smoothas possible.REQUIREMENTSOn incorporation, a private companymust have at least one shareholder,two directors, a company secretary ,and an Irish registered office and beable to demonstrate that it will conductbusiness in Ireland. Shareholders arenot required to be Irish but at leastone director must be an Irish residentunless an insurance bond is in place.The management of the companyis generally entrusted to a Board ofDirectors. An auditor must be appointedand the accounts must be publicly filedeach year.The nominal share capital of a privatecompany can be as large or as smallas the founders wish and can be in anycurrency denomination. There must beat least one issued share.Every company must appoint an auditorand must publicly file audited accountseach year. The detail required in theseaccounts varies according to the size ofthe company.BRANCHESAn alternative to incorporation whichforeign direct investors may chooseis to establish a branch operation.Although generally not as advantageousas incorporation, branches may servea particular purpose. A branch has aseparate management structure whichenables it to negotiate contracts withthird parties, and has an elementof financial independence. Foreigncorporations establishing a branch inIreland are obliged to register certaininformation with the CompaniesRegistration Office within one monthof establishment. Foreign corporationswith branches in Ireland are required topublicly file their accounts each year.

10 I Why Ireland? A guide to doing business in Ireland I ByrneWallaceLabourTHE IRISH EMPLOYMENTENVIRONMENTEmployment law in Ireland is acombination of Irish and EU legislationcomplimented by common lawjurisprudence and Irish Constitutionallaw. Parties to an employmentrelationship are free to negotiateand conclude agreements betweenthemselves, subject to compliance withcertain minimum requirements as setby law.THE EMPLOYMENTRELATIONSHIP IN IRELANDThe employment relationship may bebroken down into three distinct stages,each involving its own specific legalissues, as follows;Pre-EmploymentPotential employers must ensure toexercise care from the outset of theemployment relationship, beginningwith advertising and recruitment.The most common pitfall in this arearelates to non-compliance with equalitylegislation. Employers must ensure thatall processes involved in the recruitmentprocess, including advertising, interviewand selection, are transparent and fullycompliant with equality legislation.Where possible, interview panelsmust contain a gender balance,questions should be appropriate andcontemporaneous notes must be takenoutlining the reasons why a candidateis ultimately successful or unsuccessful.In addition, caution must be exercisedin the drafting of advertisements asthey may subsequently be found tohave formed part of the employmentcontract.Regulation of the EmploymentRelationshipContracts of Employment:Employers are obliged by law toprovide employees with a writtenstatement of specific terms of theiremployment within two months of thecommencement of the employment.While this may be regarded as beingthe irreducible minimum in terms ofrequired documentation, the realityis that the employment relationshipwill generally be governed by a moreexpansive contract of employment.This contract will include both expressterms and implied terms. Implied termscover rights and obligations which areimposed on the contracting parties;(a) by common law and which havebeen found by the Courts to applyto every contract (e.g. the duty ofmutual trust and confidence);(b) by Statute (e.g. minimum noticeperiods);(c) by the Irish Constitution (e.g. theright to join a trade union);(d) by collective agreements (e.g.levels of overtime for a specificclass of workers as negotiated by arecognised trade union); and(e) by custom and practice in aparticular workplace (i.e. the practiceof awarding a bonus on meetingtargets notwithstanding that thereis no contractual right to a bonus).Implied terms are automaticallyincorporated into an employee’scontract of employment, regardlessof whether or not they are expresslyincluded.Minimum Requirements:Irish law provides for a minimum wage,minimum notice period, maximumworking time allowances and minimumannual leave entitlement of 20 days ayear (with an additional entitlement to9 public holidays a year). In addition,employees are entitled to a variety ofother forms of leave, albeit on an unpaidbasis, including maternity leave, parentalleave, adoptive leave, carer’s leave, forcemajeure leave and health and safetyleave. There is no entitlement to paidsick leave under Irish law.Policies and Procedures:In addition to the written statement/contract, an employer is obliged toput various policies and proceduresin place, such as grievance anddisciplinary procedures. Such policiesmust be drafted carefully in order toensure that they encompass fairness,transparency and the principles of naturaljustice. Such policies must be givento the employee within 28 days of thecommencement of employment.Health and Safety:Finally, under health and safetylegislation, employers are obligedto prepare a report confirming howthey intend to safeguard the health,safety and welfare of its employeesin the workplace (known as a ‘safetystatement’). This statement should coverissues such as victimisation, bullying andstress in the workplace.Pensions and Benefits:In terms of pensions, employers who donot provide access to an occupationalpension scheme for their employeeswithin six months of the commencementof employment are obliged toprovide access to a Standard PersonalRetirement Savings Account and tofacilitate employee participation therein

ByrneWallace I Why Ireland? A guide to doing business in Ireland I 11Ireland toppedForbes 2014 list ofThe Best Countriesfor Business

12 I Why Ireland? A guide to doing business in Ireland I ByrneWallaceemployee’s request, in respect of theemployee’s contribution to the PRSA.There is no obligation on the employerto contribute to such PRSA.Where an employer wishes to extendadditional benefits to its employees inthe form of bonus schemes, health/lifeinsurance and share option schemes,this should also be dealt with by way ofcontract.Protection of the Employer’s Interests:Where an employer is concerned toprotect its business and goodwill inthe event that key personnel decide toleave their employment, a restraint oftrade/non solicitation clause should beincluded in the employment contract.Caution must be exercised in thedrafting of such clauses however as theCourts will only uphold such clausesinsofar as they are necessary to protectthe legitimate business interests ofthe employer. Our employment lawteam has a wealth of experience in thedrafting of contracts of employment,workplace handbooks, policies andprocedures and will be happy toadvise you on any of your draftingrequirements.Post-EmploymentData Protection and Retention ofRecords:Following the termination ofemployment, employers are obligedto retain certain personnel records ofthe departed employee for a specifiedperiod of time. Any information whichis collected, processed and/or retainedby or on behalf of an employer onits employees is protected by DataProtection legislation and employersmust ensure that it is held in a safeand secure manner and processed incompliance with the Data ProtectionActs.Aggrieved Employees:The termination of an employmentrelationship may be amicable oracrimonious. A plethora of fora isavailable to an aggrieved former, andat times existing, employee under Irishlaw, including the Rights CommissionerService, the Equality Tribunal, theLabour Court, the Employment AppealsTribunal as well the Courts systemitself. Generally speaking, the keysto ensuring a secure defence againstsuch actions are workplace policies andprocedures which have been properlydrafted, fully implemented and correctlyutilised by the employer.At ByrneWallace, we have extensiveexperience in advising and representingclients at all levels of litigation. Wecan also offer advice in relation toalternative dispute resolution and thevarious mechanisms which may beutilised to settle disputes where partieswish to avoid contentious litigation.OTHER ISSUESEqualityEmployment in Ireland is subject toequality legislation and discriminationon the grounds of age, gender,disability, race, religious belief, sexualorientation, marital status, family statusor status as a member of the Travellercommunity is prohibited throughout allstages of the employment relationship.Trade Unions and Industrial RelationsWhile the Irish Constitution enshrinesthe right of the employee to join atrade union, there is no correspondingobligation on an employer under Irishlaw to recognise that trade union, savein very specific circumstances where ithas either been the established practiceof the employer to recognise a tradeunion or where a business transferhas occurred which falls within theremit of the European Communities(Protection of Employees on Transfer ofUndertakings) Regulations 2003.In a non-unionised workforce, it isrecommended that some mechanism isput into place to facilitate the resolutionof disputes directly between employerand employees. Either party to adispute may request the assistance ofthe Labour Court which may provideguidance on the matter as well as offervarious services including mediationand conciliation. Depending on thesize of the workforce, employers maybe obliged to consult with, and inform,employees about various issues whichmay impact on their employment.At ByrneWallace, our employmentpartners possess expertise in the areasof equality law and industrial relationslaw and can offer proactive and practicaladvice in these areas to any entityconsidering the establishment of anoperation in Ireland.

ByrneWallace I Why Ireland? A guide to doing business in Ireland I 13Atypical EmployeesIrish law also provides for atypicalworking arrangements such as part-timeemployment, fixed term employment,agency/relief work and outsourcing.In addition, some employers facilitateflexible working arrangements includingjob sharing and e-working.Immigration, Work Permits andSecondmentAn entity wishing to set up an operatingbase or branch in Ireland may wish totransfer employees from an alreadyestablished company for the purposesof establishing the new Irish base. Inthe case of employees who are notIrish citizens, Irish immigration law mustbe complied with and applications forresidency and/or work permits may berequired. Various types of work permitsare available and, for companies wishingto transfer employees between offices,an Intra Company Transfer Permit isusually the most suitable, providingthe qualification criteria have beenmet. In addition, employers may wishto establish a secondment policy tofacilitate the temporary transfer ofemployees between operations.occurs where (i) there is a change inemployer as a result of a legal transferor merger; (ii) following the transfer, thebusiness of the operation is continuedon by the new employer; and (iii) thebusiness is transferred as a ‘goingconcern’. Where these criteria aresatisfied, the legislation provides thatthe new employer is legally obliged totake on the existing employees of thebusiness. The terms and conditionsunder which those employees areengaged transfer automatically to thenew employer (with the exception ofpension entitlements) and there is nobreak in continuity of service from theemployees’ point of view.ByrneWallace can help an individualor company intending to invest inIreland to identify the full extent ofissues which will require addressing inorder to ensure a smooth transition.We can assist with the processing ofimmigration documentation and workpermits and also provide in housetraining and seminars to HR teams whomay be new to the Irish employmentmarket as well as those simply wishingto improve on their knowledge in thearea.Protection of Employees on Transferof Undertakings RegulationsWhere it is intended to invest in, orpurchase, an established Irish business,consideration must be given to theEuropean Communities (Protection ofEmployees on Transfer of Undertakings)Regulations 2003. Pursuant to thislegislation, a transfer of undertaking

14 I Why Ireland? A guide to doing business in Ireland I ByrneWallaceReal estateIreland is a commonlaw jurisdiction.The acquisition,development andoccupation of realestate in Irelandis governed bylegislation, case lawand contract lawprinciples. Thereare no particularrestrictions on non-Irish or EU persons orbodies acquiring orleasing real estate inIreland.There are two main activities: (a) buyingand selling property; and (b) occupationalleasing. Neither of these transactions areeffected electronically although work ispresently underway to establish a systemof e-Conveyancing in the short to mediumterm.BUYING AND SELLING PROPERTYTitle and OwnershipTitle to Irish real estate can either beacquired outright by acquiring thefreehold interest or by acquiring a longleasehold interest with a term usually inexcess of 200 years subject to a nominalrent with a capital premium paid at theoutset and subject to certain limitedcovenants on the part of the “tenant”.Title insurance is rarely used save wheretitle is investigated and found to bedefective.RegistrationTwo systems of registration of real estateexist namely: (a) the Property RegistrationAuthority (formerly Land Registry) titles(“Registered”); and (b) the Registry ofDeeds titles (“Unregistered”).Title to Registered land is evidencedby one document issued by the LandRegistry know as the “folio” which is Stateguaranteed (save in respect of mapping)as the Property Registration Authorityinvestigate title to the property prior toregistering same.Title to Unregistered land is evidenced bytitle deeds showing the devolution of titlefrom one party to another over a numberof years. At least fifteen years good andmarketable title must be evidenced.Title in urban areas tends to beunregistered with the majority of ruralproperty being registered. All counties ofIreland – other than Dublin and Cork – arewithin areas of compulsory registration.It is hoped that all land will beRegistered in the coming years, anecessary precursor to the introductionof e-conveyancing.Due Diligence and Contract for SaleThe commercial terms of the sale ofproperty are usually negotiated by realestate agents and once settled referredto real estate lawyers acting for thevendor and purchaser. It is the obligationof the vendor’s solicitor to draw up theContract for Sale and demonstrate theability of their client to deliver “goodand marketable title” to the subjectproperty. The Contract for Sale willnot only deal with title matters but alsoplanning, taxation and the condition ofthe property.Before the Contract for Sale is signedthe real estate lawyer acting for thepurchaser will carry out a due diligencedesigned to ensure that not only doesthe vendor have title to the subjectproperty but also that there has beencompliance with statute and thatthere are no liabilities attaching to theproperty which would pass with the titleto the purchaser.While the vendor will usually disclose anyimperfections, the principle of “caveatemptor” (let the buyer beware) applieswith the obligation on the purchaser tomake adequate enquiries in relation toboth legal and regulatory matters and tophysically inspect the subject property.The transfer of the title usually occurswithin six weeks of the executionof the Contract for Sale. In certaincases completion of the transaction ispostponed or conditioned upon theoccurrence of certain events (e.g.) thepurchaser procuring planning permissionfor the property, development financeto construct a building or procuringstatutory body (e.g. IDA) or bank consentto the disposal of the asset.

ByrneWallace I Why Ireland? A guide to doing business in Ireland I 15On execution of the Contract for Salea 10% deposit is paid with the balancepayable on the closing date. Thedeposit is usually held as stakeholder bythe lawyer acting for the vendor and it isusually refundable in nature where thetransaction does not proceed for reasonsother than the default, neglect or delayof the purchaser.OCCUPATIONAL LEASINGBusinesses in all sectors occupylands and buildings in pursuanceof occupational leases with a largenumber of retail, office and industrialdevelopments constructed in the pastten years. It is unusual for buildings tobe occupied under licence save for verylimited purposes (e.g. seasonal trade) orin retail outlet parks.“ Landlords and tenants areincreasingly focused oncommitments towards energyefficiency, carbon reduction, use ofrenewable energy, wastereduction and water usereduction.”TermOccupational leases terms are typicallybetween five and twenty five years.Recent statutory changes (both VATand Landlord and Tenant rights) andincreased tenant bargaining power in adepressed market has created greaterflexibility for prospective occupiers.Ireland has not yet adopted theEuropean model of short lease terms.Irish business leases often give bothlandlords and tenants security of tenureand an opportunity for both to recovertheir respective capital investments.Increasingly, tenants are negotiating“break clauses” giving them the optionto terminate their leases after the fifth,tenth or fifteenth years, depending onthe duration of the initial term.ObligationsThe typical Irish occupational leaseis what is known as an “FRI” or fullrepairing and insuring lease with the

16 I Why Ireland? A guide to doing business in Ireland I ByrneWallacenegative covenants on the part ofthe tenant including: the obligationto pay rent; maintain and repair thepremises; limitations on the permitteduse; restrictions on alienation andalterations; agreement on the conditionto which the premises must be restoredon determination of the lease.Rents and Service ChargesRental levels have fallen in recentyears and rents are negotiated andagreed by real estate agents. Turnoverrents are increasingly prevalent inhigh-turnover retail locations. Inmulti-occupied developments servicecharge and insurance contribution aretypically payable in addition to rent andcalculated on a pro-rata basis.Rent ReviewSince the 1960’s practically every Irishcommercial lease for a term in excessof five years contained a five yearly“upwards only” rent review clause.Such clauses provided that the rent firstreserved would be reviewed every fiveyears to the higher of the rent payableimmediately before the review or theopen market rent at the date of thereview.Section 132 of the Land andConveyancing Act 2009 providesthat rent review clauses in leasesgranted after the 28 February 2010be interpreted as reviewing rents toopen market value introducing thepossibility of downward movement onreview for the first time in many years.The provision is not retrospective in asmuch as it does not apply to existingarrangements on that date, thuscreating a two tier system. Green Leases– landlords and tenants are increasinglyfocussed on commitments towardsenergy efficiency, carbon reduction, useof renewable energy, waste reductionand water use reduction as the cost ofsuch items escalates and it would not beunusual to see leases addressing theseissues.TAXATIONStamp DutyA tax on deeds and instruments, StampDuty is payable by the purchaser ofproperty on the purchase price of theproperty. The top rate of Stamp Duty oncommercial property is currently six percent of the consideration paid or themarket value whichever is higher. StampDuty is also payable on occupationalleases by the tenant at a rate of onepercent of the annual rent.Value Added Tax (VAT)In certain circumstances VAT is payablewhen purchasing property and is alsocharged in many cases on rents payablepursuant to commercial leases. TheVAT regime was extensively overhauledin 2008. Where chargeable on anacquisition the current relevant rate ofVAT is 13.5% of the purchase price.Whether or not VAT is chargeable willdepend on the age of the property,whether it has been developed orredeveloped (as defined in the VATActs) and the use to which it is put. Inrelation to commercial rents, if thelandlord “opts to tax” the Lease thenVAT is payable at the current rate of 23%on the rents payable. It is unusual fora landlord not to opt to tax as he mostlikely will have reclaimed VAT in thecourse of development giving rise to apotential claw back if he does not opt totax. VAT registered entities can reclaimVAT paid and it is important for any newenterprise to process its VAT registrationin a timely fashion.PLANNING ANDENVIRONMENTALPlanning Permission is requiredbefore buildings can be constructed,significantly altered or the use of samechanged. Applications are made to therelevant Local Authority with a right ofappeal to An Bord Pleanala (the appealsboard). A planning application is apublic process affording members of thepublic a right to make observations andobjections. Planning Permission will takeat least three months to procure; howeverthis process can take significantly longerif there is a third party objection and/oran appeal or review.Each Local Authority is required to devisea Development Plan at regular intervalsin which areas are zoned for particularuses to facilitate the orderly developmentof regions and ensure that adequateinfrastructure is available to support suchdevelopment. Planning Permissions mustbe in accordance with the DevelopmentPlan.All works (including internal nonstructuralworks) must be carried out inaccordance with the Building Regulationswhich regularise construction standards,energy efficiency, fire safety requirementsand disabled access to premises amongstother matters.EU legislationAn extensive and ever-increasingnumber of EU directives now form partof Irish domestic law. The EnvironmentalProtection Agency of Ireland (EPA),the Department of the Environmentand Local Authorities all play a role insanctioning and controlling activitieslikely to impact on the environmentthrough assessment of environmentalimpact statements, planning conditionsand IPC licences.

ByrneWallace I Why Ireland? A guide to doing business in Ireland I 17Intellectual propertyIntellectual property (IP) is often an organisation’s most valuableasset. For companies with an extensive IP portfolio, Ireland is anideal location for their intellectual property, both from aregulatory / legal perspective as well as a tax perspective. TheIrish legal and tax regimes offer a highly effective and efficientmeans of enhancing research and development opportunitiesfor IP and for exploiting and protecting this intangible asset.The key areas of IP protection availablein Ireland are generally considered tobe patents, trademarks, copyright anddesigns. However, in addition to theseareas, Irish law also effectively protectsother forms of intellectual property, suchas domain names, databases, customerlists and computer software. Ireland alsohas a well developed data protectionand e-commerce regime.ACQUISITION OFINTELLECTUALPROPERTY RIGHTSPatentsPatent protection is a very strong formof protection for inventions, as it offersmonopoly rights to owners of inventionsin a defined territory. The Irish patentsystem is governed by the Patents Act1992 and there are two types of patentprotection available under that Act: (1)a full-term patent and (2) a short-termpatent. The duration of the full-termpatent is 20 years from the date of filing,provided that annual renewal fees arepaid and the patent is not revoked atany stage. The term of a patent can beextended via a supplementary protectioncertificate for a maximum of fiveyears where the patent is for a medicinalproduct for human or animal use or forplant production.products. The period of protection fora short-term patent is 10 years and aswith full-term patents supplementaryprotection certificates may be obtained.Ireland is also a member of theEuropean Patent Organisation and hasratified the Patent Co-Operation Treaty(PCT). When granted, a EuropeanPatent has the effect of a national patentin each of the countries designated. AEuropean Patent designating Irelandtherefore has the same effect as if itwere a full-term patent granted by theIrish Controller of Patents. The PCTprovides a system whereby a singleinternational application allows for thedesignation of some or all thecontracting countries. A PCT applicationrequesting patent protection in Irelandis deemed to be an application for aEuropean patent for Ireland.Trade MarksTrade marks are protected under Irishlaw under the Trade Marks Act 1996 andalso at common law by way of action forpassing off. A trade mark registered underthe 1996 Act confers on the proprietorexclusivity of rights and there is norequirement to prove a reputation inorder to obtain registration.Registration is initially for a period often years (from the date of filing of theapplication) and it can subsequently berenewed every ten years on paymentof the renewal fee, with the potential tolaw indefinitely.Ireland is party to the Community trademark system, and an applicant mayapply through the Irish Patents Officefor a Community trade mark which, ifregistered, will take effect throughoutthe 28 EU Member States. Ireland hasalso ratified the Madrid Protocol whichgoverns international trade mark registrations.An international registrationproduces the same effects as a separateapplication for national registration ofthe mark made in each of the Countriesdesignated by the applicant.DesignsIreland has implemented Europeanharmonising legislation in relation toregistered industrial designs via theIndustrial Designs Act 2001. Registrationconfers an exclusive right to authoriseothers by means of licensing to use thedesign. The legislation provides thata design that is new and has individualcharacter may be registered.

18 I Why Ireland? A guide to doing business in Ireland I ByrneWallaceManufacturers are allowed a 12 monthgrace period within which they canmake a design available to the publicwithout destroying its ‘novelty’ andthereby the prospects of registeringit at a subsequent date. This allowsdesigners to test the success of productson the market before embarking on theregistration process. When a design isregistered, protection is granted initiallyfor 5 years. Protection can then berenewed for four further periods of fiveyears each (on payment of the prescribedfee), giving a maximum of 25 years’protection from the date of registration.The Community unregistered design rightregime came into effect in Ireland on 6March 2002. This unregistered right issimilar to copyright in that no registrationrequirement must be satisfied and theright comes into existence automatically.The Community unregistered design rightlasts for 3 years from the date on whichthe design is first made available to thepublic within the EU.which protection is sought. Ireland is asignatory to the Berne Convention for theProtection of Literary and Artistic Workswhich requires its signatories to recognisethe copyright of works of authors fromother signatory countries (known asmembers of the Berne Union) in the sameway as it recognises the copyright of itsown nationals.Database RightsCopyright subsists in original databasesand the period of protection lasts until70 years after the death of the author.The Copyright and Related Rights Act,2000, introduced a new form of copyrightprotection available where there hasbeen a substantial investment made inobtaining, verifying or presenting thecontents of a database. This databaseright expires 15 years from the end ofthe calendar year in which the making ofthe database was completed. However,a database which is continually updatedcould have the benefit of protectionunder this new database right indefinitely.decision, it is advantageous to enter thecase in the Commercial Court list. Theefficiency of disposal of cases and thequality of judgments of our CommercialCourt have been recognised internationally.The threshold of €1 million that acase must normally meet in order to beeligible for the Commercial Court doesnot apply to cases involving IP rights,meaning that the court has jurisdictionover the majority of IP disputes.The EU-wide directive on enforcement ofintellectual property rights wasimplemented in Ireland in 2006, andcomplements the comprehensive rangeof enforcement tools and reliefs availableto those seeking to enforce their IP rightsthat were previously generally availableunder Irish law.CopyrightThe Irish Copyright and Related RightsAct, 2000, is recognised as one of themost sophisticated pieces of legislationin this field in Europe. Copyrightprotects original literary, dramatic,musical and artistic works, as well asfilm, sound recordings, broadcastsand the typographical arrangement ofpublished editions, moral rights in suchwork, computer software and originaldatabases, and performances andperformer’s rights.There is no system of registration forcopyright protection in Ireland and thisform of protection arises automatically onthe creation of an original work, providedthat it has resulted from the creator’s skilland effort and is not simply copied fromanother work.In most cases, copyright lasts for thecreator’s lifetime plus 70 years, althoughthe duration of protection doesdepend on the nature of the work forEXPLOITATION OF INTELLECTUALPROPERTY RIGHTSFrom a legal perspective, owners of IPrights are generally free to exploit theserights under the principle of freedom tocontract, although Irish and EuropeanCommunity competition law will berelevant in certain circumstances.ENFORCEMENT OF INTELLECTUALPROPERTY RIGHTSOne of the most attractive features ofIreland’s IP regime is the dispute resolutionmechanism available to owners ofintellectual property rights who wish toenforce those rights. The Irish High Courthas a dedicated forum, the CommercialCourt, for resolving commercial disputes,including IP disputes. The CommercialCourt was established in 2004 and is oneof the most innovative developmentsin the Irish IP legal landscape in recenttimes. This Court provides a condensedprocedure for enforcement of IP rights.For parties wishing to expedite mattersand obtain an early and informed

ByrneWallace I Why Ireland? A guide to doing business in Ireland I 19TechnologySome of the world’s leading technology companies such asMicrosoft, Dell, Google and Facebook have chosen to locateoperations in Ireland due to the favourable conditions for investment.Ireland has succeeded in attracting such technologycompanies not only due to the attractive tax benefits butalso due to the access to an educated and skilled workforceand a favourable regulatory regime for the creation and exploitationof intellectual property.DATA PROTECTIONIreland had one of the earliest dataprotection legislative regimes inEurope. The Data Protection Acts 1988and 2003 are the principle pieces oflegislation governing the area of dataprotection in Ireland. The Acts specifythe data protection principles whichmust be complied with when personaldata is being processed. Differentprovisions apply depending on whetherthe personal data being processed isclassed as sensitive or non-sensitivedata. Duties of data controllers and dataprocessors are also set out in the Acts.Certain rights are conferred on datasubjects including the following: theright to be informed of data being kept;the right to prevent data being usedfor the purpose of direct marketing; theright to access personal data; the rightto change or remove details; and theright to prevent use of personal details.The Acts also contain restrictions onthe transfer of personal data by a datacontroller to a country outside of theEuropean Economic Area (the “EEA”)and provides that such a transfer maynot take place unless that particularcountry or territory ensures an adequatelevel of protection for the privacy ofits data subjects in relation to theprocessing of their personal data. Thereare also a number of ways to transferdata to “unapproved states” such asusing the Safe Harbour Principles orusing a special EU approved modelcontract.E-COMMERCEIreland was one of the first countriesin the EU to pass legislation providingfor a framework to encourage andfacilitate the growth of electroniccommerce and electronic transactionsin Ireland. The Electronic CommerceAct 2000 provides for the recognitionof electronic contracts, electronicsignatures and also gives admissibility toelectronic information generally. The Actalso addresses electronic originals, theretention of electronic documents andthe admissibility of electronic evidencein courts. In addition, the Act providesfor the accreditation and supervision ofcertification service providers and alsocontains provisions dealing with theirliability.Ireland has a comprehensive legislativee- commerce regime derived fromEU law and Ireland has implementednumerous EU Directives in this area,including the following:(i) Electronic Signatures Directive(1999/93/EC);(ii) Electronic Commerce Directive(2000/31/EC);(iii) Distance Selling Directive (97/7/EC);(iv) Electronic Money InstitutionsDirectives (2000/28/EC and2000/46/EC).The Electronic Commerce Regulations2003 implemented the remainingprovisions of the Electronic CommerceDirective which had not beenimplemented by the Act. It appliesto almost all organisations who offercommercial services to customersonline. It provides that certaininformation must be provided by anonline service provider in a mannerwhich is easily, directly and permanentlyaccessible to recipients of a service.The Distance Selling Directive aimed toharmonise laws in respect of distancecontracts for consumers throughout theEU, substantially increasing protection

20 I Why Ireland? A guide to doing business in Ireland I ByrneWallaceconsumers. The Distance SellingDirective provides that certain priorinformation must be supplied by thesupplier and it also provides details ofthe cooling off period and confirmationof the contract terms. The requirementsof the Electronic Commerce Regulationsand the Distance Selling Directive canbe met by having appropriately draftedterms and conditions.CLOUD COMPUTINGIreland is home to a high concentrationof data centres through whichtechnology giants such as Microsoft,Vodafone, Google, EMC, Yahoo! andAmazon Web Services drive most oftheir traffic and host the majority oftheir services for Europe. The key factorfor choosing to locate here is Ireland’sambient climate which means thatmany data centres do not have to usetheir cooling equipment for much ofthe year, which results in a substantialsaving for the data centre owners. Otherinfluential factors are Ireland’s geologicalstability, proximity to high-speed fibreoptic communications networks andaffordable energy rates. As a resultIreland is ideally placed as a Europeanbase for cloud computing activities ofcompanies.Data Protection and Data SecurityTwo of the most important issues arisingfrom the fact that cloud computingtranscends national borders concerncompliance with national data protectionlaws and the security of the data that isplaced in the cloud. As detailed abovethere is a well established body of lawat European and domestic level settingout the data protection obligations ofcompanies in relation to personal datathey control and process. Generally thecustomer will be responsible forcompliance with the Data ProtectionActs (as the data controller), but shouldensure that:• the supplier takes appropriatetechnical and organisationalmeasures to protect the data and tokeep it secure;• the contract with the supplierincludes appropriate termscontrolling what the supplier mayand may not do in respect of thedata; and• any transfer of data outside the EEAis dealt with appropriately.Where the cloud computing modelinvolves passing personal data to athird party, the Data Protection Actsprohibit companies from doing sounless there are adequate measures inplace to protect personal data. Manydata centres that are used to hostservices are located outside the EEAand as mentioned above personal datacannot be transferred outside of theEEA unless strict conditions are met.Many international cloud computingservice providers are now publicisingtheir moves to establish data centreswithin Ireland because the onus on thecustomer to comply with data protectionlegislation is reduced.Other legal issues with regard to cloudcomputing which need to be addressedare data security, liability for servicefailure, licensing issues, jurisdictionalissues and the ability to recover datastored or processed in the cloud.

ByrneWallace I Why Ireland? A guide to doing business in Ireland I 21“ByrneWallace provides a one stop shop for all legalaspects of the foreign direct investment project.The advice, support, service and attention fromByrneWallace has played a big part in the smoothsuccess of our operation.”Bentley Systems

22 I Why Ireland? A guide to doing business in Ireland I ByrneWallaceCompetition andantitrustIreland’scompetition, oranti-trust, regimeis governed bythe CompetitionActs 2002 to2014. The Actsprovides for bothcivil and criminalsanctions againstboth businessesand executives,where they breachcompetition law.The Competitionand ConsumerProtectionCommission isresponsible forthe enforcementof both Irish andEU competitionlaw in Ireland, withEU competitionlaw applying topractices whichhave an affect oninter-state trade,within the EuropeanUnion.Enforcement and administration of theCompetition Acts, 2002 to 2014 is theresponsibility of the Competition andConsumer Protection Commission(“CCPC”). Whilst the CCPC caninvestigate anti-competitiveconduct and secure undertakingsfrom businesses to desist with anticompetitiveconduct, only the IrishCourts may award damages or imposefines for anti-competitive practices.ANTI-COMPETITIVE AGREEMENTSSection 4 of the Competition Act 2002governs anti-competitive arrangementsand is modelled on Article 101 of theTreaty on Functioning of the EuropeanUnion (TFEU). Both the CCPC and IrishCourts apply EU competition law, as wellas domestic competition law, in Ireland,where the result of any agreement orpractice has an affect of trade betweenMember States (of the EU).Section 4 prohibits anti-competitivearrangements between undertakings,decisions by associations ofundertakings and concerted practicesinvolving undertakings which prevent,restrict or distort competition in Irelandor any part of Ireland, unless theycomply with certain specific conditionsset out in Section 4 of the Act or are thesubject of a declaration (see VerticalRestraints below at Sect 7, for anexample of a declaration).Section 4(5) of the Act sets out theconditions which must be fulfilled for anindividual agreement to benefit from theexemption. These are:• the arrangement must contributeto improving the productionor distribution of goods orthe provision of services or topromoting technical or economicprogress• the arrangement must allowconsumers a fair share of theresulting benefit• the arrangement must not imposeon the undertakings concerned anyterms which are indispensable tothe attainment of those objectives• the arrangement must not affordundertakings the possibility ofeliminating competition in respectof a substantial part of the productor services in question.ABUSE OF DOMINANCEThe provision of the Act relating toabuse of dominance is primarily basedon Article 102 of the TFEU. The Actprohibits the abuse of dominance byany undertaking having a dominantposition in Ireland or in any part ofIreland. The Act does not seek to definean abuse of a dominant position, but itdoes indicate that the following mattersmay be regarded as an abuse:• directly or indirectly imposing unfairpurchase or selling prices or otherunfair trading conditions• limiting production, markets ortechnical development to theprejudice of consumers• applying dissimilar conditions toequivalent transactions with othertrading parties thereby placingthem at a competitive disadvantage• making the conclusion of contractssubject to the acceptance byother parties of supplementaryobligations which by their natureor according to commercial usagehave no connection with the subjectof such contract.Examples of abuse of dominanceinclude predatory and discriminatorypricing, refusal to supply, marginsqueeze, and tying /bundling, amongstothers.

ByrneWallace I Why Ireland? A guide to doing business in Ireland I 23RIGHT OF ACTION & IMPOSITIONOF PENALTIESIn serious cases, such as price fixing,where an agreement is found to breachcompetition law, it will be void (i.e.legally unenforceable) as a matter oflaw. Other penalties include (a) finesof up to the greater of 4 million or10% of world-wide turnover on theundertakings in breach of either ofthese provisions and on the officersof such undertakings (e.g. directors,managers); as well as (b) civil sanctionson undertakings and the executivesof undertakings in breach of the Act.In addition, a finding of the existenceof an anti-competitive arrangementmay result in criminal sanctions, withpotential imprisonment of officers ofthe undertaking for up to five years inthe event that cartel offences have beencommitted (e.g. price fixing). Criminalactions for breaches of the Act are takenby the Director of Public Prosecutions,with a number of successful convictionshaving been secured in recent years.An aggrieved party, who has suffered asa result of any action prohibited underthe Act, has a right of civil action forrelief.Under the Act, a Court may granteither an injunction restraining thecontinuance of the matter complainedof or impose a declaration, along withgranting damages (including exemplarydamages). Where the court has decidedthat an undertaking has abused itsdominant position contrary to the Act, itmay also require the dominant positionto be discontinued or adjusted, forexample, by ordering the dominantundertaking to divest assets.ENFORCEMENT BY THE CCPCThe CCPC enjoys far-reachingenforcement and investigative powersunder the Act, including the ability toconduct dawn raids on companies inIreland, where it has reason to believethat evidence may exist in relation toanti-competitive practices. As part ofthe dawn-raid process (covered by anappropriate search warrant), the CCPCmay search executives’ homes and cars,in addition to business premises, withthe ability to seize documentation. TheCCPC may also summon executives /individuals to provide evidence on oathand produce documents relating toalleged anti-competitive practices.IRISH MERGER REGIMEA notifiable merger arises once control(essentially the capability of exercisingdecisive influence) over an undertakingis acquired, regardless of how suchcontrol is acquired. Asset acquisitions,as well as full function joint ventures, arealso notifiable. It is mandatory under theAct for undertakings to notify the CCPCof any merger or acquisition whichexceeds the relevant thresholds. Thosethresholds being:• the aggregate turnover in the Stateof the undertakings involved is notless than €50 million; and• the turnover in the State of eachof two or more of the undertakingsinvolved is not less than €3 million.The CCPC has issued a guidancenote, clarifying the term “carrying onbusiness” to mean either where: a) thecompany has a physical presence onthe island (such as a registered office,branch or agency) and sales and/orsupply of services to customers onthe island of Ireland; or, b) where thecompany has sales into the island ofIreland of at least €2 million in the mostrecent financial year.Where the above thresholds are notmet, but the merger gives rise to seriouscompetition concerns, the parties mayvoluntarily notify the transaction to theCCPC, for its assessment. This gives theparties legal comfort that, once clearedby the CCPC, the transaction will notbe investigated under either Section4 or 5 of the Competition Act 2002, ifimplemented.The test applied by the CCPC iswhether the merger or acquisition wouldsubstantially lessen competition in Irishmarkets for goods or services.Failure to notify a notifiable merger isan offence, punishable by a fine of up to€250,000. Where a notifiable merger isimplemented without being cleared bythe CCPC, the merger is void as a matterof Irish law.VERTICAL AGREEMENTSThe CCPC Declaration in Respect ofVertical Agreements and ConcertedPractices of 1 December 2010, providesa safe-harbour for vertical agreements,including exclusive and selectivedistribution agreements, that giveslegal comfort to suppliers and buyersthat relevant vertical agreements do notbreach the prohibition of Section 4(1)of the Act, subject to certain conditionsbeing met, including:

24 I Why Ireland? A guide to doing business in Ireland I ByrneWallace“10 of the Top 10 “Born on theInternet” Companies50% of the world’s top banks.”Source: IDA Ireland: Ireland Update Q4 20141) That the market share of thesupplier does not exceed 30% ofthe relevant market on which it sellsthe contracted goods / services, andthat the market share of the buyerdoes not exceed 30% of the relevantmarket on which it purchases thecontracted goods;2) That the agreement does not restrictthe buyer’s ability to determine itssale price (Resale Price Maintenance),without affecting the supplier’s abilityto recommend a sale price or imposea maximum sale price;3) That the agreement does notimpose territorial restrictions on thebuyer’s ability to sell the contractgoods or services, subject to certainexemptions such as;– allowing the restriction of activessales into the exclusive territory orto an exclusive customer groupreserved for the supplier orallocated by the supplier to theanother buyer;– restricting sales to end users by abuyer operating at the wholesalelevel of trade;– restricting sales by members of aselective distribution system tounauthorised distributors withinthe territory reserved by thesupplier tooperate the system;4) That the agreement does notrestrict active or passive sales toend users by members of a selectivedistribution system operating atretail level of trade;5) That any direct or in-direct noncompeteobligation, is not ofindefinite duration and does notexceed five years.A “non-compete” obligation is definedas any direct or indirect obligationcausing the buyer not to manufacture,purchase sell or re-sell goods or serviceswhich compete with the contract goodsor services, or any an obligation on thebuyer to purchase from the supplier morethan 80% of the buyer’s total purchasesof the contract goods or services (andtheir substitutes). A non-compete whichis tacitly renewable beyond a period of5 years is deemed to be of “indefinite”duration.In the CCPC opinion, verticalagreements, that meet the conditionsof its Declaration, comply with theconditions of Section 4(5) of the Act (asper Section 2 above).

ByrneWallace I Why Ireland? A guide to doing business in Ireland I 25Credit institutions andbankingOVERVIEWThe Central Bank of Ireland (theCentral Bank) is the entity with overallresponsibility for the regulationand supervision of financial servicesproviders, such as banks, insurersand investment firms, operating inIreland. In addition to its supervisoryand oversight roles, the Central Bankis tasked with ensuring the stability ofthe Irish financial system overall. Theregulatory provisions applicable atnational level are, to a large extent,driven by European Union measureswhich are designed to enhance theconcept of the single market andfacilitate cross-border establishmentand provision of services within theEuropean Union.AUTHORISATION AND OWNERSHIPOF CREDIT INSTITUTIONS/BANKSIn order to provide banking services inIreland an undertaking must, subject tocertain exemptions, be the holder of alicence from the Central Bank of Irelandor be authorised in a member state ofthe European Union pursuant to theapplicable banking directives and havepassported its services into Ireland.The application process is detailed andcan take in excess of twelve monthsfrom inception, depending on the trackrecord of the applicant institution. Anundertaking must establish appropriatepolicies and procedures relating tofunding their activities relative to thesize and the nature of its assets in orderto obtain a licence from the CentralBank. An undertaking must also meetminimum capital requirements andensure appropriate levels of liquidity.Particular emphasis will be placed onthe structure and composition of theboard and senior management. Inthis regard, a new annual CorporateGovernance Code for Credit Institutionsand Insurance Undertakings wasintroduced in 2010 which sets outprescriptive measures for the minimumstandards that Irish banks, amongothers, are expected to satisfy. The nextone is due to be publish in early 2015.INVESTMENT FIRMSThe Markets in Financial InstrumentsDirective (the MiFID Directive) cameinto effect in November 2007. TheMiFID Directive introduced the conceptof a harmonised set of rules acrossthe European Union governing theorganisation of the business of aninvestment firm necessary to obtainan authorisation, and rules governingthe conduct of an investment firm’sinvestment business activities. TheMiFID Directive has been transposedinto Irish law by the EuropeanCommunities (Markets in FinancialInstruments) Regulations, 2007 (asamended) (the MiFID Regulations).The Central Bank is responsible for theregulation and supervision of MiFIDfirms (investment firms) in Ireland.Investment firms offering financialservices to clients or customers locatedwithin the EEA are potentially affectedby the MiFID Directive, either directlyor indirectly. The MiFID Regulationsprovide that any party that proposes toact as an investment firm in Ireland mustbe either authorised by the Central Bankto do so or authorised to do so underthe MiFID Directive by the competentauthority in another Member State (byway of passport).If an undertaking’s occupation orbusiness is the provision of one or moreinvestment services to third parties ona professional basis, or the activity ofdealing on own account on a professionalbasis, relating to financial instrumentsthen that undertaking will be consideredto be an investment firm for the purposesof the MiFID Regulations.Broadly speaking, the types of firm likelyto fall within MiFID’s scope include:• retail banks;• investment banks;• portfolio managers (excluding firmsacting as managers of collectiveinvestment schemes);• stockbrokers and broker-dealers;• many futures and options firms;• corporate finance firms;• wholesale market brokers;• operators of Regulated Markets andmulti-lateral Trading Facilities;• providers of custody services; and• commodities and venture capitalfirms.The MiFID Regulations exempts a varietyof entities from the requirement toobtain authorisation under the MiFIDRegulations (including insurers, entitieswho provide services exclusively togroup entities, investment funds andpension funds and their managers anddepositories, various public bodiesetc.) There are other exemptions forinvestment firms which carry on certainown account dealing activities.

26 I Why Ireland? A guide to doing business in Ireland I ByrneWallace“ Ireland was ranked 10th worldwide for thenumber of jobs created in business supportservices, including call centers, sharedservices centers and business outsourcing ina study undertaken by IBM highlighting therole of foreign direct Investment.”

ByrneWallace I Why Ireland? A guide to doing business in Ireland I 27INVESTMENT INTERMEDIARIES ACT,1995While the MiFID directive replacedand repealed, at European Union level,the provisions of the Investment inIreland must therefore consider thepotential application of both the MiFIDRegulations and the IIA to its business.A different regulatory regime will applyto a firm depending on whether it offersan IIA service or a MiFID service andit is most important to note that thedefinitions of “investment services” and“financial instruments” under MiFID areof “investment business services” and“investment instruments” under the IIA.If your business involves the provisionof “investment business services”or provision of services relating to“investment instruments” under the IIA,further authorisation as an investmentbusiness firm under the IIA will berequired.THE PASSPORT CONCEPTDirective 2006/48/EC provides thatany credit institution authorised by therelevant supervisory authority of anEU member state (the Home State),can do business in any other MemberState without obtaining a licence/authorisation from the supervisoryauthority of that member state (theHost State). The licence/authorisationissued by the Home State essentiallyconstitutes a “passport” to operatewithin specified parameters in the HostState. Having passported in, the bankmay (i) set up a branch in the Host State;or (ii) provide banking services in theHost State without formally establishinga branch in the Host State, dependingupon the scope of their application. Theauthorisation must address all the of theapplicant’s relevant proposed activities.The credit institution must lodge certaininformation with the national supervisoryauthority of its Home State, which willbe notified to the Host State regulator.The position of the Central Bank is thatthe relevant institution should not carryon business in Ireland (as the Host State)until the Central Bank has receivednotification from the Home State. Oncethe notification is received, the relevantcredit institution is placed on a list ofauthorised entities and can start to dobusiness in Ireland.In addition, the MiFID Directiveimproved the operation of the‘passport’ for investment firms by moreclearly delineating the allocation ofresponsibilities between Home Stateand Host State for passported branchesand generally clarifying some of thejurisdictional uncertainties that aroseunder the ISD.

28 I Why Ireland? A guide to doing business in Ireland I ByrneWallaceInvestment funds2.3 trillion of funds are administered from IrelandOVERVIEWIreland is recognised globally as one ofthe leading jurisdictions for the establishmentand administration of investmentfunds. The range and flexibility ofthe legal structures which are availablehas facilitated the growth of fundsaimed at investors with varying investmentcriteria in a multiple of jurisdictions.Ireland enjoys a reputation as acentre of excellence both for promoterslooking to establish funds and for theservicing of investment vehiclesdomiciled in other jurisdictions.THE REGULATORY AUTHORITIESThe Central Bank is responsible for theauthorisation and ongoing regulation ofinvestment funds in Ireland. It is also thesupervisory authority for the authorisationand regulation of providers ofinvestment services in Ireland whichservices include giving of investmentadvice, provision of fund administrationand custodial services and receiving,transmitting and executing orders inrelation to securities.The Irish Stock Exchange Limited (theISE) is responsible for the listing ofinvestment funds in Ireland. In order tolist, a fund must first appoint a Sponsor,which is registered with the ISE. TheSponsor is responsible for ensuring thatthe fund is suitable for listing and fordealing with the ISE in relation to allaspects of the fund’s listing. Manypromoters choose to list their funds onthe Irish Stock Exchange as their targetinstitutional investors may beconstrained to invest only in listedsecurities or securities which are listedon a recognised and regulated stockexchange.TYPES OF FUNDSThe principal forms of funds undermanagement in Ireland are:• UCITS funds constituted inthe form of (i) unit trusts, (ii)investment companies with variableshare capital, and (iii) commoncontractual funds; and• Non-UCITS funds constitutedin the form of (i) unit trusts, (ii)investment companies with variableshare capital, and (iii) commoncontractual funds Funds may alsobe established in other forms suchas investment limited partnerships,although these are very rare inpractice.UCITSUndertakings for Collective Investmentin Transferable Securities (UCITS)are collective investment schemesestablished and authorised under aharmonised EU (EU) legal framework.A UCITS established and authorisedin one EU Member State can be soldor “passported” cross border intoother EU Member States withouta requirement for an additionalauthorisation. This “European passport”enables fund promoters to create asingle product for the entire EU ratherthan having to establish an investmentfund product on a jurisdiction byjurisdiction basis.NON-UCITSNon-UCITS funds are establishedpursuant to domestic law rather thanEU law and, as such, do not qualify fora passport in order to be marketed inother EU Member States. It follows,therefore, that the Central Bank hasmore flexibility regarding the impositionor relaxation of conditions generally.In developing its regulatory regimefor non-UCITS, the Central Bank hasdrawn a distinction between differentcategories of investors, in terms of levelof ‘sophistication’ (i.e. whether retailor professional). In addition, certainspecialist funds (for example, real estateand private equity funds) which are notpermitted under the UCITS rules arepermitted as non-UCITS.Non-UCITS funds can be established inbroadly three regulatory categories: (i)retail, (ii) professional investor; and (iii)qualifying investor. Retail non-UCITSare subject to similar conditions andrestrictions in relation to investmentand borrowing as UCITS funds. Theseconditions and restrictions are relaxedsomewhat for professional investorfunds. The conditions and restrictionsrelating to investment and leveragedo not apply almost in full in respectof funds which are marketed solelyto qualifying investors. The investorsthemselves must also meet a qualifyinginvestor test.TAXATION OF FUNDSUnless an investor in an Irish fund isresident or ordinarily resident in Ireland,generally there is no tax payable inIreland on either a fund’s income andgains or in respect of any paymentsreceived from the fund by the investor.Irish regulated funds, however theyare constituted, are not subject to taxon their income and gains but insteadoperate an exit tax regime where apotential tax liability only arises inrespect of certain chargeable eventssuch as a payment of any kind to aninvestor, or a transfer of units. In certaincircumstances, the fund may elect not tooperate the exit tax on such a deemedchargeable event, in which

ByrneWallace I Why Ireland? A guide to doing business in Ireland I 29case it must report certain investordetails to the Irish Revenue and the taxliability arises on the investor on a selfassessment basis. However, such anexit charge tax only arises to the extentand only in respect of Irish resident orordinarily resident investors.Many categories of Irish residentinvestors are entitled to an exemptionfrom this exit tax including pensionschemes, insurance companies, otherfunds, charities, approved retirementfunds, approved minimum retirementfunds, special savings, incentive accountsand PRSAs and credit unions.THE IRISH COLLECTIVE ASSETMANAGEMENT VEHICLE BILL 2014The new Irish Collective Asset-Management Vehicle Bill 2014 (the“ICAV”) is expected to be introducedover the coming months. The ICAV willbe a new corporate structure tailoredspecifically to provide for Irish investmentfunds. The introduction of this newstructure will inhance Ireland’s attactiveas a place of domicile for collectiveinvestment funds.Presently investments are structured aspublic limited companies under PartXIII of the Companies Act 1990. Whilstthis is proven to be an effective formof governance, not every requirementis necessarily applicable to investmentcompanies and thus ICAVs, followingtheir enactment, will only be subject torequirements that are relevant to them, inturn reducing the administrative burdenand costs.One of the main advantages provided bythe new ICAV structure will be the ICAVsability to self-elect their classification. ForUS tax purposes, ICAV will be treated asa partnership thus allowing them to avoidadverse tax consequences. This differsto the status of and Irish public limitedcompany which currently is not able to“check the box” for US tax purposes.SERVICE PROVIDERSFunds established in Ireland are requiredto appoint (i) an Irish-based custodianto act as a custodian/trustee of Irishauthorised funds for the safe keeping ofthe funds assets and (ii) an Irish basedadministrator responsible for maintainingthe accounts and records of the fund.Custodians and administrators mustbe approved by the Central Bank. Theinvestment manager for an Irish fund isnot required to be located in Ireland butmust seek the approval of the CentralBank. A fund set up as an investmentcompany must have at least two Irishresident directors. The managementcompany of unit trust or a CCF must alsohave at least two Irish resident directors.REDOMICILE OF FUNDSTO IRELANDThe Companies (MiscellaneousProvisions) Act 2009 enables non-Irishfund companies to redomicile into Irelandon the basis that the migrating fundcompany will continue its existence asa company registered under Irish law.This is likely to be of particular interest topromoters of alternative investment fundssuch as hedge funds, real estate fundsand private equity funds who wish toredomicile their offshore funds to aregulated, well-serviced OECD and EUjurisdiction. In particular, the legislationwill benefit the many hedge fundmanagers seeking to avail of thedistribution opportunities afforded by theUCITS Directive and for these preparingfor the introduction of the proposedAlternative Investment Fund ManagersDirective, which currently contemplatesthe granting of an EU marketing passportto EU domiciled funds only.

30 I Why Ireland? A guide to doing business in Ireland I ByrneWallaceOur inwardinvestment expertiseOur Foreign DirectInvestment Teamdraws on thetechnical expertiseof lawyers fromacross the firm’spractice areas. Wepool our diverseandcomplementaryskills in anintegrated, practicaland innovativemanner accordingto client needs.This dynamic andflexible approachhas enabled usto develop andmaintain a leadingposition in theprovision of focusedadvice tomultinationals inIreland.Corporate and commercialOur team has dedicated foreigndirect investment lawyers and isfully integrated with our CompanySecretarial team which can providecompany secretarial services tomultinationals. Our Corporate andCommercial department advises on theestablishment of the Irish operation,mergers and acquisitions, restructuringand contracts. Our New York officefacilitates US clients needing Irishadvice in an as efficient a manner aspossible.Regulatory and anti-trustOur team advises on a broad rangeof regulatory issues including foreigndirect investment grants, executivevisas and industry specific licences.TaxOur tax team, a full service tax practice,serves a broad range of domesticand multinational clients in all majorbusiness sectors. We advise on alltax aspects of establishing operationsin Ireland and tax issues arising forestablished operations. We also haveextensive experience in cross-borderand international tax matters.Intellectual propertyOur Intellectual Property Groupprovides expert advice on bothcommercial and contentious intellectualproperty matters. The team bringstogether a wealth of experience inadvising clients on intellectual property,ICT and industry specific mattersand regularly advises on intellectualproperty rights (patents, trademarks,design rights and copyright) andrelated issues – including registrations,exploitation (licenses and assignments),IP due diligence and IP enforcement.Our lawyers focus on providingpragmatic solutions to the domesticand international IP issues faced byour clients. In relation to contentiousIP matters, the firm has a unit headedby a specialist intellectual propertylitigation partner with experience inall areas of hard and soft IP litigation,including obtaining search orders andusing all forms of ADR from arbitration tomediation and co-mediation.LabourOur labour unit provides tailored legaladvice on all aspects of EU and Irishlabour issues including employmentcontracts, trade union recognition,disputes and transfer of undertakings.Real estateOur property unit uses its strong workingrelationship with Irish commercial agentsto help negotiate favourable commercialterms as efficiently as possible.OutsourcingOur outsourcing unit draws togetherthe extensive experience, industryknowledge and business acumen ofexperienced lawyers from each of thekey practice areas within the firm toensure that our clients receive a seamlessand comprehensive service in what canbe a sensitive sector.We recognise the importance ofcontracts which are sufficiently detailedto govern the relationship on a day today basis but also sufficiently flexibleand practical to anticipate and facilitatechange.

ByrneWallace I Why Ireland? A guide to doing business in Ireland I 31Our lawyers have advised the following multinationals ontheir Irish operations

32 I Why Ireland? A guide to doing business in Ireland I ByrneWallaceOur teamCatherine GuyManaging PartnerCatherine is ManagingPartner of the firm. Shepreviously headed up ourProperty department and has a strongtrack record in large scale commercialdevelopment projects. She works witha wide range of clients and deals with avariety acquisition and investment anddevelopment proposals. This includesland acquisition and sales, mixed usedevelopment schemes, significantcommercial development schemes andtax driven investments.Direct line: +353 1 691 5678Email: cguy@byrnewallace.comDarren DalyPartner, ICT & TechnologyDarren advises on bothgeneral corporate lawmatters and also provides specialistadvice on Intellectual property, ICT,e-commerce, data protection andtechnology issues with a particularemphasis on advising technologyclients in the health services, pharma,and medical device sectors.Direct line: +353 1 691 5274Email: ddaly@byrnewallace.comDennis AgnewPartner, CorporateDennis is a corporatetransactional lawyer whoheads the firm’s ForeignDirect Investment team and acts for abroad range of US and Irish companies.Dennis’ role is to provide Irish legaladvice and know-how to US companiesin as efficient a manner as possible.Direct line: +353 1 691 5293Email: dagnew@byrnewallace.comColin SainsburyPartner & Head of LifeSciencesColin is a corporate transactionallawyer with over 16 years’experience in the international life sciencesector and acts for a broad range of Irishand foreign life sciences companies. Colinwas previously Senior VP and GeneralCounsel of Elan Corporation’s Drug DeliveryDivision.Direct line: +353 1 691 5277Email: csainsbury@byrnewallace.comPaul McGennisPartner, Banking & Real EstatePaul is a Senior Partner andformer Managing Partner ofByrneWallace. His areas of legal expertise,for over 25 years, include FDI, banking andcommercial property. Paul has a proventrack record of the development andmanagement of bespoke multi-disciplinarylegal teams on behalf of large domestic andinternational clients acting as a single pointof contact. Paul has been instrumentalin extending the Firms international reachparticularly with US based investmentclients. Paul is one of the founder membersof Gateway to Europe and is a foundingmember of the REITS Forms(www.irishreits.ie).Tel: +353 1 691 5202Email: pmcgennis@byrnewallace.comMichael KennedyPartner & Head ofEmploymentMichael leads ByrneWallace’semployment law team andhas more than 25 years experienceadvising exclusively on contentious andnon-contentious employment mattersacross all aspects of the employmentrelationship. Michael advises a widerange of clients including corporations,public bodies, professional organisationsand individuals. He is Secretary of theIrish Society for Labour Law and is amember of the Law Society’sEmployment and Equality Committee.Direct line: +353 1 691 5660Email: mkennedy@byrnewallace.comAnthony SmythConsultant, TaxAnthony is the Head of theTax Group where he advisesinternational corporationsand financial institutions on all areas oftax involving Ireland. He specialises infinancial services (including insurance,funds, leasing and structured products /capital markets) inward investment, crossborderplanning projects and transferpricing.Direct line: +353 1 691 5281Email: asmyth@byrnewallace.com

www.dglaw.co.ilDoing BusinessIn Israel

Table of ContentsIsrael – Introduction …………………………………………………………………………………….… 2Forming a company in Israel ……………..………………………………………………………… 4Taxation - monthly and annual tax filings ……………………………………………… 6Privileged and approved enterprises ………………………………………………………… 8Research & Development (R&D) ……………………………………………………….…….… 12Employment & Labor law …………………… ……………………………………..……………….. 14Work Permits (visas) ………………………………………………………………….…..………………… 17Venture Capital & Private Equity……………………………………..……..…………………. 17Competition Law ……………………………………………………………………………..……………… 24Oil and Gas exploration ……………………………………………………...……..……………… 26

1Israel - IntroductionThe State of Israel is a small, parliamentary democracy of8,002,300 people, situated on the eastern shore of theMediterranean Sea. The major urban centers are the capital,Jerusalem with a population of approximately 801,000 people,the metropolitan area of Tel Aviv with 3,405,000 and Haifa with268,000.Important industries are software, telecommunications, hi-tech,bio-tech, tourism, precision instruments, chemicals,pharmaceuticals and textiles.Until recently, Israel’s natural resources were limited to potash,phosphates, bromine and salts, found in the Dead Sea area. Inthe last few years, Israel has begun developing off-shore gasfields such as the Tamar and Leviathan Fields, and it is expectedthat the country has enough gas reserves to be a net energyexporter for many years to come.Free Trade AgreementsIsrael has signed free trade agreements with the European Union, the USA andthe European Free Trade Association (EFTA). Israel has also signed free tradeagreements with Canada and Turkey.Israel-European Union Free Trade AgreementIn 1975, Israel and the EU signed an agreement providing for the establishmentof a Free Trade Area for industrial and some agricultural products. According to

the agreement, and subject to rules of origin, Israel’s industrial exports to the EUare exempt from customs duties and other import restrictions. Israel haseliminated all duties on industrial imports from the EU.Israel-USA Free Trade AgreementIsrael and the USA signed a Free Trade Agreement which was fully implementedon January 1, 1995. The agreement, subject to rules of origin (which are differentfrom those of the EU agreement), eliminates all import duties and traderestrictions between the two countries.Israel-OECD MembershipOn May 2010, the Organization for Economic Co-operation and Development(OECD) accepted Israel as a full member in the organization.LandThe Israel Lands Administration (ILA) is responsible for managing land owned bythe State of Israel, Keren Kayemet Le'Yisrael (Jewish National Fund, KKL), andRashut Pituach (Development Authority), comprising 93% of the land in Israel.Land managed by the ILA is considered to be State-owned and is generally soldor leased on the basis of issuing tenders.

2Forming a company in IsraelFor most enterprises, a company is the preferred way of doingbusiness in Israel.A company generally has limited liability, where the companymay be sued to the extent of its capital and resources. It ispossible to be self-employed or to form a partnership or limitedpartnership under Israeli or foreign law.Limited partnerships usually enable foreign individual investorsto credit Israeli taxes (or utilize any Israeli losses) for taxpurposes in their home country.Subsidiary of a non-Israeli companyIn the past, many Israeli hi-tech companies were formed as subsidiaries of a US(or other foreign) parent corporation in order to avoid Israeli capital gains taxupon any exit at rates of up to 50% .Israel now offers passive foreign investors exemption from capital gains tax inmost cases upon exit - see below.Furthermore, the use of a US parent corporation is particularly problematic as theUS may tax undistributed profits under complex provisions in Subpart F of the USInternal Revenue Code.An Israeli company may enjoy tax breaks on its profits - see below.It is possible to operate a business operation in Israel as a branch of a foreigncorporation. In this way, it may be possible to avoid dividend withholding tax (upto 25%) in most cases, but company tax (see below) will still be payable onIsraeli source profits. The Israeli Tax Authority may request to see the overseasaccounting records of the foreign corporation to check how much income andexpenses are allocable to its Israeli branch for company tax purposes. US

investors occasionally use US LLCs with no other activity to conduct Israelioperations that do not qualify for Israeli tax breaks.Most Israeli businesses tend to be conducted by an Israeli company as this iseasier when dealing with Israeli suppliers, customers and banks.Dual listingsThe Securities Law enables Israeli companies traded on foreign exchanges todual-list, and it empowers the Israel Securities Authority to allow foreigncompanies traded in U.S. markets to dual-list under the law as well.The Securities Law enables companies to list easily and at almost nocost, and offers many benefits for U.S.-traded companies, their founders andinvestors, as well as for the Israeli securities industry.Companies trading on the NASDAQ, New York Stock Exchange or London StockExchange for at least a year since their IPO's, or for less than a year if theymaintain a market value exceeding $150 million, are eligible to dual-list under theSecurities Law.Incorporating in Israel and registering for tax purposesCompanies may be either public or private. A private company must have at leastone shareholder and one director. A public company is a company whose sharesare traded on a stock exchange (in Israel or abroad) or have been offered to thepublic pursuant to a prospectus under the Securities Law and are held by thepublic. It usually takes 1-2 days to incorporate an Israeli company. A foreigncompany must be registered at the Israeli Companies Registry as a foreigncompany if it has a place of business or an office for share transfers in Israel.Separate registrations of a new business in Israel are needed for:(1) income tax (2) Value Added Tax (3) payroll and other withholding taxes (4)national insurance (social security).Non-residents are required to appoint an Israeli tax representative and VATrepresentative if any part of their activities is conducted in Israel. The taxrepresentative is empowered to pay Israeli tax from the foreign resident's assets.For more info please visit our site: www.dglaw.co.il

3Taxation - monthly and annual tax filingsThe Israeli tax year is normally the calendar year. Subsidiaries offoreign publicly traded companies may sometimes be allowed touse a different fiscal year.Companies are generally required to file audited annual taxreturns and financial statements within five months of the end oftheir fiscal year, but extensions may be obtained. Israeli certifiedpublic accountants are usually allowed to spread the filing of thetax returns over a period of up to 13 months after the end of thetax year.Companies must file monthly returns on account (bi-monthlysometimes if the business is small) accompanied by taxpayments. The filings and payments are made by the 15 th dayafter the end of the month at a local post office or bank. If ataxpayer is a few days late, a computer-generated penalty isusually issued.Officially, books and returns should be in Hebrew or Arabic,although English is usually accepted by most tax offices.

Payments for expensesFor most domestic Israeli expenses, withholding tax rates of up to 50% areprescribed unless the recipient has received confirmation from the Israeli TaxAuthority allowing a lower rate. For remittances from Israel, the Israeli banksmust withhold tax, generally at rates of 25%-31%, unless the remittances relateto imported goods. A withholding tax exemption or a reduced withholding ratemay be obtained from the payor's tax office when a treaty applies or when thepayments are for services that are rendered entirely abroad. Failure towithhold will result in a denial of the relevant expense and lead topossible penalties.Capital GainsWith regard to capital gains, subject to any tax treaty, foreign residents aretaxable on Israeli source "real" (inflation adjusted) capital gains at varying rates(individuals: 20-49%; companies: 25-31%). Foreign residents not doing businessin Israel may enjoy an exemption from Israeli capital gains tax (tax only in theinvestor's home country) where: The investors reside in a country that had a tax treaty with Israel during the 10years before their investment and report it within 30 days to the Israeli TaxAuthority. Shares in a research-intensive company were issued to the foreign residentinvestor on or after January 1, 2003. Venture capital funds obtained an advance tax ruling from the Israeli taxauthorities. Securities are traded on the Tel Aviv Stock Exchange. Securities of Israeli companies are traded on a recognized foreign stockexchange. Any applicable tax treaty (restricted to under 10% shareholders in the US-Israel tax treaty) provides so.

42Privileged and approved enterprisesThe Law for Encouragement of Capital Investments (the "Law")main goal is to increase the attractiveness of the Israeli economyin the face of international competition for investment anddevelopment. The Law promotes a more geographically balanceddistribution of the population across the country and aims tostrengthen the peripheral areas. The law includes two mainschemes of government incentives: the grant scheme whichallows up to 30% government grant on qualified investments forestablishing or expanding an industrial enterprise in preferredareas; and the tax incentive scheme.The Law applies to industrial enterprises which qualify as an"International Competitive Enterprise", which is defined asincluding industrial enterprises that own Productive activitiesincluding: textiles, food, electronics, chemicals, pharmaceuticals,computer software, biotechnology, nanotechnologies, etc.In order to meet the International Competitive Enterprise rule,25% of the enterprise's revenues should be driven by exporting tolarge international markets.LocationThe government grants scheme is affected by the location of the company'sactivities.

Several regions in Israel have been declared National Priority Regions (PriorityArea A), among them:The GalileeJordan ValleyThe NegevJerusalem (for hi-tech enterprises)The Grant SchemeAn industrial enterprise located in "Priority Area A" fulfilling the terms of the Law,may be eligible for grants to be calculated as a percentage of theapproved investment. The grants may be 20% of the actual investmentsof the enterprise for the follow assets: Buildings, machinery and other equipment (not including private vehicles)owned by the enterprise and used according to the approved program (by theIncentive Center). Expenses made for land development. Expenses made for renovation of the building.The grant scheme is only applicable for enterprises located in Priority Area A.Enterprises from other areas do not qualify for the grant scheme, but may beentitled to tax benefits under the Law.Enterprises complying with the requirements of the Law may benefitsimultaneously from both the tax benefits (lower corporate tax rate) as well asapplicable non refundable grants (only relevant for Area A).The tax benefits schemeEnterprises located in Priority Area A are eligible for a reduced corporate tax of8% on all preferred income. Corporate tax rate on other regions is 12%.Preferred EnterprisesAs mentioned, the tax benefits scheme will apply only to Preferred Income (asdefined below) of a Preferred Enterprise. According to the law, a PreferredEnterprise is one of the following: Engaged mainly in biotechnology or nanotechnology, and has obtained theapproval of the Head of Industrial R&D Administration; At least 25% of its Preferred Income was produced from exporting tointernational markets; or

Engaged mainly in the field of renewable energy.Preferred IncomeThe Preferred Income is the gross income of a Preferred Enterprise (notincluding discounts) which was produced or which accrued during the course ofbusiness activities of the enterprise in Israel, as follows:Income from products manufactured in Israel, including componentsmanufactured by subcontractors. Income derived from natural resources(Gas, Minerals, Oil) would not be calculated as part of the Preferred Income.Income from the sale of semiconductors manufactured by independentsubcontractors, as long as the IP belongs to the Preferred Enterprise.Income derived from royalties for the use, or the right to use, a patent orknowhow which was developed by the Preferred Enterprise.Income derived from industrial research and development made for a foreignresident, as long as an approval of the head of the R&D center has beenprovided.Tax BenefitsPreferred Enterprise is eligible for tax benefits for each tax year on which it hasfulfilled a 25% export condition.Investments IncentivesCorporate Income Tax of a Preferred Enterprise is 6% if the enterprise is locatedin "Priority Area A", and 12% if it is located in other regions.However, a transitory provision for the years 2011 to 2014 determine thefollowing tax rate as described in the following table (ordinary tax rate is shownfor convenience):Tax Year Priority Area A Other Areas Ordinary Tax Rate2011 10% 15% 24%2012 10% 15% 25%2013 7% 12.5% 25%2014 7% 12.5% 25%2015 6% 12% 25%

Tourism ProjectsThe law for encouragement of capital investments also applies to tourismenterprises."Tourism Enterprise" is defined as a tourism facility which includes at least 11hotel rooms and which provides sleeping arrangements services and additionalservices such as catering, recreation and leisure. Unique tourist attractions havealso been included as Tourist Enterprises.The Grant SchemeTourist Enterprises which are located in Priority Area A will be eligible for a nonrefundable grant of up to 20% of approved investments. Tourist Enterpriseswhich are located in the Negev will be entitled to a 30% grant.Tourist Enterprises which are located in Priority Area B will be eligible for a nonrefundable grant of up to 10% from approved investments.In addition to the grants, Tourism Enterprises are eligible for tax benefits,including: reduced corporate income tax rates, and accelerated depreciation onrelated assets.

5Research & Development (R&D)The Office of the Chief Scientist (OCS) of the Ministry ofEconomy and Trade is responsible for implementing governmentpolicy regarding the support and encouragement of industrialresearch and development in Israel. Research & developmentgrants are available from the OCS at rates ranging from 20% to85% of the approved budget. R&D grants of up to 50% may alsobe available from a number of bilateral funds signed betweenIsrael and: Maryland, New York, Wisconsin, Massachusetts,Colorado, Oregon and Virginia, USA; UK, Belgium, France,Germany, Italy, the Netherlands, Portugal, Spain, Sweden,Canada, Hong Kong, India, Korea, China, Australia, Singaporeand Taiwan.Development of Novel ProductA single or multi-year program that will provide know-how, processes or methodsfor the manufacture of a new product or the major improvement of an existingone or a new process or a major improvement in an existing process. Theproduct must have a sizeable potential for export sales. Support is in the form ofa conditional grant amounting to 30-50% of the approved R&D budget.Support for Start-Up CompanySupport is in the form of a conditional grant of 66% of the approved R&D budgetup to a maximum of $250,000 per year for up to two years. Any approved R&D

expenditure above $250,000 may receive a conditional grant of 50%. The R&Dsupport includes beta-site testing as well as patent registration.Royalty PaymentsAny income deriving from an R&D program that has enjoyed government supportis liable for the payment of royalties to the OCS. The royalty payments are basedupon a percentage of sales up to the repayment of the grant.Technological IncubatorsTechnological incubators provide a supportive framework enabling entrepreneurswith innovations to develop their ideas into a commercial product, and to reachthe point at which they can attract capital investments from the private businesssector. R&D activities conducted in technological incubators are entitled to grantsof up to 85% of the approved program or 100% in peripheral incubators. Thegrant is limited to NIS 2.1 million for a two-year period.Biotechnological IncubatorsBiotechnological incubators are aimed at supporting biotech research, given thespecific nature and needs of that sector. In line with the current tendency forprivatization, the private sector, in the form of franchisees, plays a key role in theproject. The government’s participation in such projects is through a convertiblebond, while the incubators are actually managed by the franchisees.The franchisee obtains, for each project, a government loan of up to 85% of theapproved budget in the 1st year, up to 80% in the 2nd year and up to 75% in the3rd year. The approved budget for up to 3 years shall not exceed NIS 8,100,000.The franchisee is responsible for raising supplementary funding to cover the restof the approved budget.For each incubator project, the franchisee negotiates with the entrepreneur thepercentage of control in the company running the project.The franchisee provides a physical plant with adequate infrastructure forbiotechnological R&D, administrative staff and accessibility to consultingservices. In return for covering the operating costs of the biotechnologicalincubator, the franchisee receives up to 5% of the shares of each companyaccepted by the incubator.Aid to Individual Technology Entrepreneurs

6TNUFA- The Israel Idea Promotion Center is a non-profit Israeli, governmentsupportedorganization, dedicated to helping individual entrepreneurssuccessfully commercialize their new product ideas by providing seed moneygrants of 85% or up to NIS 200,000 in addition to free legal, marketing andbusiness-management consultations. Most of TNUFA’s budget is based onroyalties from successful projects.EmploymentTrade Unions and Workers CouncilsThere is no legal requirement for employers to recognize any trade union unlessa majority of the work force votes in favor of such recognition. Agreementsbetween employers and trade unions over pay and conditions are not binding bylaw and unions may not take industrial action without first securing a majorityvote in a secret ballot of their members. There is no legal requirement foremployees to be represented on the board of directors of companies.Labor Related CostsThe Israeli employee’s labor and social security costs include the following: National Insurance (Social Security )For an employee earning up to 60% of the average national salary, theemployer will pay 3.45% in national insurance and the employee will pay0.4% of his salary in national insurance. For an employee earning more than60% of the average national salary, the employer will pay 6.75% in nationalinsurance and the employee will pay 7% of his salary in national insurance.Cover includes unemployment insurance, maternity benefits, work injury, childallowances, old age pensions, medical care costs and reserve military dutycompensation.Health InsuranceFor an employee earning up to 60% of the average national salary, theemployer will deduct 3.10% from the employee’s salary for health insurancepayments. For an employee earning more than 60% of the average nationalsalary, the employer will deduct 5% from the employee’s salary for healthinsurance payments.Paid Vacation

Employees are entitled to yearly paid vacations of from 2 to 4 weeksdepending on length of employment. They are also entitled to a recreationalallowance based on length of service.Severance Pay and Pension FundsEmployees are entitled to severance pay on dismissal or reaching retirementage (67 for men and 64 for women) but not on voluntary resignation. Howeversome employers are required to pay severance pay on resignation underterms of specific labor agreements.Severance pay amounts to one month’s salary for every year of employmentbased on the last month’s salary received. Many employers provide for this bymonthly payments to a provident fund.In addition, most employers are required by labor agreements to makemonthly payments to pension funds, at the rate of 5% of salaries, foremployees’ retirement pension.Sick Leave:Employees are entitled to paid sick leave.Education Fund:Some employers make provision for the ongoing education of senior andacademic employees by monthly payments, at the rate of 5 - 7.5 % ofemployees’ salaries, to a provident fund.For more info please visit our site: www.dglaw.co.il

7Israel B-1 Work VisaForeign employees, have no vested right to enter Israel for thepurpose of employment. A foreigner, who wishes to performwork in Israel, regardless of duration, must first obtain a workpermit (B-1) from the Ministry of Interior, the Department ofForeign Workers.A foreign worker will be deported from Israel if he works withouta work permit and he will further be subjected to fines andpossible imprisonment. In addition the employer will beprevented from sending other employees to Israel and will besubjected to criminal offences if he employs a foreigner under atourist visa.Obtaining a work permit entails completing a four-step process.1. The first step involves receiving a recommendation from the Ministry ofInterior to work in Israel. This is possible only after convincing the Ministry thatthe employee is an expert in his field, earning more than twice the averagesalary in the market and proving that there is no other local Israeli citizen whocan perform the same task.2. The second step includes submitting a request to the Ministry of the Interior toinvite the worker to Israel.3. The third step involves having the visa stamped in the worker’s passport.

4. The fourth step involves the stamp of multiple entries, after entering thecountry.Reviewing a working permit application usually take up to 90 days. Permitsapproved will usually be given for 1 year but they may be extended for up to 5years depending on the uniqueness of the worker in question.It is not possible to convert a tourist and business visitor’s visa (B-2) to a workingvisa (B-1) while the foreigner is in Israel. Therefore an employee who wishes towork in Israel is required to obtain a work permit before entering Israel.The Ministry of the Interior has started to conduct periodic inspections ensuringthat companies comply with local law concerning the employment of expats inIsrael. The inspectors intend to make sure that foreign employees are lawfullybeing employed and have a valid B1 working visa. There is an increasing trend toinitiate criminal proceedings against employers and their managers (personally)that unlawfully employ foreign employees.According to the Law of Entry into Israel, 1952, a person entering Israel without apermit, or committing a breach of one of the conditions of his entry permit, iscommitting an offense and the punishment is one year of imprisonment. Such aperson may be deported.A person entering Israel without a permit, providing false information to obtain forhimself or another a visa or a license to reside, committing a breach of one of theconditions of his entry permit, or who violates any other instructions orregulations of this law commits an offense and the punishment is one year ofimprisonment. The offender may be deported.Employing a foreign worker who is not permitted to work in Israel according to theLaw of Entry will be subject to a fine of ILS 75,300 (approx $ 20,350) or two yearsimprisonment.Further to the Foreign Workers Law (Unlawful Employment) – 1991, an employerwho employs a foreign worker who does not have a work permit will be liable topay fines of ILS 58,400 (approx $ 15,780) and an additional fine of ILS 5,600(approx $1510) per worker for each day that the offense continues.In the event that the foreign worker is employed unlawfully, the punishment maybe up to one year’s imprisonment or a fine of ILS 116,800 (approx $ 31,568) andan additional fine of ILS 5,600 (approx $1510) per employee for every day theoffense continues.The fines are subject to future changes.For more info please visit our site: www.dglaw.co.il

8Venture Capital & private equityIsraeli VCs are focused on technology companies, mainly in thefields of communications and components, software,semiconductor chip design and manufacture, Internet ande-commerce, Bio-tech, Cleantech and medical devices.Types of target companyIn VC transactions, target companies may be seed/pre-seed stage companies orlater-stage companies. The companies may be registered in Israel or becorporations registered in Delaware with Israeli subsidiaries.InvestorsIn recent years, several foreign venture funds and venture lending companieshave opened offices in Israel and have invested in local Israeli companies.Tax IncentivesForeign investors are generally exempt from Israeli capital gains tax on therealization of their investment in Israeli high-tech companies if the followingconditions are met: the shares were purchased on or after 1 January 2009; theshares were not held through a permanent establishment maintained by the nonresidentshareholder in Israel; the shares are not in a company whose assets

consist primarily of real estate; the shares were not purchased from a relatedparty. The exemption does not apply to shares in publicly-traded companies.VC Fund managementVC funds typically establish a management company in Israel, and pay an annualmanagement fee of approximately 2.5% of total fund commitments. This fee maydecrease after an investment.VC Fund as Limited PartnershipsVC funds are not regulated and do not require a license. VC funds are usuallylimited partnerships and are subject to securities legislation restricting the offeringof limited partnership units to no more than 35 persons, excluding certainqualified investors consisting primarily of financial institutions.Investor ProtectionThe VC fund’s limited partnership agreement governs the relationship betweeninvestors and the fund. Investors usually seek: confirmation of limited liability;restrictions on the use of proceeds; Employee Retirement Security Act 1974(ERISA) restrictions; restrictions on recourse borrowing; financial reporting; keyman provisions; non-competition restrictions preventing promoters from settingup a competing fund until certain time periods have passed; conflicts of interestprovisions.Investment ObjectivesLong term capital appreciation from high growth, technology companies.VC funds generally have a 7-10-year term with the ability to extend this term by anumber of one-year periods (usually two to three extensions). VC funds usuallyaim to complete their investment period (deploy capital in new portfolioinvestments) within 3-4 years of the fund’s initial closing (while retaining capitalfor management fees and follow-on investments until exit) and to exit most of itsinvestments within 3-5 years of investment. Since 2001, the average periodbetween investment and exit has lengthened. VC funds in Israel now usuallyextend their investment periods (sometimes to 6-7 years).Investments

VC funds generally invest in equity in the form of preferred shares. The use ofconvertible debt is also very common before an investment round, both as bridgefinancing for immediate use and as a means to circumvent the need to set acompany valuation when no third party investors are available to set a valuation.Venture lending, where lenders provide secured loans to portfolio companies andreceive an equity component in the form of warrants or an option to invest in thenext round, has increased over the last few years.Preferred ShareholdersHolders of preferred shares typically have the right to receive a dividend inpriority to the payment of a dividend to any other class of shares. Although thisright is very common, most high-tech private companies in practice do not paydividends.Liquidation preferenceThe right to a liquidation preference, typically a participating preference entitlingthe holder to some kind of preferred return (in Israeli companies, with an annualinterest component, typically 6% to 8%), followed by the right to participate withthe holders of ordinary shares on an “as converted” basis in any remainingproceeds. The liquidation preference applies both to actual liquidation of thecompany and to most exit events including a sale of all or substantially all of theassets of the company.Anti-dilution protection is typically implemented by adjustments to the conversionrate under which the preferred shares may be converted into ordinary shares.The protection ranges from full ratchet to broad-based weighted average.Board RepresentationTypically, investors receive representation on the board of directors and/or theright to appoint a non-voting observer to the board. This right may be conditionalon the investor maintaining a certain level of ownership in the investee company.Protective provisionsAs holders of preferred shares, the fund also benefits from protective provisions,requiring the approval of the fund (occasionally of a director appointed by thefund, and occasionally of a specified majority of all holders of preferred shares)for a variety of actions, often including: creation or issuance of a class of

securities equal or senior to those held by the fund; approval of exit events(mergers and acquisitions and initial public offerings); the payment of dividends;the repurchase of ordinary shares; adverse changes to the rights of the shares;increasing the size of the board of directors; incurring indebtedness in excess ofa specified amount; material changes to the business of the company;management type activities including, hiring and firing of key executives; banksignature rights; establishment of an annual operational budget.Right of first refusalInvestors usually have a right of first refusal in relation to the sale of shares byother shareholders. Sometimes this right is limited to the holders of a certainminimum number of shares (for example, 2% of the outstanding share capital)and is exercised on a pro rata basis. This right is usually not reciprocal, that is,the holders of ordinary shares do not have a right of first refusal in relation tosales of shares by the fund.Exercise of the right of first refusal is often conditional on the purchase by theshareholders of all the shares being offered. There are exceptions for transfers ofshares for estate planning purposes.No saleOften founders are completely barred from, or severely limited in selling theirshares for a specific period of time (often at least three years, but occasionallyuntil exit). Typically, exceptions are made for transfers of shares to familymembers or for other bona fide estate planning purposes. These restrictions areintended to ensure that the founders recognize their economic interests as beinglinked with the success of the company.Minority Shareholder ProtectionInvestors have the right to sell shares together with the founders (or other holdersof ordinary shares), if and when the founders sell shares to third parties. Thisright (tag-along right or right of co-sale) may be exercised if the investor electsnot to exercise its right of first refusal. The rationale is that the investors areinvesting in the founders, and if the founders decrease their shareholdings, theinvestors have the right to exit with the founders.

Tag-along rights also serve to make it more difficult for founders to sell theirshares and, in practice, force any such sale to be made in full coordination withthe investors. It is very uncommon for founders to have tag-along rights inrelation to sales of shares by VC funds.Drag-along (bring-along) rightsDrag-along rights (also referred to as bring-along rights) facilitate the sale of thecompany in the face of opposition from minority shareholders. The articles ofassociation often provide that where a specific percentage of shareholders (oftenincluding the holders of a specific percentage of preferred shares) agree to abona fide third party purchase offer, all shareholders must then sell.The Companies Law 1999, provides that if the holders of 80% (90% in the caseof companies established before 1999) of shares wish to sell, then allshareholders can be forced to sell.Pre-emption rightsInvestors almost invariably require pre-emptive rights to participate in futurefinancing rounds. Sometimes the right is limited to participation on a pro ratabasis; other times the investor obtains a right of over-allotment to take up sharesthat other participating shareholders elect not to purchase. Companies typicallyattempt to resist the request for over-allotment rights. These rights are generallysubject to certain standard exclusions, such as: issuances on exercise ofemployee share options; issuance on conversion of preferred shares; and alsocertain issuances of warrants to strategic partners in transactions not primarilyintended as financing transactions.ConsentsApproval by the company’s shareholders and board of directors is required tocomplete the investment. In addition, if the company has already raised funds inan earlier investment round, approval by the earlier investor is also likely to berequired. If the company has received tax incentives or a grant from the Ministryof Economy and Trade, consent from the department providing the tax incentivesor grant is also required.

Share OptionsIsraeli companies usually provide incentives to employees (including founders)by granting share options which are subject to vesting over a number of years..Employees typically receive share options, which are exercisable if the employeecontinues to be employed during the relevant vesting period.For more info please visit our site: www.dglaw.co.il9Competition lawThe Antitrust Law, 1988, is enforced by the Israeli AntitrustAuthority. Under the Law, a restrictive arrangement is anagreement made between parties conducting business, where atleast one of the parties restricts itself in a way that could obviateor reduce the business competition between that party and partor all of the other parties to the agreement, or between that partyand an entity that is not a party to the agreement.An agreement that determines prices, market share, profitmargins, or quotas will be deemed to be a restrictive agreement.However, the law excludes some agreements from its generaldefinition and they are not considered restrictive agreements(e.g. entitlement to use proprietary rights, internationaltransport, etc.).Participation in any restrictive agreement is prohibited unlessthe agreement has been approved by a court of law, received atemporary permit from the Director-General of the AntitrustAuthority or was granted an exemption.

In recent years, enforcement of this law has become moreevident, in view of the expansion of the Antitrust Authority andthe growing awareness of the advantages of competitive marketsin Israel.Block exemptionIn 2000, the Director-General of the Antitrust Authority defined block exemptionsthat exempt specific agreements from the need for a permit.These block exemptions include R&D agreements, joint ventures and franchises.According to the Restrictive Business Practices Law, the following mergers andacquisitions require the approval of the Antitrust Authority:Subsequent to the merger or acquisition, the share of the merged parties inthe production, sale, marketing, or purchase of a single product or a group ofproducts or services will exceed 50%.The combined turnover of the merged companies (domestic turnover only) inthe fiscal year prior to the merger exceeded NIS 150 million (approximatelyUS$ 39 million), and at least two of the merged companies have aturnover of more than NIS 10 million (approximately US$ 2.62 million)each.One of the parties is already a monopoly.4For more info please visit our site: www.dglaw.co.il

10Oil and Gas Exploration in IsraelIsrael’s “Oil Rush”Israel is currently undergoing an oil and gas exploration boom.Recently, Israel has seen some of the world’s largest discoveriesof gas and oil. These new oil and gas discoveries havejumpstarted significant foreign investment into drilling andexploration rights. The most recent discovery in December 2010named Leviathan was the world’s largest discovery of natural gasin a decade. It is projected to have 19 trillion cubic feet of gas(540 billion cubic meters) of gas, enough to supply all of Europefor over a year. Many experts believe there could be more than 4billion barrels of crude oil below these natural gas deposits.Israel’s infrastructure minister called this discovery “the mostimportant energy news since the founding of the State of Israel.

Tamar Gas FieldThe Tamar gas field is a natural gas field in the Mediterranean Sea off the coastof Israel. The gas field is located roughly 80 kilometres (50 mi) west of Haifa inwaters 1,700 metres (5,600 ft) deep. While there have been small oil and gasdiscoveries in Israel over the decades, Tamar was the first large-scalehydrocarbon resource discovered within Israeli territory. It was also the first gasdiscovery made in geological layers dating back to the Oglio–Miocene era in theup-until-then little-explored Levant basin of the Eastern Mediterranean. SinceTamar's discovery, large gas discoveries have been made in other analogousgeological formations of the same age in the region. The Tamar gas field isestimated to contain a probable 275 billion cubic metres (9.7 trillion cubic feet) ofnatural gas. In September 2010, Noble announced that development of theTamar field was beginning at an expected cost of $3 billion, and with a targetcompletion of Q4 2012. In March 2012 the Tamar partners signed a 15-year,US$14 billion deal with the Israel Electric Corporation to supply it with 42 billioncubic meters (BCM) of natural gas, with an option to increase the gas purchasesup to $23 billion. By March 2012, the consortium developing Tamar had signeddeals worth up to a total of $32 billion with six Israeli entities, thereby committingup to 133BCM, or approximately half of the deposit's total probable reserves of275BCM (as estimated by Texas-based Netherland, Sewell & Associates Inc.,(NSAI).

Leviathan Gas FieldThe Leviathan gas field is a large natural gas field located in the MediterraneanSea off the coast of Israel. It was discovered in June 2010. The gas field islocated roughly 130 kilometres (81 mi) west of Haifa in waters 1,500 metres(4,900 ft) deep in the Levantine basin, a rich hydrocarbon area in one of theworld’s larger offshore gas finds of the past decade. The Leviathan gas field islocated 47 kilometres (29 mi) south-west of the Tamar gas field.The first well, Leviathan 1, was first drilled to a depth of 5,170 metres (16,960 ft)where the deposit found was estimated to contain 16 trillion cubic feet (450 billioncubic metres) of natural gas. The well was drilled by Homer Ferrington drilling rig.The second stage of drilling of the Leviathan 1 well was intended to reach adepth of 7,200 metres (23,600 ft) where the estimated natural gas reserve is anadditional 9 trillion cubic feet (250 billion cubic metres) and potentially 600 millionbarrels of oil. While the gas discovery at -5170m was made in the Tamar sandslayer which was already known to contain gas in other geological formations ofthe same type in the region, the additional oil and gas potential exists in a deeper

layer which to date has not been drilled in the Levant basin. At the time ofdiscovery, the Leviathan gas field was the largest find ever discovered in theunder-explored area of the Mediterranean Sea and the largest discovery in thehistory of Noble Energy. Noble Energy operates Leviathan with a 39.66%working interest; Delek Drilling holds 22.67%; Avner Oil Exploration holds22.67%; and Ratio Oil Exploration holds the remaining 15%. In February 2014,Woodside Energy agreed to buy a 25% stake of the Leviathan field for up toUS$2.55 billion.The field is being developed Noble Energy Corp , which will remain the project'slead partner, while Delek Drilling, Avner Oil Exploration and Ratio Oil Exploration,will each sell one-quarter of their stakes to Woodside.Following these discoveries preceded by smaller significant natural gasdiscoveries, Israel is seeing new entrants into its oil and gas industry. NobleEnergy, which has significant ownership in the Leviathan and Tamar fields hasthe largest footprint in Israel. ATP Oil & Gas Corporation and Caspian DrillingCompany, a subsidiary of State Oil Company of Azerbaijan Republic (SOCAR),one of the world's largest oil companies are both currently operating inIsrael. Other oil and gas companies with smaller operations have recentlyentered the market such as: GeoGlobal Resources, Transocean, Baker Hughesand Halliburton. However, most of the larger global oil and gas corporations(Shell, Exxon-Mobil etc) have stayed away. Former Petroleum Commissioner,Dr. Yaakov Mimran said this was due to the fact that those global oil companieswould lose oil suppliers in countries hostile to Israel (70% of the world’s oil arelocated in such countries.) This gives more opportunity for lesser known andsmaller firms interested in entering the Israeli gas market.”

The Laws Governing the Israeli Oil and Gas IndustryThe Israel Petroleum Law (1952) (the “Law”) and subsequent amendments andregulations governs the exploration and production of petroleum in Israel,including the continental shelf. The competent authority that grants licenses is, inmost cases, the Ministry of National Infrastructure while applications forpetroleum rights are submitted to the Petroleum Commissioner.Under the Law, “Petroleum” is defined as “any petroleum fluid, whether liquid orgaseous, and includes oil, natural gas, natural gasoline, condensates and relatedfluid hydrocarbons, and also asphalt and other solid petroleum hydrocarbonswhen dissolved in and producible with fluid petroleum”.Petroleum resources belong to the State of Israel, whether or not located on statelands. No person is allowed to explore for or produce petroleum withoutreceiving a right under the Law. The Law provides for three types of rights, tworelevant to the exploration stage and the third relates to production.Preliminary PermitThe lowest level right is the preliminary permit, which may be granted for a periodnot exceeding 18 months. The permit allows the prospector to conductpreliminary investigations, except for test drilling, to ascertain the prospects fordiscovering petroleum in the area covered by the permit. The recipient of apreliminary permit is entitled to request a priority right on the permit area, which,if granted, prevents the awarding of any other petroleum right in the area. Thereare no statutory restrictions as to the maximum size of the permit area or to thenumber of permits which may be held by a prospector, however the policy is toaward no larger an area than that which the applicant has a reasonable plan ofoperation and has demonstrated possession of the necessary financial resourcesto execute the plan.LicenseThe second type of right is the license, which provides an exclusive right toundertake further exploration work, requiring the drilling of test wells. The initialterm of a license is up to three years and may be extended for up to an additionalfour years. A license area may not exceed 400,000 dunams (approximately100,000 acres).

Production Lease (Concession)Upon the discovery of petroleum, the licensee has a statutory right to receive thethird type of right, which is a production lease. The initial lease term is 30 years,extendible for a maximum period of 50 years. A lease confers upon the lesseethe exclusive right to explore for and produce petroleum in the lease area andrequires that the lessee produce petroleum in commercial quantities (or pursuetest or development drilling). The lessee is entitled to transport and market thepetroleum produced, subject to the right of the Government to call upon it tosupply local needs first, at market price. A lessee is liable to pay a royalty of12.5% of the quantity of petroleum produced and saved from the lease area,excluding the quantity of the petroleum used in operating the leased area, andsubject to a minimum royalty set forth in the Law.The holder of a petroleum right is expected to carry out its operations with duediligence and in accordance with the accepted practice in the petroleum industry.It is required to submit progress and final reports, as detailed in the Law andRegulations. The information supplied by the holder of the petroleum right is keptsecret for as long as it has a petroleum right (permit, license or lease) in the areaconcerned.Holder of a petroleum right is entitled to import to Israel, free of customs duties,the goods required by it for petroleum exploration purposes.The grant of a petroleum right does not automatically entitle the holder to enterthe land to which the right applies or to carry out exploration and production work.Such work often requires the consent of other public bodies such as planningauthorities, maritime nature reserves etc.). The holder of a petroleum right mayrequest the Government to acquire, on its behalf, land required for petroleumpurposes.The Law provides for an administrative structure, headed by the PetroleumCommissioner who acts in consultation with an Advisory Board. The Law isunder the responsibility of the Minister of National Infrastructures.Applications for petroleum rights are submitted to the Petroleum Commissioner,in accordance with the provisions set out in the Law and Regulations.

The award of petroleum rights, with the exception of the preliminary permit andpriority right, is a matter of public record and is published in the PetroleumRegister and in the Official Gazette.Dardik Gross & Co. Law FirmDardik Gross & Co has significant knowledge and advisory experience inobtaining licenses and permits for drilling and exploration rights in Israel. DG isable to provide assistance in coordinating with the Ministry of NationalInfrastructures and with the Petroleum Commissioner and handle all regulatoryissues and negotiations. In addition, DG can secure work permits for foreignworkers employed in drilling and exploration. DG can assist with contacting theproper authorities in order to ensure the fastest, most efficient route for takingadvantage of the immense oil and gas opportunities that Israel has to offer.DISCLAIMER: The information above is not legal advice; it is foreducational and informational purposes only.For more info please refer to our site: www.dglaw.co.il.For specific legal advice, please do not hesitate to contact DG law -Dardik Gross & Co., at: gross@dglaw.co.ilDoing business in Israel

LUXEMBOURG ALTERNATIVEINVESTMENT VEHICLESMay 2014

CONTENTSITHE FAVOURABLE LUXEMBOURG ENVIRONMENT FORINVESTMENT TRANSACTIONS 4II THE FIVE KEY VEHICLES FOR INVESTMENT TRANSACTIONS 4A. UNREGULATED SPECIAL PURPOSE VEHICLES IN CORPORATEFORM (SPVs), INCLUDING HOLDING COMPANIES 41. Legal Forms of SPV 42. Regulatory Aspects 43. Tax Aspects 44. Participation Exemption 55. Applicability of AIFM 5B. SECURITISATION VEHICLES 61. The 2004 Securitisation Law 62. Definition of a Securitisation under 2004 Securitisation Law 63. Securitisation Companies 64. Securitisation Funds 65. Creation of Multiple Compartments 66. Issuance of Debt and Equity Securities 67. Regulated or Unregulated Securitisation Vehicles 68. Bankruptcy Remoteness 69. Tax Treatment 610. Applicability of AIFM 7C. THE SICAR 71. Purpose of the SICAR Regime and Eligible Investments 72. Necessity of Risk Capital 73. Investments in Real Estate 74. Eligible Investors 75. Organisation of SICARs 76. Multiple Compartments 87. Capitalisation 88. Regulation and Reporting 89. Taxation 810. Applicability of AIFM 8D. SPECIALISED INVESTMENT FUND 81. Eligible Investors 82. Organisational Flexibility 93. Capital and Payment of Dividends 94. Investment and Leverage Restrictions 92

5. Investment Policy 96. Management and Investment Manager 97. Supervision 98. Disclosure and Reporting 109. Taxation 1010. Applicability of AIFM 10E. PRIVATE WEALTH MANAGEMENT COMPANY 101. Permitted Investments 102. Lending Transactions 103. Business Organisation 114. Eligible Investors 115. Supervision 116. Taxation 117. Applicability of AIFM 11F. LAW ON ALTERNATIVE INVESTMENT FUND MANAGERS 11III. COMPARATIVE TABLE 123

LUXEMBOURG ALTERNATIVE INVESTMENT VEHICLESI. The Favourable LuxembourgEnvironment for InvestmentTransactionsThe Grand-Duchy of Luxembourg offersinvestors and promoters a very efficient andflexible jurisdiction for investment vehicles.Although Luxembourg is well-known forregulated investment funds of the UCITSvariety, this brochure covers the alternativeinvestment regimes available in Luxembourgand their salient features as well as the impactof the transposition of the AIFMD Directive intoLuxembourg law.Luxembourg provides a favourable taxenvironment with numerous attractivecharacteristics, such as no withholding tax onmost interest payments and exemptions fromcorporate taxation of dividends and capital gainsreceived on the holding of significant equityparticipations.Moreover, Luxembourg enjoys a very flexibleregulatory environment that encourages theundertaking of investment transactions througheither (a) unregulated vehicles (unregulatedspecial purpose vehicles, securitisation vehicles,and private wealth management companies) or(b) vehicles subject to reasonably lightregulatory supervision (SICARs and SpecialInvestment Funds).II. The Five Key Vehicles forInvestment TransactionsA. UNREGULATED SPECIAL PURPOSEVEHICLES IN CORPORATE FORM (SPVs),INCLUDING HOLDING COMPANIESLuxembourg has a long-established reputation asa favourable jurisdiction for holding companies(which are often known as SOPARFIs, orsociétés de participations financières). In additionto holding equity stakes in portfolio companies, aSOPARFI can hold other assets, such asintellectual property as well as real estate, andcan undertake financing and investmentmanagement activities. Moreover, the sharestructure can accommodate different classes ofshares as well as tracking shares that “track”identified underlying assets. A SOPARFItypically requires neither a business license norother regulatory approval (see applicability ofAIFM, infra.); however, a VAT identificationnumber may be necessary, depending on thecircumstances.1. Legal Forms of SPVAlthough a variety of legal forms are available inLuxembourg, the three most common legalforms for SPVs are the public limited company(société anonyme, or S.A.), the private limitedliability company (société à responsabilitélimitée, or SARL), and the partnership limited byshares (société en commandite par actions, orS.C.A.).The fundamental differences between an SARLand an S.A. are that (i) the initial capital for theSARL, which must be paid in in its entirety, is€12,400, whereas the initial capital of an S.A. is€31,000 (but only 25% need be paid in uponcreation), (ii) an S.A. may issue bearer shares,whereas an SARL may not, and (iii) an S.A. maylist securities, whereas as SARL may not do so.There are no significant differences between thetwo forms in respect of corporate governance ormanagement, assuming that there is a soleshareholder. The S.C.A. is quite similar to anS.A. in most respects, but requires a generalpartner with unlimited liability that is responsiblefor managing the S.C.A. The general partner willoften take the form of an SARL.The choice of corporate form depends oncorporate law and corporate governanceconsiderations. The flexibility of Luxembourg'slaw on commercial companies allowscustomised solutions on a case-by-case basis.2. Regulatory AspectsThe setting-up of an SPV does not require aregulatory license, approval or authorisation solong as its activity is not deemed by theLuxembourg financial sector regulator(Commission de Surveillance du SecteurFinancier, or “CSSF”) to constitute bankingactivity or another regulated activity of thefinancial sector. SPVs will also typically notrequire a business license from the LuxembourgMinistry of Middle Classes, which is required ofcompanies carrying out commercial activities inLuxembourg.3. Tax AspectsUpon incorporation, there is a modestregistration duty of €75, but no capital duties arepayable in Luxembourg. There is also aminimum annual corporate income tax in theaggregate amount of €3210, if the holdingcompany’s financial assets, transferablesecurities, and cash exceed 90% of thecompany’s balance sheet.The income generated by the SPV (if any) issubject to corporate/municipal income tax at therate of 29.22%. However, there is a broadexemption from corporate tax on dividends,capital gains, and liquidation proceeds receivedby the SPV (as described below under“Participation Exemption”).The SPV is also subject to net worth tax4

amounting to 0.5% of the net assets ascalculated on January 1st. However, equityparticipations held by the SPV that qualify underthe participation exemption (see below) areexempt from the calculation of net worth tax.A leveraging of the investments through acombination of equity and debt investments canbe achieved, and the Luxembourg SPV maytake advantage of tax exemptions on incomethrough applicable double taxation treaties orthe EU Parent-Subsidiary Directive if morefavorable than those available underLuxembourg domestic legislation.Generally, there is no withholding tax inLuxembourg on interest or royalty paymentsmade to corporate entities. Withholding taxcould, however, under certain circumstances bedue on interest paid by the SPV to individualsresiding in Luxembourg or in another EUMember State (EU Savings Directive).Shares, bonds and other securities issued bythe SPV are exempt from any stamp duty.As mentioned above, the SPV can be used forintra-group financing activities. In this respect,one should note that any intra-group lendingactivities through a Luxembourg entity could besubject to the transfer pricing guidelines issuedby the Luxembourg tax authorities in CircularL.I.R. number 164/2. If such entity is“principally” engaged in intra-group financingtransactions (holding company activities aredisregarded for this purpose), then the vehiclemust meet “substance” requirements inLuxembourg, have equity “at risk”, and becompensated on “arm’s length” principles(generally following the OECD guidelines). If allcriteria are met, including having real substancein Luxembourg and sufficient equity to assumethe risks connected with its business (both asfurther described in the Circular), the entity mayrequest an “advanced pricing agreement” fromthe tax authorities that is binding for five years.4. Participation ExemptionOne aspect of Luxembourg taxation deservesparticular attention. While the SOPARFI is afully-taxable company under Luxembourg law,under the “participation exemption” no corporatetax or municipal business tax is imposed inLuxembourg on inbound dividends received bythe SOPARFI from an affiliate operational orholding company, on capital gains generatedfrom the sale of its shareholding in an affiliatecompany, or on liquidation proceeds from anaffiliate company. If the affiliate company isabroad, the withholding regime of country wherethe affiliate is domiciled must be considered,including any double tax treaty.The foregoing exemption applies so long as theLuxembourg company (i) holds at least 10% ofthe share capital of the paying entity (or,alternatively, the minimum acquisition cost wasat least €1.2 million (for dividends andliquidation proceeds) or €6 million (for capitalgains)), and (ii) holds such participation for atleast 12 months, provided that such payingentity is an EU-resident company or, if not,subject to tax that corresponds to theLuxembourg corporate tax (i.e., determined tobe at least 10.5%). However, any expensesdirectly related to the shareholding that havereduced the tax base of the Luxembourgcompany (e.g., interest) are disallowed up tothe amount of the exempt dividends.Moreover, if the SOPARFI holds at least 10% ofthe capital of a company (or if the acquisitionprice was at least € 1.2 million), then the valueof such holding is exempt from the calculationof net worth tax.Additionally, there is no withholding ondistributions made to the shareholders of theSOPARFI as follows: (1) No withholding ondividends so long as the shareholder is a fullytaxablecompany resident in the EU (or, if not,resident in a country with which Luxembourghas a tax treaty and is subject to a tax of atleast 10.5%) and holds at least 10% of theshare capital for a minimum of 12 months orhas purchased the participation for at least €1.2million; (2) no withholding on capital gains solong as the shareholder is resident in a countrywith which Luxembourg has a tax treaty, or,holds either less than 10% of the share capital,or more than 10% for at least 6 months; (3) nowithholding on liquidation proceeds regardlessof the status of the shareholder or of theSOPARFI.Finally, as a corporate entity under Luxembourglaw, the SOPARFI is entitled to benefit from thehighly favourable network of 70 (to date) taxtreaties that Luxembourg has entered into. Thispermits significant tax planning for non-residentinvestors.5. Applicability of AIFMIn principle, SOPARFIs fall within the scope ofthe law of 12 July 2013 regarding alternativeinvestment fund managers (“AIFM Law”), whichtransposed the Alternative Investment FundManagers Directive into Luxembourg law (SeeF., infra.) Although the AIFMD law exempts“holding companies” from its scope, a “holdingcompany” is defined to include companies (i)with shareholdings in other companies andeither (ii) whose shares are listed on a regulatedmarket in the EU or which is not established forthe main purpose of generating returns for itsinvestors. That is, unless the shares of theSOPARFI are listed on the Luxembourg StockExchange or another regulated market in the EUor unless the SOPARFI is not-for-profit - - -neither condition is met by a typical SOPARFI - -5

- then the SOPARFI falls within the scope of theAIFM Law. However, if the entirety of the sharesof the SOPARFI is held by a single shareholder,the SOPARFI would not be considered an“alternative investment fund” under that Law, assuch definition requires the raising of capitalfrom a “number of investors.” Hence, aSOPARFI can be structured to avoid theapplication of the AIFM Law.B. SECURITISATION VEHICLES1. The 2004 Securitisation LawThe Luxembourg Securitisation Law of 22March 2004 (“Securitisation Law”) is generallyconsidered one of the most attractive regimesfor securitisations in Europe, permitting a verybroad range of assets to be securitised througheither a regulated (by the CSSF) or unregulatedstructure. The unregulated structures enjoysubstantial cost savings, as very few filings arerequired.2. Definition of a Securitisation under the2004 Securitisation LawThe 2004 Securitisation Law defines asecuritisation as a transaction by which a“securitisation undertaking” assumes, directly orthrough another undertaking, risks relating toclaims, other assets, or obligations assumed bythird parties or inherent in all or part of theactivities of third parties, and issues securities,whose value or yield depends on such risks".The possibility for the securitisation vehicle toacquire a very broad range of underlying assetsmakes this vehicle very attractive for investmenttransactions. The CSSF considers both thestructure of the transaction and the origin of therisk when considering whether a transactionqualifies as a securitisation undertaking. Thespecific examples of assets provided for by theCSSF include loan portfolios, goods andequipment, and the securitisation of shares ininvestment funds, hedge funds, and companies.The main funding source of a securitisationundertaking must come from the issuance ofsecurities.3. Securitisation CompaniesLuxembourg securitisation vehicles in corporateform may be organised as a public limitedcompany (société anonyme), a corporatepartnership limited by shares (société encommandite par actions), private limited liabilitycompany (société à responsabilité limtée), or acooperative company (société coopérativeorganised as a société anonyme).4. Securitisation FundsSecuritisation funds have no status as a legalentity. Rather, they constitute a pool of assetsmanaged by a management company.They can take the form of either (i) a coownershipof assets (copropriété) where theinvestors have a right in rem to the relevantunderlying assets or (ii) a fiduciary propertywhere the management company holds theunderlying assets as such (and segregated fromits other assets).5. Creation of Multiple CompartmentsThe Securitisation Law allows the setting-up ofsecuritisation vehicles with multiplecompartments that can be efficiently “ringfenced”by an effective segregation of assets asregards investors' and creditors' rights.6. Issuance of Debt and Equity SecuritiesA securitisation vehicle may in principle issueany kind of transferable debt or equitysecurities. It is not unusual for a securitisationvehicle (whether regulated or unregulated) to listits debt in Luxembourg.7. Regulated or UnregulatedSecuritisation VehiclesSecuritisation vehicles that issue securities (i) tothe public and (ii) "on a continuous basis" areregulated by the CSSF. Only if both conditionsare met does the vehicle fall within theregulatory oversight of the CSSF.However, the great majority of Luxembourgsecuritisation vehicles remain unregulated, asno issuance of securities to the public takesplace in most cases.8. Bankruptcy RemotenessThe Securitisation Law ensures bankruptcyremoteness by expressly recognising the validityof non-petition clauses, as well as limitedrecourse and subordination clauses. Suchclauses are typically found in the Articles ofIncorporation and/or the offering document ofthe securitisation vehicle.9. Tax TreatmentSecuritisation companies are subject tocorporate/municipal income tax, which currentlyamounts in the aggregate to 29.22%. However,the Securitisation Law allows the deduction fromincome of all commitments vis-a-vis investorsand creditors.Securitisation vehicles organised as funds arenot subject to (i) income tax, (ii) subscription tax(which distinguishes it from investment funds),or (iii) net worth tax.Currently, distributions made by securitisationvehicles to their investors and creditors areexempt from Luxembourg withholding tax(subject to the provisions of the EU Directive on6

the taxation of savings and, in particular, in theevent of payments made by a Luxembourgpaying agent to individuals who are residents inLuxembourg or in another EU Member State)Agreements or transaction documents relatingto a securitisation transaction do not need to beregistered (except agreements transferringrights in respect of real estate located inLuxembourg or ships, airplanes or boatsregistered in Luxembourg).Management services provided to asecuritisation vehicle are VAT-exempt.10. Applicability of AIFMSecuritisation special purpose entities areexpressly excluded from the scope of the AIFMLaw.C. THE SICARIn a further effort to meet market expectations inthe Luxembourg financial sector and to boost itscompetitiveness vis-à-vis its Europeanneighbours in that space, Luxembourgintroduced in 2004 a risk capital regimespecifically targeting private equity and venturecapital (the “SICAR Law”). The Parliamentsought to encourage private equity and venturecapital vehicles by combining light regulatoryoversight with reasonable investor protectionand a favourable tax status.1. Purpose of the SICAR Regime andEligible InvestmentsThe purpose of the SICAR (sociétéd'investissement en capital à risque) regime isto promote the pooling of funds fromsophisticated investors in a single vehicle, whichthen invests in securities (of entities) having acertain risk profile deemed to be “risk capital”.Investment in “risk capital” is defined by theSICAR Law as the direct or indirect investmentin entities with a view to their launch,development, or listing on a stock exchange.The CSSF, the regulatory body with oversight ofSICARs, has provided some clarification of theconcept of risk capital in a circular of April 2006.2. Necessity of Risk CapitalThe CSSF specifically identifies the elements ofhigh risk and the intention to develop the targetentities as characterising investments in “riskcapital”. In practice, the SICAR is often at somelevel actively involved in the management of thetarget entities in an advisory capacity or asBoard representative with a goal to createadded-value, maximise profits, and to sell theinvestments at a profit.In terms of the form of investment, the CSSFconstrues this very broadly, although hedgefunds are specifically excluded. All types of exitare permissible, and there are no restrictionsregarding risk diversification. Therefore, unlikeinvestment funds, SICARs can invest in only onetarget company.3. Investments in Real EstateSICARs cannot hold real estate directly.However, it is permissible for a SICAR to holdreal estate indirectly through affiliate companies,provided that the real estate has risk capitalcharacteristics. In this respect, the underlyingreal estate assets must be shown to represent aparticular risk (above the normal real estate risk)and be developed to create added value(construed in a broad sense). Generally, theCSSF has indicated that “opportunistic” realestate investment strategies characterised bythe transformation of the premises or thebuilding of new premises (rather than a simplerental strategy) are acceptable.4. Eligible InvestorsInvestment in SICARs is limited to sophisticatedinvestors that the law defines as (i) institutionalinvestors, (ii) professional investors, and (iii)investors confirming in writing that they are wellinformedinvestors and either invest €125,000 orproduce an evaluation by a financialprofessional attesting to their expertise andinvestment knowledge. Nevertheless, for anindividual a minimum investment of €125,000 iseffectively the threshold for investment in aSICAR.5. Organisation of SICARsLike most Luxembourg regimes, the SICAR isnot a type of company, but, rather, an electedstatus, which must appear in the company'sArticles of Incorporation. In this respect, there isa wide range of business forms eligible forSICAR status, including the typical capitalcompanies (public limited company, privatelimited company, partnership limited by shares,and cooperative company), as well as thelimited partnership (société en commanditesimple or “s.c.s.”), which is not a capitalcompany, but a vehicle that is treated from a taxperspective as a look-through entity, and aspecial limited partnership (société encommandite spéciale or s.c.s.p.), which issimilar to an s.c.s., except that it is created bycontract between the partners and has no legalpersonality (in this sense, it is similar to theAnglo-Saxon notion of a limited partnership)(see below.). The public limited company(société anonyme) and partnership limited byshares (société en commandite par actions)have historically been the preferred vehicles forSICARs.7

6. Multiple CompartmentsLike a securitisation vehicle or a SIF, the SICARcan have multiple compartments therebyallowing for segregation of assets and risks.Each compartment may have its owninvestment policy, and may be liquidatedindependently of the others or of the SICARitself.7. CapitalisationSICARs must be capitalised with at least €1million, which must be reached within 12 monthsof the CSSF's authorisation. In-kind capitalcontributions are permissible. However, theSICAR can elect in its Articles of Incorporationto have a variable share capital equal to netasset value (SICAV). In this event, none of thetypical formalities of publication is required eachtime the share capital is increased. Moreover,there are no “thin capitalization” criteria for theSICAR requiring a minimum debt-to-equity ratio.8. Regulation and ReportingAs mentioned above, SICARs are regulated bythe CSSF, which specifically authorises theiractivities. The SICAR must have its registeredoffice and central administration in Luxembourg.Once the CSSF approves the application, theSICAR is entered on a list of such approvedvehicles. And once on such list, the SICAR can,in principle, be listed on the Luxembourg StockExchange, if it is in the form of an S.A. orS.C.A.. However, to comply with the SICAR law,it will need to ensure that only eligible investorsacquire the shares.The SICAR has various reporting requirementsto the CSSF and to the investors, includingannual reports on the valuation of its assets(which is based on fair value), and an updatedoffering circular every time there is an issuanceof additional securities. The SICAR must alsoappoint an independent auditor (réviseurd'entreprises) for the annual accounts, as wellas a custodian, which must be a credit institutionin Luxembourg or the Luxembourg branch of anEU credit institution.9. TaxationThere are two regimes for taxing SICARs,depending on whether the SICAR takes theform of a capital company (public limitedcompany, etc.) or a limited partnership (S.C.S.or S.C.S.P.), which is considered as a lookthroughentity for tax purposes. If a capitalcompany, the income of the SICAR (if any) will,in principle, be subject to corporate andmunicipal tax at a combined rate of 29.22%.However, with the following availableexemptions, the SICAR is effectively exemptfrom tax in Luxembourg. It will also be able totake advantage of the vast network of doubletaxation treaties that Luxembourg has enteredinto, which provides opportunities for taxplanning. Moreover, the SICAR is exempt inLuxembourg from corporate income tax, networth tax, and municipal business tax onincome from transferable securities as well ason income from their sale or liquidation,including dividends, interest, and capital gains.Finally, any income arising from funds awaitinginvestment in risk capital is also exempt fromtax.If in the form of a limited partnership (s.c.s.) orspecial limited partnership (s.c.s.p.), the SICARis not liable for corporate or municipal businesstax or net worth tax, as it is consideredtransparent, and all income is deemed taxabledirectly at the shareholder level. However, thisapplies to the s.c.s.p. in respect of MBT only tothe extent that any general partner that is aLuxembourg company holds less that 5% of thepartnership interests of the s.c.s.p.Shareholders can, in principle, themselves takeadvantage of the double taxation treatyprovisions between their countries of fiscalresidence and the domicile of the portfoliocompany.Regardless of the form of business organisationthe SICAR opts for, it will be exempt fromsubscription tax. The SICAR is, however, liablefor a minimum annual fee of €3,000 to theCSSF.10. Applicability of AIFMSICARs, as typical alternative investmentvehicles, fall within the scope of the AIFM Law.However, if the entirety of the shares of theSICAR is held by a single shareholder, thensuch SICAR should not be considered an“alternative investment fund” for purposes of theAIFM Law. If a self-managed SICAR is an AIFMfor purposes of the AIFM Law, its initial capitalmust be € 300,000. (For more informationregarding the AIFM Law, See F., infra.)D. SPECIALISED INVESTMENT FUNDWith the Luxembourg law on SpecialisedInvestment Funds (the “SIF Law”), which cameinto effect on 13 February 2007, theLuxembourg legislators responded to thedemands of the investment community andcreated a legal framework for lightly-regulatedinvestment fund vehicles for all types ofalternative investment fund products, includinghedge funds, private equity and real estatefunds.1. Eligible InvestorsLike the SICAR law, the SIF Law limits thescope of eligible investors to sophisticatedinvestors. In addition to institutional andprofessional investors, the law deems asophisticated investor any person who confirms8

in writing that he is a sophisticated investor andeither invests a minimum of €125,000 in thespecialised investment fund or - in the event thatthe invested amount is lower - that he has beensubject to an assessment made by a creditinstitution, an investment firm or by amanagement company.2. Organisational FlexibilityA SIF may be structured as either:• A common fund (fonds commun de placementor “FCP”) managed by an investmentcompany• An investment company with variable capital(société d'investissement à capital variable or“SICAV”) to be established in the form ofeither a public limited company (sociétéanonyme) or a partnership limited by shares(société en commandite par actions) or aprivate limited company (société àresponsabilité limitée) or a cooperative in theform of a public limited company (sociétécoopérative sous forme de société anonyme),or• Any other legal form available underLuxembourg law, including an s.c.s. or ans.c.s.p., even though the latter is created bycontract and has no legal personality.The words “fonds d'investissement specialisé”or the abbreviation “FIS” must be added to thename and the title of the particular investmentfund.3. Capital and Payment of DividendsThe central administration of the SIF must besituated in Luxembourg. The minimum capitalmust reach €1,250,000 within a period of 12months following the approval by the CSSF.Although there are in principle no restrictions onthe payment of dividends, such payments toinvestors must not result in a decrease of theSIF’s capital below the minimum level of€1,250,000. The SIF must appoint a custodianhaving its registered office in Luxembourg orbeing the Luxembourg branch of a bank with itsregistered office in another Member State of theEU.4. Investment and Leverage RestrictionsA SIF may issue either equity or debt, and mayborrow for investment purposes. Generally,borrowing is limited to 200% of the SIF’s NAV,but may be increased to 400% if there is a highlevel of correlation between long positions andshort positions. The rules applicable tosubscription, redemption and distributions,valuation of assets and thecompartmentalisation of assets may be freelydetermined by the creator of the SIF in thearticles of incorporation (if a SICAV) or in themanagement regulations (if a FCP). The SIFmay create sub-funds, each with a differentinvestment policy. As regards the valuation ofthe SIF's assets, the only requirement providedby the SIF Law is that the valuation of its assetsbe made in accordance with the accountingprinciple of “fair value” (juste valeur).5. Investment PolicyAlthough the principle of risk diversificationremains applicable in general, the CSSFinterprets this in a flexible way. The offeringdocument (PPM) should include quantifiablerestrictions evidencing that the SIF is engagedin risk-spreading. Specifically, (i) with limitedexceptions, a SIF may not invest more than30% of its assets/commitments in securities ofthe same type issued by the same issuer, (ii) aSIF should not hold a short position in securitiesof the same type issued by the same issuerrepresenting more than 30% of its assets, and(iii) the SIF must ensure, when using financialderivatives, risk-spreading via appropriatediversification of the underlying assets.Otherwise, the creator of a SIF is free todetermine the investment policies of the SIF.SIFs may be launched with specific investmentpurposes such as the investment in transferablesecurities, money market instruments, realestate, hedge funds, funds of funds, privateequity, commodities, financial derivativeinstruments, debts, microfinance, etc.6. Management and Investment ManagerThe management of the SIF must be approvedby the CSSF, and will be, in principle, subject tothe Alternative Investment Fund Managers Law(see 10 infra). The persons constituting theBoard must be of sufficiently good repute andsufficiently experienced, and particularlyregarding the type of investments the SIFintends to make. In addition, the investmentmanager, entrusted with managing theinvestment portfolio, is subject to the priorapproval of the CSSF. The investment managermust demonstrate his good repute andprofessional experience, and must beauthorized or registered to carry out portfoliomanagement and be subject to “prudentialsupervision”.7. SupervisionTo acquire the authorisation of the CSSF, thefounding documents as well as the choice of thecustodian of the SIF must first be approved bythe CSSF.The SIF Law does not require specialisedinvestment funds to have a promoter withsignificant financial resources that would besubject to the approval of the CSSF.Consequently, SIFs may be created not only forbut also by sophisticated investors within the9

scope of the Law. The legal representatives of aSIF (the “Directors”) are, however, required toobtain the CSSF's approval. To obtain suchapproval, the Directors of each SIF must submitevidence of their professional qualification, goodstanding and integrity to manage the SIF.A SIF needs to develop a conflict of interestpolicy as well as a risk management system.8. Disclosure and ReportingEach SIF must establish an offering document.Such offering document need not have anyrequired minimum content and must be updatedin the event of a new issuance of securities.Subject to the applicability of the LuxembourgProspectus Law of 10 July 2005 (which would inprinciple apply only in the event of a listing orpublic offering), the SIF Law does not prescribeany particular minimum content. It must, inprinciple, contain information necessary for aninvestor to be able to make an informedjudgment of the investment proposed and therisks involved.In respect of disclosure and reportingrequirements, a SIF is required only to producean annual audited report covering the relevantfinancial year and that must be made availableto investors within six months of the end of thefinancial year. It should be noted that neither along-form report nor semi-annual report isrequired.9. TaxationIn principle, no withholding tax on capital gainsis levied on non-resident investors beyond thescope of the EU Savings Directive.Consequently, non-resident investors aretypically not subject to capital gains taxation inLuxembourg on the disposal of shares in a SIF.SIFs are subject to an annual subscription tax(taxe d'abonnement of 0.01 %) levied on thebasis of the value of the entire net assets on thelast day of each quarter of the year. However,certain institutional cash funds and pensionpooling funds are exempt from the subscriptiontax.The Grand-Duchy of Luxembourg has enteredinto 70 double taxation treaties (to date), and aSIF in corporate form is covered by many ofthem. As a FCP under Luxembourg law has nofiscal status as a legal entity, a SIF organised inthe form of a FCP should typically not be able tobenefit from such double taxation treaties. Thisapplies as well to SIFS in the form of an s.c.s. ors.c.s.p., which are deemed transparent for taxpurposes. If in the form of a limited partnership(s.c.s.) or special limited partnership (s.c.s.p.),the SIF is not liable for corporate or net worthtax; however, this applies in respect of MBT onlyto the extent that any general partner that is aLuxembourg company holds less that 5% of thepartnership interests of the s.c.s. or s.c.s.p.Instead, the investors should directly claim anytreaty benefits under the particular doubletaxation treaty concluded between theircountries of residence and the domicile wherethe underlying assets are located.The SIF is liable for a minimum annual fee of€ 3,000 to the CSSF.10. Applicability of AIFMSIFs, as typical alternative investment vehicles,fall within the scope of the AIFM Law. However,if it is in the form of a SICAV/SICAF, is selfmanaged,and if the entirety of its shares is heldby a single shareholder, then such SIF shouldnot be considered an “alternative investmentfund” for purposes of the AIFM Law. If a selfmanagedSIF is an AIFM for purposes of theAIFM Law, its initial capital must be €300,000.(For more information regarding the AIFM Law,See F., infra.)E. PRIVATE WEALTH MANAGEMENTCOMPANYThe Luxembourg vehicle known as a privatewealth management company (société degestion de patrimoine familial), or “SPF,” wasintroduced into Luxembourg law in May of 2007in order to replace the 1929 holding company,which regime was repealed as of the end of2010.1. Permitted InvestmentsThe SPF is intended as a tax-efficient entity forthe management of private wealth, whose solepurpose is to acquire, hold, manage, anddispose of financial instruments, cash, and otherassets, but without carrying out a commercialactivity.An SPF may hold participations in other entities,provided that it is not involved in or interferes intheir management. Furthermore, an SPF maynot hold real estate directly, but it may hold realestate indirectly through a fiscally-opaquesubsidiary.An SPF is not required to entrust its assets to acustodian.2. Lending TransactionsAn SPF may borrow funds, and, in this respect,is not subject to a specific maximum debt ratio.The amount of debt, however, may have animpact on its fiscal status (see below“Taxation”). An SPF may not engage inremunerated lending, regardless of whether theentity to whom it lends is an affiliate company. Itmay, however, make advances and provideguarantees to an affiliate company as anancillary activity and without remuneration.10

3. Business OrganisationLike most Luxembourg regimes, the SPF is nota type of company, but, rather, an electedstatus, which must appear in the company'sArticles of Incorporation. An SPF, whoseregistered office must be in Luxembourg, maytake any of the following forms: public limitedcompany (société anonyme), private limitedliability company (société à responsabilitélimitée), partnership limited by shares (sociétéen commandite par actions), or a cooperative inthe form of a public limited company (sociétécoopérative sous forme de société anonyme).4. Eligible InvestorsInvestors that are permitted to hold shares in anSPF are the following: (i) individuals acting inthe context of the management of their privatewealth, (ii) wealth management entities actingexclusively in the interest of the private wealth ofone or more persons, and (iii) intermediariesacting on behalf of the above.It should be noted that shares issued by an SPFcannot be offered to the public or be listed.5. SupervisionThe SPF is not regulated by the CSSF, but,rather, is subject to the supervision of theindirect tax administration (Administration del’Enregistrement et des Domaines). Oversight islimited to the certification each year by thedomciliation agent, independent auditor, orchartered accountant of the SPF that theinvestors of the SPF fall within the scope of theSPF law, as amended.6. TaxationAn SPF is exempt from Luxembourg corporateincome tax, municipal business tax, and netweath tax.An SPF is subject to an annual subscription tax(taxe d’abonnement) of 0.25% on the amount of(1) its paid-in capital, plus (2) its share premium,plus (3) the amount by which its debt exceedseight times the amount of (1) and (2), subject toa maximum of € 125,000 and a minimum of €100.Dividend distributions by an SPF to itsshareholders (and capital gains earned on thesale of shares in an SPF by non-residentinvestors) are exempt from withholding inLuxembourg. However, as paying agent, an SPFmust withhold 10% on interest payments madeto Luxembourg residents and 35% on interestpayments made to individuals resident inanother EU Member State.Because of its special tax status, an SPF cannottake advantage of double tax treaties.As an SPF is not engaged in commercialactivity, it is not subject to VAT.7. Applicability of AIFMAs private wealth management companies areintended to manage the private wealth ofindividuals, and to the extent that they do notraise external capital, they should not fall withinthe scope of the AIFM Law.F. ALTERNATIVE INVESTMENT FUNDMANAGERS LAWFor those alternative investment vehicles thatfall within the scope of the AIFM Law, they willneed to either engage an authorized alternativeinvestment fund manager (“AIFM”) asmanagement company or seek authorizationthemselves from the CSSF as AIFMs (i.e.,internally-managed AIFs). However, there aretwo important exemptions from the authorizationrequirement:1) The AIFM Law does not apply toAIFMs established in Luxembourg if theymanage AIFs whose only investor is theAIFM, the parent or a subsidiary of the AIFM,provided that none is itself an AIF.2) No authorization is required of thoseAIFMs (including self-managed AIFs) whoseassets under management, including throughthe use of leverage, do not exceed€100,000,000 or whose assets undermanagement, unleveraged and with noredemption rights exercisable for 5 yearsfrom the initial investment, do not exceed€500,000,000.However, such AIFMs set forth in 2) above willneed to register with the CSSF and provide itinformation regarding investment strategies andother information on a regular basis. It should benoted that a self-managed AIF can engage onlyin activities of internal management of the AIF(i.e., portfolio management, risk management,administration, marketing, and activities relatedto the assets of AIFs).For all other AIFMs that manage or market unitsor shares of a Luxembourg AIF or arethemselves a Luxembourg AIF, authorization bythe CSSF is required, if the AIFM is based inLuxembourg. If the AIFM is domiciled in anotherEU Member State it is authorized by theregulatory authority of the country of its domicile.The latter can manage Luxembourg AIFs on thebasis of a “European passport.”The authorization process of a LuxembourgbasedAIFM is beyond the scope of thisbrochure. DSM can provide further informationregarding the authorization of AIFMs uponrequest.11

III. COMPARATIVE TABLEThe following comparative table sets out the main differences between the five vehiclesanalysed above.RelevantLegislationUnregulatedSpecial PurposeVehicles inCorporate FormLaw of 10 August1915 on commercialcompaniesUnregulatedSecuritisationVehiclesLaw of 22 March2004 onsecuritisationRisk CapitalStructures (SICAR)Law of 15 June 2004regarding investmentcompanies in riskcapitalSpecialisedInvestment Funds(SIF)Law of 13 February 2007on specialised investmentfundsPrivate WealthManagementCompany(SPF)Law of 11 May2007 on thecreation of aprivate wealthmanagementcompanySupervisionby the CSSFNo (except forbanking activity oranother regulatedactivity of thefinancial sector)NoYesNo approval of:• Promoter• Investment ManagerYesNo approval of:• PromoterNoEligibleAssets /StrategiesUnrestricted withinthe scope of itsarticles ofincorporationAlmost any kind ofrisks related to anykind of assets andobligationsRisk capital as definedby the Law and theCSSF. No directinvestment in real estateUnrestricted within thescope of its managementregulations, subject torisk-spreading principlesFinancialInstruments, cash,and other assetsheld in an accountRiskDiversificationRequirementNo No No Yes.As determined in themanagement regulations(if organised as FCP).Also, applicable for eachcompartment.NoEntity TypeTypically, a publiclimited company ora private limitedcompanyEither asecuritizationcompany in the formof a• Partnershiplimited by shares• Public limitedcompany• Private limitedcompany• Co-operativecompanyorganised aspublic limitedcompany ora securitizationfund• Common limitedpartnership• Partnershiplimited by shares• Public limitedcompany• Private limitedcompany• Co-operativecompany organizedas public limitedcompany• Special limitedpartnership(contractual) Common Fundsmanaged by aLuxembourgmanagement company Investment companieswith variable sharecapital Any other legalform available underLuxembourg law,including commonlimited partnership andspecial limitedpartnership• Partnershiplimited byshares• Public limitedcompany• Private limitedcompany• Co-operativecompanyorganised aspublic limitedcompanyEligibleInvestorsNo restrictions No restrictions Sophisticated investorsas defined by the LawSophisticated investors asdefined by the Law Individuals Wealthmanagemententities Intermediaries12

UnregulatedSpecial PurposeVehicles inCorporate FormUnregulatedSecuritisationVehiclesRisk CapitalStructures (SICAR)SpecialisedInvestment Funds(SIF)Private WealthManagementCompany (SPF)Substance inLuxembourg /Nationality orResidencyRequirementsRegistered office inLuxembourg. Nonationality/residencyrequirement forshareholders anddirectors/managersRegistered office inLuxembourg. Nonationality/residencyrequirement forshareholders anddirectors/managersRegistered office inLuxembourg. Nonationality/residencyrequirement forshareholders anddirectors/managersRegistered office inLuxembourg. Nonationality/ residencyrequirement forshareholders anddirectors/ managersRegistered office inLuxembourg. Nonationality/residencyrequirement forshareholders anddirectors/managersSegregatedSub-FundsNo Yes Yes Yes NoCapital Fixed capital Fixed capital Fixed or variable capital Fixed or variable capital Fixed capitalRisk Calculationof NAVNot applicable Not applicable The NAV must bedetermined at leastonce a year based onfair valueThe NAV must bedetermined at least oncea year based on fairvalueNot applicableMinimumCapital / NetAssetsRequirementsUpon incorporation: SA/SCA: € 31,000 S.àr.l: € 12,400Upon incorporation: SA/SCA: € 31,000 S.àr.l: € 12,400 SCoSA: norequirementSubscribed sharecapital must reach €1Mwithin 12 months fromautorisationFor FCPs:Net assets must reach€1.25M within 12 monthsfrom authorisation.For SICAV/Fs:Subscribed share capitaland share premium mustreach €1.25M within 12months fromauthorisation.Upon incorporation: SA/SCA:€ 31,000 S.àr.l: € 12,400 SCoSA: norequirement13

TAX REGIMEUnregulatedSpecial PurposeVehicles inCorporate FormUnregulatedSecuritisationVehiclesTax Regime SPVs are subject to: Securitisationvehicles in the formof companies aresubject to: CorporateIncome Tax MunicipalBusiness Tax(combined rate of29.22%)The SPV is subjectto net worth taxamounting to 0.5%of the net assets.However, equityparticipations heldby the SPV whichwould qualify underthe participationexemption areexemptCorporate IncomeTax MunicipalBusiness Tax(combined rate of29.22%)Deduction of alloperational costs.SPVs are exemptfrom: Subscriptiontax.Agreements relatingto a securitisationtransaction need notbe registered(except thosetransferring rights inreal estate locatedin Luxembourg or invessels or aircraftsregistered inLuxembourg).Managementservices are VATexemptRisk CapitalStructures (SICAR)SICARs organised ascapital companies aresubject to:Corporate IncomeTax Municipal BusinessTax(combined rate of29.22%)SICAR is exempt inLuxembourg fromcorporate income tax onincome fromtransferable securitiesas well as on incomefrom their sale orliquidation, includingdividends, interest andcapital gains. Incomearising from fundsawaiting investment inrisk capital is alsoexempt from tax. If ascs or scsp, the SICARis not liable forcorporate or net worthtax or municipalbusiness tax, as it isconsidered a lookthroughentity, and allincome is deemedtaxable directly at thepartner level (so long asany general partner thatis a Luxembourgcompany holds lessthan 5 % of the scsp).SICARs are exemptfrom net worth tax andsubscription tax. TheSICAR must pay to theCSSF a minimumannual fee of € 3,000SpecialisedInvestment Funds(SIF)In principle, nowithholding tax on capitalgains for non-residentinvestorsSIFs are subject to anannual subscription tax of0.01 % levied on netasset value on the lastday of each quarter of theyear. The SIF Law,however, provides forseveral exemptions.If a limited partnership(s.c.s.) or special limitedpartnership (s.c.s.p.), theSIF is not liable forcorporate or net worth tax;however, this applies inrespect of MBT only to theextent that any generalpartner that is aLuxembourg companyholds less that 5% of thepartnership interests ofthe s.c.s. or s.c.s.p.The SIF must pay to theCSSF a minimum annualfee of € 3,000Private WealthManagementCompany(SPF)Not subject to CIT,MBT, or NWT. Inprinciple, nowithholding tax ondividenddistributions or oncapital gains tonon-residentinvestors.SPFs are subjectto an annualsubscription tax of0.25% levied onpaid-in capital plusshare premiumplus an amount bywhich its debtexceeds eighttimes the amountof capital plusshare premium14

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Legal Guideto Doing Businessin Mexico3

Legal Guideto Doing Businessin MexicoVON WOBESER Y SIERRA, S.C.2008

All Rights Reserved ©Von Wobeser y Sierra, S.C.Guillermo González Camarena 1100, 7º pisoSanta Fe, Centro de CiudadDelegación Álvaro Obregón01210, México D.F.Tel. (52 55) 52 58 10 00First edition in Spanish: 2006First edition in English: 2008ISBN 978-968-9141-01-3Responsible for the publication: Von Wobeser y Sierra, S.C.Editor: Ignacio Ortiz MonasterioDesigner: Rogelio RangelAssistant Editor: Mariana Riva PalacioIf you would like to reproduce any of the texts published inthis book for exclusively personal use and no other purpose,you may do so provided that the reproduction is made inaccordance with the copyright notice shown in this page.Printed in MexicoThe publication of this book is intended as a service to our clients and friends. Its purposeis to provide information on legal matters. This book is not legal advice on any particular matteror case, nor does it reflect the personal opinions of the attorneys who have contributed to itspreparation. It reflects even less the advice or opinions of the firm of Von Wobeser y Sierra, S.C.

PrefaceIn 2005, as we approached the twentieth anniversary of Von Wobesery Sierra, S.C., we decided to offer our clients and friends—as well asother groups and individuals seeking precise and reliable informationon Mexican law—a series of texts that would synthesize and explainthe most important aspects of the Mexican legal framework.The objective we set was to provide companies and businesspeople,both national and foreign, especially those whom we have had theprivilege of assisting with their legal matters, a relatively compact workto which they could turn to clarify doubts or to learn what the lawestablishes with respect to certain points of interest to them. With thisin mind, the firm began the process of selection, collection, writtensynthesis, and editing that finally culminated in the book the readernow has in hand.This work constitutes a careful survey of the width and breadth ofthose topics that in our twenty years of experience have been pointedout to us as being of the greatest interest and utility to clients. After aquick, panoramic overview of Mexico as a nation, 22 additional chaptersexplain the existing law in Mexico regarding the creation, development,and general management of a company in our country.7

8First, the book explains the legal conditions that must be fulfilledin order to form a company, with an emphasis on foreign investmentand on the establishment of offices and industrial plants. The bookthen addresses what is undoubtedly the most important aspect of acompany doing business in Mexico—its employees and workers—in chapters on labor law and immigration. Next, the book addressesthe fundamental topic of taxes, which is covered in depth. The lawapplicable to internal trade and to imports and exports is covered inthree more chapters that are followed by one chapter on obtainingfinancing and granting guarantees and by two on industrial andintellectual property. A series of miscellaneous but no less importanttopics related to business activities follow, including antitrust, regulatedactivities, government procurement, environmental law, andbusiness entities regulated by the Securities Market Law. Finally, infour additional chapters, information is provided on the handling ofcritical situations such as litigation and disputes, insolvency, andbankruptcy.While it is not exhaustive or in any way a replacement for personalizedadvice, we believe that this work can be of great use to those whoengage in or aspire to engage in business in Mexico. Undoubtedly, itwill also satisfy the curiosity of any businessperson or lawyer whoincludes Mexican law in his or her area of expertise.At Von Wobeser y Sierra, S.C., we are proud of this work which, to theextent that it supplements the services that we have been providingto our clients for exactly twenty years, is for us the best way possibleof celebrating this important anniversary. This book is also a faithfulreflection of the talent, professionalism, and dedication of all the partnersand associates who make up this firm, and especially those whogenerated the content we present here.

To the partners and associates of the firm, I express my appreciation;to our clients and friends, my gratitude for their trust throughout thesetwenty years; and to the reader, the wish that this book will be useful.CLAUS VON WOBESERDecember 20069

Preface to theEnglish EditionWe are pleased to present our English-speaking clients and friendswith the English edition of our Legal Guide to Doing Business in Mexico,which was published in Spanish one year ago in celebration of thetwentieth anniversary of our firm.We have taken the opportunity to update Chapter 1 of the book toreflect the changes in the past year in the national political and economicarenas. We have also added a chapter on the function of courtprecedent in the Mexican legal system, and we have updated each ofthe chapters where changes in the law have occurred. We are confidentthat this English edition contains the latest information available onMexican business law.We hope to reach an even wider audience with this edition and to beable to provide the same useful legal guidance to our English-speakingclients that we have provided in the past to our Spanish-speaking clientsregarding Mexican regulation of business activities.11CLAUS VON WOBESERJanuary 2008

Partners, Associates,of Counsel, and LegalInterns2008PARTNERSASSOCIATES12Maclovio Sierra Madero (1955-1988)Claus von WobeserJavier Lizardi CalderónFernando Moreno Gómez de ParadaLuis Burgueño ColínMarco Tulio Venegas CruzRaúl F. Cárdenas EychenneLuis Miguel Jiménez CortésElisa de Anda MadrazoMauricio Bueno BarreraMariana Campos ClasingFernando Carreño Núñez de AlvarezVirginia E. CornettMarie-Alsace Galindo RoelMargarita Gárate TurranzasEdmond Frederic Grieger EscuderoRupert HüttlerPatrícia Kaim FonsecaMaría Fernanda Magallanes FernándezAdrián Magallanes PérezMontserrat Manzano EscalónGloria Andrea Martínez CastilloAna Mendoza CoronaPatrick Meshoulam Aguila

OF COUNSELAlberto Muerza SierraGabriela Negrete AlvarezAndrés Nieto Sánchez de TagleRaymundo Pérez ArellanoLuis Alberto Pérez GonzálezAline Priscila Gandia Robertson HernándezKatharina Roehr KiesslingPablo Sáenz y SáenzGabriela Salazar TorresEfrén Sánchez HernándezFederico Scheffler KulmannDiego Ignacio Sierra LarisRodolfo Trampe MartínezPaulina Valencia VillaseñorNallely van Pratt AnguloManuel Lizardi AlbarránIgnacio Magaña Cárdenas (1942-2003)LEGAL INTERNSDiego Barrera PieckAlejandra Cárdenas DuckerMichelle Carrillo TorresRobert Edward Dolan IsunzaMauricio Etchegaray HernándezJessica Kraig WarmanAngélica Lance PesadoLuis Ignacio Martel Gómez de LeónRicardo Rabasa CossuJaime Ostos Rincón GallardoLuis Antonio Rutz VegaPablo Saez WilliamsMarcos Siqueiros BallesterosRaymundo Soberanis Cortéz13

ContentsPreface Claus von Wobeser 7Preface to the English Edition Claus von Wobeser 11Partners, Associates, of Counsel, and Legal Interns 12Acronyms and Abbreviations 21CHAPTER IProfile of the Country 271. Geography and Demographics 272. History 283. Constitutional and Political System 304. Economic System 33CHAPTER IIForeign Investment Regulation 351. The Foreign Investment Law 38CHAPTER IIIRequirements for Establishinga Company in Mexico 491. Types of Companies 492. Formation of Companies 513. Registries 534. The Limited Liability Company 54

5. The Stock Corporation 586. Public Registry of Commerce 657. Establishment of a Branch of a Foreign Company in Mexico 658. Non-Income Earning Representative Office 67CHAPTER IVOffices and Industrial Plants 691. Acquisition of Real Estate 692. Leasing Property in Mexico 71CHAPTER VLabor Law 731. Labor Contracts 732. Unions and Collective Bargaining Agreements 96CHAPTER VIImmigration Regulatory System 1031. Introduction 1032. Forms of Legal Entry into the Country 1033. Foreigners Working in Mexico 1064. Other Types of Visas 109CHAPTER VIITax Regime 1111. Taxes That Must Be Paid in Mexico 1112. Income Tax 1123. Single Rate Business Tax 1214. Value Added Tax 1255. Special Tax on Production and Services 1306. Tax on Cash Deposits 1337. Local Taxes 136Chart 1. States that Have Fiscal Agreementswith Mexico, 2007 140Chart 2. Retention Rates for Dividends, Interests,and Fees in the Double Taxation Treaties EnteredInto by Mexico, 2007 148

CHAPTER VIIIForeign Trade and Customs Regulations 1571. Introduction 1572. Exchange of Goods 1583. Customs Regulations 1604. Tariff Treatment Applicable to Companies of the Manufacturing,Maquiladora, and Export Services Industry / Other Programs 1635. Other Taxes Associated with the Definitive Importationof Goods into the Country 1666. Automotive Industry 168CHAPTER IXCommercial Regulation 1691. Forms of Commercial Distribution 169CHAPTER XSpecial Regulations for the Sale of Products 1771. Introduction 1772. Labeling Requirements 1783. Product Advertising Requirements 1804. Sanitary Regulation 181CHAPTER XIFinancing Guarantees 1911. Introduction 1912. Surety Bond 1913. Pledge 1934. Working Capital Loans 1975. Mortgage 1986. Trusts 202CHAPTER XIIIndustrial Property 2051. Introduction 2052. Creations with Industrial Application 205

3. Distinctive Signs 2104. Appellation of Origin 2145. Industrial Secrets 2156. Domain Names 2167. Administrative Proceedings Related to Industrial Property Rights 2178. Industrial Property Crimes 2229. Indemnification for Damages and Losses 222CHAPTER XIIIIntellectual Property 2251. Introduction 2252. Copyright 2253. Reservation of Rights for Exclusive Use 2324. Copyright Management Associations 2345. Administrative Copyright Proceedings 236CHAPTER XIVEconomic Competition 2411. Introduction 2412. The Federal Economic Competition Law 2433. Monopolistic Practices 2444. Mergers 252CHAPTER XVRegulated Activities 2551. Introduction 2552. Transportation 2553. Energy 259CHAPTER XVIGovernment Acquisitions 2751. Introduction 2752. The Contracting Procedure 2763. Acquisitions, Leases, Services, and Public Worksin the States and Municipalities of the Mexican Republic 280

CHAPTER XVIIEnvironmental Law 2831. Introduction 2832. Environmental Impact Assessments 2853. Waste 2884. Regulation of Air Pollution 2945. Legal Framework Governing Water in Mexico 2976. Environmental Liability 299CHAPTER XVIIIAdministrative Litigation 3031. Introduction 3032. Administrative Appeal 3033. Judicial Review 3054. Other Administrative Bodies and Courts 3075. Legal or Governmental Arbitration 3076. The Amparo Proceeding against Laws 309CHAPTER XIXCommercial Companies Regulatedby the Securities Market Law 3111. Introduction 3112. Investment Promotion Corporation 3123. Stock Market Investment Promotion Corporation 3164. Stock Market Corporation 318CHAPTER XXInsolvency and Bankruptcy 3211. Introduction 3212. The Business Reorganization Law 3223. Persons Authorized to Petition for a JudicialDeclaration of Business Reorganization 3234. Statutory Presumptions of Commercial Bankruptcy 3235. Stages of Business Reorganization 3236. Specific Protections of Creditors’ Rights 327

CHAPTER XXIState Liability 3291. Introduction 3292. Statutory Presumptions for Indemnification 3303. Extent of Indemnification 3324. Terms of Indemnification 3325. Form and Time Periods for Claiming the Right to Indemnification 333CHAPTER XXIIDispute Resolution 3351. Introduction 3352. Choice of Applicable Law and Jurisdiction 3353. Enforcement of Foreign Judgments 3384. Proceedings before Mexican Courts 3395. National and International Arbitration 3456. Recognition and Enforcement of Arbitral Awards 3567. Mediation 3588. Conciliation 3599. Free Trade Agreements 36010. Agreements for the Reciprocal Promotion and Protection of Investments 364CHAPTER XXIIICourt Precedent 3671. Court Precedent by Confirmation 3672. Court Precedent by Unification of Interpretations 3683. Court Precedent Arising from Unconstitutionality Actionsand Constitutional Disputes 369

Acronymsand AbbreviationsAAAAAAEADRALADIBBITsCCAMCAMCACANACOCCFCEMPROCFCCFECFPCAmerican Arbitration Association (Asociación Americana de Arbitraje)Agreement for the Strengthening of the Economic Association Betweenthe United Mexican States and Japan (Acuerdo para el Fortalecimientode la Asociación Económica entre los Estados Unidos Mexicanos y el Japón)Alternative Dispute Resolution (Resolución Alternativa de Disputas)Latin American Integration Association (Asociación Latinoamericanade Integración)Bilateral Investment Treaties (Acuerdos para la Promocióny Protección Recíproca de las Inversiones, APPRI)Arbitration Center of Mexico (Centro de Arbitraje de México)Commercial Arbitration and Mediation Center for the Americas(Centro de Arbitraje y Mediación Comercial para las Américas)National Chamber of Commerce (Cámara Nacional de Comercio)Federal Civil Code (Código Civil Federal)Mexican Center for Copyright Protection and Promotion (CentroMexicano de Protección y Fomento a los Derechos de Autor, S.G.C. de I.P.)Federal Competition Commission (Comisión Federal de Competencia)Federal Electricity Commission (Comisión Federal de Electricidad)Federal Code of Civil Procedures (Código Federal de Procedimientos Civiles)21

22CIACCICCNIECOACONAGUACONANPCPCDFCPDCREDDNSEEJEEMAFFONACOTFTAAGGATTIICANNICCInter-American Convention on International Commercial Arbitration(Convención Interamericana sobre Arbitraje Comercial Internacional)International Chamber of Commerce (Cámara Internacional de Comercio)National Foreign Investment Commission (Comisión Nacionalde Inversiones Extranjeras)Annual Operating Card (Cédula de Operación Anual)National Water Commission (Comisión Nacional del Agua)National Commission of Protected Natural Areas (Comisión Nacionalde Áreas Naturales Protegidas)Civil Procedures Code for the Federal District (Código de ProcedimientosCiviles para el Distrito Federal)Construction Products Directive (Directriz de Productos de Construcción)Energy Regulatory Commission (Comisión Reguladora de Energía)Domain Name ServerMusic performers association (Ejecutantes, S.G.C. de I.P.)Mexican Accreditation Entity (Entidad Mexicana de Acreditación, A.C.)Fund of Development and Guarantee for the Consumption of the Workers(Fondo de Fomento y Garantía para el Consumo de los Trabajadores)Free Trade Area of the Americas (Área de Libre Comercio de lasAméricas, ALCA)General Agreement on Tariffs and Trade (Acuerdo Generalsobre Aranceles y Comercio)Internet Corporation for Assigned Names and NumbersInternational Chamber of Commerce (Cámara de Comercio Internacional)

ICDR International Centre for Dispute Resolution (Centro Internacionalpara la Resolución de Disputas)ICSID International Centre for Settlement of Investment Disputes(Centro Internacional de Arreglo de Diferencias Relativasa Inversiones, CIADI)IDE Tax on Cash Deposits (Impuesto a los Depósitos en Efectivo)IEPS Special Tax on Production and Services (Impuesto Especialsobre Producción y Servicios)IETU Single Rate Business Tax (Impuesto Empresarial a Tasa Única)IMMEX In-bond Manufacturing (Industria Manufacturera, Maquiladoray de Servicios de Exportación)IMPAC Asset Tax (Impuesto al Activo)IMPI Mexican Institute of Industrial Property (Instituto Mexicanode la Propiedad Industrial)IMSS Mexican Social Security Institute (Instituto Mexicano del Seguro Social)INDAUTOR National Copyright Institute (Instituto Nacional del Derecho de Autor)INE National Ecology Institute (Instituto Nacional de Ecología)INFONAVIT Institute of National Workers’ Housing Fund (Instituto del FondoNacional de la Vivienda para los Trabajadores)IP Internet ProtocolISAN Tax on New Automobiles (Impuesto Sobre Automóviles Nuevos)ISR Income Tax (Impuesto Sobre la Renta)IVA Value Added Tax, VAT (Impuesto al Valor Agregado)23LLAALAASSPLANLAULFCELFDALFPALFPCALFTCustoms Law (Ley Aduanera)Public Sector Acquisitions, Leasing, and Services Law(Ley de Adquisiciones, Arrendamientos y Servicios del Sector Público)National Waters Law (Ley de Aguas Nacionales)Single Environmental License (Licencia Ambiental Única)Federal Law of Economic Competition (Ley Federalde Competencia Económica)Federal Copyright Law (Ley Federal del Derecho de Autor)Federal Law of Administrative Procedures (Ley Federal de ProcedimientoAdministrativo)Federal Law of Administrative Law Court Procedure (Ley Federalde Procedimiento Contencioso Administrativo)Federal Labor Law (Ley Federal del Trabajo)

24LGEEPALGSLGSMLGTYOCLIELISRLOPLPILRACRPLSPEENNAFTANICNOMOOASOCDEOFGPPANPCTPEMEXPITEXPRDPRIGeneral Law of Ecological Balance and Environmental Protection(Ley General del Equilibrio Ecológico y la Protección al Ambiente)General Health Law (Ley General de Salud)Law of Business Corporations (Ley General de Sociedades Mercantiles)General Law of Negotiable Instruments and Credit Operations(Ley General de Títulos y Operaciones de Crédito)Foreign Investment Law (Ley de Inversión Extranjera)Income Tax Law (Ley del Impuesto sobre la Renta)Public Works Law (Ley de Obras Públicas)Industrial Property Law (Ley de la Propiedad Industrial)Law Regulating Article 27 of the Constitution in PetroleumMatters (Ley Reglamentaria del Artículo 27 Constitucionalen el Ramo del Petróleo)Law of Electricity Provision to the Public (Ley del ServicioPúblico de Energía Eléctrica)North American Free Trade Agreement (Tratado de Libre Comerciode América del Norte, TLCAN)Network Information CenterOfficial Mexican Standard (Norma Oficial Mexicana)Organization of American States (Organización de Estados Americanos, OEA)Organisation for Economic Co-operation and Development(Organización para la Cooperación y el Desarrollo Económico)Official Federal Gazette (Diario Oficial de la Federación, DOF)National Action Party (Partido Acción Nacional)Patent Cooperation Treaty (Tratado de Cooperación en Materia de Patentes)Mexican National Petroleum Company (Petróleos Mexicanos)Program of Temporary Importation to Produce Export Articles(Programa de Importación Temporal para Producir Artículos de Exportación)Democratic Revolution Party (Partido de la Revolución Democrática)Institutional Revolutionary Party (Partido Revolucionario Institucional)

PROFEPAPROSECRRETCRFCRGLPRGNRLFCERLSPEERNIERNVFederal Environmental Protection Enforcement Agency(Procuraduría Federal de Protección al Medio Ambiente)Sectorial Promotion Programs (Programas de Promoción Sectorial)Registration of Emissions and Transfer of Contaminants(Registro de Emisiones y Transferencia de Contaminantes)Federal Taxpayers Registry (Registro Federal de Contribuyentes)Liquid Petroleum Gas Regulation (Reglamento de Gas Licuado de Petróleo)Natural Gas Regulations (Reglamento de Gas Natural)Regulation of the Federal Economic Competition Law(Reglamento de la Ley Federal de Competencia Económica)Regulation of the Provision of Electricity to the Public Law(Reglamento de la Ley del Servicio Público de Energía Eléctrica)National Foreign Investment Registry (Registro Nacionalde Inversiones Extranjeras)National Securities Registry (Registro Nacional de Valores)25SSAB Stock Market Corporation (Sociedad Anónima Bursátil)SACM Composers association (Sociedad de Autoresy Compositores de Música, S.G.C. de I.P.)SAPI Investment Promotion Corporation (Sociedad Anónima Promotorade Inversión)SAPIB Stock Market Investment Promotion Corporation (Sociedad AnónimaPromotora de Inversión Bursátil)SAR Retirement Savings System (Sistema de Ahorro para el Retiro)SAT Tax Administration Service (Servicio de Administración Tributaria)SCJN Supreme Court of Justice of the Nation (Suprema Corte de Justiciade la Nación)SCT Ministry of Communications and Transportation(Secretaría de Comunicaciones y Transportes)SE Ministry of the Economy (Secretaría de Economía)SEGOB Ministry of the Interior (Secretaría de Gobernación)SEMARNAT Ministry of the Environment and Natural Resources(Secretaría de Medio Ambiente y Recursos Naturales)SENER Ministry of Energy (Secretaría de Energía)

26SHCP Ministry of Finance and Public Credit (Secretaría de Hacienda y Crédito Público)SI System of Units (Sistema Internacional de Unidades)SIEM Mexican Business Information System (Sistema de InformaciónEmpresarial Mexicano)SMAOF Photographers association (Sociedad Mexicana de Autores de ObrasFotográficas, S.G.C. de I.P.)SOGEM Writers association (Sociedad General de Escritores de México, S.G.C. de I.P.)SOMAAP Fine arts artists association (Sociedad Mexicana de Autores de las ArtesPlásticas, S.G.C. de I.P.)SOMEC Choreographers association (Sociedad Mexicana de Coreógrafos, S.G.C. de I.P.)SOMEM Music performers association (Sociedad Mexicana de Ejecutantesde Música, S.G.C.)SOMEXFON Recording, Video, and Multimedia Producers Association(Sociedad Mexicana de Productores de Fonogramas, Videogramasy Multimedia, S.G.C. de I.P.)SRE Ministry of Foreign Relations (Secretaría de Relaciones Exteriores)SSA Ministry of Health (Secretaría de Salud)STPS Ministry of Labor and Social Welfare (Secretaría del Trabajo y Previsión Social)TTFJFATLCTLC-G3UUNCITRALVVATFederal Court of Tax and Administrative Justice (Tribunal Federalde Justicia Fiscal y Administrativa)Free Trade Agreement (Tratado de Libre Comercio)Free Trade Agreement between the United Mexican States and theRepublic of Colombia and the Republic of Venezuela (Tratado de LibreComercio entre los Estados Unidos Mexicanos, la República de Colombiay la República de Venezuela)United Nations Commission on International Trade Law (Comisiónde las Naciones Unidas para el Derecho Mercantil Internacional, CNUDMI)Value Added Tax (Impuesto al Valor Agregado, IVA)

CHAPTER IProfile of the Country1. Geography and DemographicsMexico is located in the northern hemisphere of the American continent. It bordersGuatemala to the south, Belize to the southeast, and the United States to the north, acountry with which it shares a 1,959-mile- (3,152-kilometer-) long border.Mexican territory has an area of 758,449 square miles (1,964,375 square kilometers).It has 6,911 miles (11,122 kilometers) of coastal area. With such a large andextended surface area, Mexico is a vast territory that unites Central America withNorth America and in which, due to its expanse, there are all types of climates: junglein the southeast; lush vegetation around the Gulf of Mexico (where the majority ofthe large oil wells are located); coastal areas, rich in fisheries and in tourist resources,both on the Pacific and the Caribbean; a high plateau suitable for agriculture, livestockfarming, and mining; and in the north, a desert, with stretches of mining and largezones that have been and continue to be recovered for agriculture and livestock grazing,thanks to irrigation.The most important centers of the maquiladora industry are in the north: Tijuana, CiudadJuárez, and Laredo. The best-developed industrial zones are located in the suburbsof Mexico City, its surrounding states, and in the city of Monterrey. There are other importantpoles of industrial development as well: Saltillo, Guadalajara, Tampico, Coatzacoalcos,and León, as well as growing harbor development in several locations.As of the 2000 census, the Mexican population was 97,483,412, with an averageannual population growth rate of 1.9 percent, a gross mortality rate of 4.3 percent, andan average life expectancy of 75.3 years. The school-age population numbers 45,460,324,including students from 3–5 years old up to 20–24 years old. The older students are normallyin technical colleges or universities. There are 4,303,641 male students and4,767,534 female students enrolled in institutions of higher learning. This means thatthere are 9,071,175 young adults who will enter the labor market in the near future.27

2. History 128C H A P T E R IThe history of Mexico can be examined according to the political model that has beenfollowed through the centuries. What follows is a summary of the principal characteristicsof the evolution of the Mexican nation, with an emphasis on public policy.In the pre-Hispanic period, particularly during the time of the dominance of theAztec nation (1325–1525), power was exercised by an absolute monarch, consideredto be a representative of the gods, who had power over the earth. He was distributorand giver of the land and demanded tributes from neighboring and distant tribes underhis power and engaged constantly in wars. While the Habsburgs ruled in Spain, Mexicowas conquered by the Spaniards and the Viceroyalty of New Spain was established. Aform of absolute monarchy was established in New Spain that was based in theory onprinciples of Christian morality, including an obligation to uphold justice for the people.In the economic sphere, restrictions were imposed, privileges and monopolies weregranted, and taxes were levied by the Crown. Meanwhile, legal inequality was established.Justice was administered by numerous special courts, who reinforced the privilegesand exceptions from which certain individuals and groups benefited.Upon the arrival of a new reigning dynasty in Spain, that of the Bourbons (1700–1808),the principles underpinning the monarchy changed to those of enlightened despotism.The new rulers’ alleged ideal was to bring happiness to the people. The Crown establishedits first monopolies and cartels, establishing a mixed economy and strengtheningthe tax system. Racial and economic discrimination broadened. These and other authoritarianmeasures, known as the “Bourbon Reforms,” hurt the Mexican population andwere the cause of conspiracies aimed at gaining independence, further fueled in the endby France’s invasion of Spain under Napoleon I and the imprisonment of Kings CarlosIV and Fernando VII.The Mexican insurgents who fought for independence (1810–1821) imagined asemi-liberal, utopian nation, based on private enterprise, the abolition of excessivetaxes, the establishment of equality, a commitment to justice for all, good government,good laws, and rights for the poor. During the years 1822–1854, the rule of ambitiouscaudillos (local chieftains) and of political parties seeking power, as well as a state ofanarchy resulting from insurrections, military revolts, and shifts of power, preventedthe achievement of these worthwhile goals. During this period, liberals and conservativesstruggled to build a country modeled after their ideals. In addition, Mexico’sdefeat in the 1846–1848 war with the United States resulted in the loss of half of itsterritory.__________1We want to acknowledge and warmly thank José Manuel Villalpando, a renowned Mexican historian, forhis contribution to this section.

From 1855 to 1876, the liberal era in Mexico was marked by an impulse towardsmodernization of the country, its laws, and its institutions. This liberal era was interruptedby an invasion of Mexico by France in 1864 and the temporary establishment ofa European monarchy. Following the fall of the monarchy came the ascendance to powerof the universally celebrated president of Mexico, Benito Juárez. Development was drivenby the free trade of goods, thanks in part to the nationalization of the lands controlled bythe Catholic Church and by indigenous communities. Foreign investment was encouraged,the bureaucracy reduced, savings increased, and the first international treaty establishingfree trade with the United States of America was signed.After the rule of Juárez, President Porfirio Díaz brought more than three decades ofpeace, order, and progress (1877–1910). Díaz was a paternalistic dictator who promotedeconomic advancement over political and social reforms. Roads and railways were built,the power industry was developed, and the first exploitation of oil occurred, all with foreigninvestment. The good reputation of the nation was forged based on the confidenceshown by foreign nations. However, crucial political and social issues—such as theabsence of democracy and existence of pervasive poverty—were disregarded, and in1910 an uprising, known as the Mexican Revolution, broke out. Officially, the MexicanRevolution ended with the adoption of the Constitution of 1917, although the militarystruggle lasted until 1920.In theory, the Revolution opened up national discourse to a discussion of democraticprinciples and principles of social justice. In practice, neither was achieved. The years1920–1933 were marked by a pragmatic approach to national problems. An alliancewas established with the United States, and political and financial institutions were createdthat guaranteed stability for the rest of the century. Urgent needs of the populationwere met and progress was made in education, but social problems otherwise remainedunaddressed.The socialist experiment of 1934–1940 led to the redistribution of agrarian land, theexpropriation of the oil industry, the creation of central unions managed by the State, anda necessary alliance with the United States during the Second World War. These accomplishmentswere the beginning of the period called “stabilizing development,” lastinguntil 1970. During this time, an authoritarian government run by the official party, theInstitutional Revolutionary Party (Partido Revolucionario Institucional, PRI), created anapparent democracy and a system of mixed economy. Growth was sustained, there waslittle acceptance of foreign investment, public corruption was pervasive, and Mexicanworkers were provided with a supportive social welfare system. The PRI fell in 1968, whenthe government acted brutally against students demonstrating for democratic rights.With the advent of a populist government (1970–1982), the Mexican economy collapsed,due fundamentally to presidential messianism, too many policies benefitingonly the majority, and an overdependence on oil exports. The uncontrolled issuance of29Profile of the Country

30C H A P T E R Icurrency caused high inflation; the bureaucratic apparatus grew, and excessive publicspending was encouraged; foreign investment decreased sharply and a third-worldmentality was promoted. The result was the loss of the purchasing power of wages, theimpoverishment of the middle class, and a loss of confidence in institutions and politicians,best known for their rapacity and corruption.The true liberal period in Mexico began around 1983 and continues to this date. Theexhaustion of the authoritarian system, demands for citizen participation, world trendstowards liberty, and the internal crisis of the PRI strengthened the political oppositionand forced modernization, based on the ideas set forth a century earlier by Benito Juárez.These changes were initiated by the PRI itself and continued by the party that came topower in 2000, the PAN. Today, direct and universal democracy has been achieved, andindependent organized groups—dedicated, for example, to the protection of humanrights—have been created. In the economic sphere, private and foreign investment hasbeen encouraged, the size of the bureaucracy is being reduced, public spending is undercontrol, and free trade agreements have been signed with numerous countries. Socially,programs assisting the most vulnerable groups have been created, such as Solidarity,Opportunities, and Peoples’ Insurance.In short, the history of Mexico has oscillated between central economic control andliberalism accompanied by elements of social assistance. The struggle for freedom inMexico has been arduous, but every day—in spite of attempts to return to the populismof the past—the certainty that freedom is an indispensable foundation for individual andsocial progress is strengthened.3. Constitutional and Political SystemAlthough Mexican independence was achieved in 1821, for several decades the legal andcourt system established under colonial rule remained in effect. The first Mexican republicangovernment adopted the Constitution of 1824, based on the United States model.With the end of French rule in Mexico, President Benito Juárez re-established the Constitutionof 1857. In 1870 the first Mexican civil code was created, which had been precededby a short-lived commerce code. The new civil code and civil procedures codefollowed the French model, and the commercial code was influenced not only by Frenchlaw, but also by the Italian model.The 1917 Constitution emerged from the Mexican Revolution, drafted by the differenttriumphing groups. It is the constitution still in force today, although it has beenamended on many occasions, especially during the 70 years of single-party dictatorship(1929-2000). As established in the 1917 Constitution, Mexico is a representative, democratic,federal republic, composed of 31 states and a Federal District. The states are freeand sovereign in their internal governance, but united in a Federation (Article 40).

It is a presidential system in the style of the U.S. system, with the most significantdifference being that during the 70 years of party dictatorship the presidential figureaccrued exaggerated powers, to the detriment of the other branches of government.Legislative power was in the hands of the PRI, which held the vast majority of seats inCongress. The judicial branch was controlled by the President, since the latterappointed the justices of the Supreme Court of Justice of the Nation (Suprema Corte deJusticia de la Nación, SCJN) and, through them, the magistrates of the Collegiate CircuitCourts. In addition, the President forced the courts to render decisions in accordancewith his own will. However, since 2000, when Mexico began its transition to democracy,Congress has become stronger and more pluralistic, while the judicial branch hasbecome ever more independent, thus greatly limiting the previously exaggerated presidentialpowers.During the party dictatorship, Congress grew in size in order to allow various sectors ofsociety and opposition political parties to express their concerns and interests. Thus, a specialcategory of legislators (still in existence) was created. It includes members of the Houseof Representatives and senators who are not elected, but hold an additional quota of seatsassigned to the political parties based on the number of votes they have received.The Mexican democratic system is quite new, which has hindered the Congress—with500 representatives and 128 senators belonging to different parties, none of which hasan absolute majority—from reaching agreements. Nevertheless, recently a series of taxreforms were approved and entered into force that amended several existing laws andestablished new taxes aimed at collecting more revenues, combatting tax evasion, andlessening dependence on income from oil and gas sales. In this regard, the Single RateBusiness Tax (Impuesto Empresarial a Tasa Única, IETU) was created, which takes the placeof the IMPAC and taxes at a single rate the tax profits arising from business activities. Furthermore,soon the Tax on Cash Deposits Law (Ley del Impuesto a los Depósitos en Efectivo)will enter into force, which is intended to reduce tax evasion by imposing a tax rateof 2 percent on cash deposits greater than $25,000 made to bank accounts (it will bepossible to credit this new tax to the taxpayer’s income tax payments).The judicial branch is the only branch of government that has experienced a positiveand straightforward development during the last 16 years. Based on the reforms of 1994and 1998, Mexico today has an independent Supreme Court of Justice consisting of justiceselected by the Congress. Candidates are nominated by the Executive and must havethe qualifications and experience necessary to make well-drafted decisions. A restructuredfederal judicial system is a reality today. The Federal Judicial Board, based on aSpanish model, has exercised a positive influence on the control of the rest of the federaljudicial system and in the handling of administrative tasks. As a result, the SupremeCourt has finally been able to dedicate itself to its substantive work. Currently, both theDistrict and the Collegiate and Unitary Circuit Court judges throughout the Republic are31Profile of the Country

32C H A P T E R Iselected by competitive examination. They are adequately trained and act objectivelyand professionally.However, the same cannot be said of the local, state, and Federal District judicial systems.Although notable efforts have been made to improve these systems, there are fewsuperior state courts that can be compared to the federal level courts. This situation leadsto a slow resolution of cases, since in the vast majority of cases the local decisions arechallenged before the federal courts in constitutional proceedings in which the legalityof the prior rulings is challenged.Furthermore, the Congress is currently debating a constitutional amendment applicableto the criminal justice system that seeks to effectively combat organized crimethrough more flexible and simplified procedures for searches and for the issuance ofarrest warrants. This bill is also notable for its inclusion of alternative means of criminaljustice, and for eliminating pretrial detentions when alternate measures exist. One pointthat should be treated with special care is the mentioned reduction in the requirementsfor the issuance of arrest warrants and the possibility of carrying out searches without awritten judicial order through the creation of so-called control judges who will beresponsible for issuing such arrest warrants expeditiously.Currently the political system is composed of three principal parties: the PRI, with aparty structure that reaches out to all corners of the country; the PAN, which currentlyholds the Presidency of the Republic; and the Democratic Revolution Party (Partido de laRevolución Democrática, PRD), which has drawn together the majority of the groups onthe left. As often happens in democratic systems and especially in a developing system,inside each of these political parties there are groups and interests with different and attimes ideologically contrary objectives.The electoral institutions are independent and fully recognized by the political players.These institutions include the Federal Electoral Institute (Instituto Federal Electoral),which conducts and certifies the elections; and the Federal Electoral Court (TribunalFederal Electoral), which resolves electoral disputes. The current electoral structure isthe product of a long political process, paradoxically initiated by the PRI, which gaveMexico the opportunity to find its own path toward democracy. However, the electoralinstitutions still need to be consolidated, a process that is underway and that will continueto be the work of the political parties and the future governments of Mexico.In this regard, a constitutional electoral reform was recently approved that seeks toresolve the problems in the recent federal elections (2006) through the regulation, amongother things, of the relationship between the press, the political parties, and their candidates.It also attempts to limit the influence of money on political campaigns and prohibitsstrategies based on messages that denigrate either political institutions or the candidates.Another important point of the electoral reform is the regulation of the propaganda putout by governmental powers in order to ensure more equitable electoral contests.

4. Economic System4.1. Recent Economic HistoryDuring more than 50 years of adhering to an economic policy of import substitution,conceived in the fifties by the United Nations Economic Commission for Latin America,Mexican trade was closed to the outside world, which was very beneficial politically forthe party dictatorship of the period.Under the economic model of import substitution, a broad industrial infrastructuredeveloped, a large part of which ceased to be efficient, to the extent that the Mexican productsmade for the protected internal market were not internationally competitive, with asmall number of exceptions. In addition, as this model ran its course, cyclical economiccrises arose more and more frequently. By 1986, it was necessary to change economic policyand to open up the system, for which purpose the Mexican government joined theGeneral Agreement on Tariffs and Trade (GATT). In 1994, the North American Free TradeAgreement (NAFTA) was signed, which was followed by the signing of other free trade andinvestment protection agreements with a broad range of countries from all parts of theworld, including a Free Trade Agreement with the European Union.In anticipation of the signing of NAFTA, while the governments of Carlos Salinas deGortari (1988–1994) and Ernesto Zedillo (1994–2000) were in power, the trend towardopening and privatizing the economy intensified, especially in the banking, finance, andtelecommunications sectors, including railways, airlines, airports, highways, and othersectors that have contributed to the development of modern Mexico. At the same time,the signing of NAFTA was the beginning of the reentry of Mexico into the world economy.One of Mexico’s first steps following the signing of NAFTA was joining the Organizationfor Economic Development and Cooperation (OECD) and the development of a moreactive role for the nation in international economics and policy.33Profile of the Country4.2. Fundamental Economic IndicatorsCurrently economic activity in Mexico is going through a stage of relative stability, butwith the possibility of being affected by the crisis in the U.S. real estate sector caused bythe granting of subprime mortgages and a housing bubble, which has generated anincrease in interest rates that has caused a number of important debtors to enter intobankruptcy proceedings. Recently the U.S. government announced a freeze on interestrates, and it remains to be seen whether or not it will produce the hoped-for results tocounteract the current conditions. Notwithstanding the above, it is hoped that the elevatedinternational price of oil and other raw materials will favor the increase of petroleum,extractive, and agricultural exports, which would continue stimulating the foreign

34trade of the country and contribute to maintaining the current climate of stability in theMexican economy.The current stability of the Mexican economy has been sustained thanks to an environmentof financial and price stability, to which discipline in the handling of publicfinances and the prudence of the monetary authority have contributed. Budgetary disciplineis an indispensable condition for Mexico to guarantee healthy economic growthand contribute to social well-being.Current economic conditions make it clear that there is still a link between the nationaleconomy and the international industrial cycle. It is also clear that the rates of growthregistered are not sufficient to meet the needs of the population. Therefore, it is importantto reduce the current synchrony of the national economy with that of the UnitedStates and to strengthen internal sources of growth. Current economic policy seeks toestablish a stable microeconomic environment that is favorable for the private sector inorder to increase investment and generate more and better jobs.C H A P T E R I

CHAPTER IIForeign InvestmentRegulationForeign investment is essential for Mexican development. It makes possible the useof foreign currency in domestic economic activity, thereby contributing to the creationof sources of employment and the adoption and dissemination of new technologies.Mexico has succeeded in recent years in becoming one of the principal countriesreceiving foreign investment, particularly in the manufacturing, transportation, andcommunication sectors, as well as in the financial services sector. In addition, Mexicaninternational trade has increased significantly in conjunction with the economic growthof the country.Among the factors most influential to this growth are the opening of the Mexicaneconomy, deregulation and administrative simplification, and the new legal frameworkcreated over the last 20 years with the goal of strengthening and facilitatingforeign investment in domestic economic activity and liberalizing Mexican internationaltrade. This new legal framework consists primarily of the following laws andregulations:a) The Foreign Investment Law (Ley de Inversión Extranjera, LIE), issued in 1993 forthe purpose of opening several economic sectors to foreign investment and establishingclear and permanent rules that provide a framework of legal certainty,thereby making investment in Mexico attractive for foreign investors and ensuringthe retention of foreign investment in the economy;b) The Regulation of the Foreign Investment Law and of the National Registry of ForeignInvestors (Reglamento de la Ley de Inversión Extranjera y del Registro Nacional deInversiones Extranjeras), issued in 1998 in order to spell out the administrative detailsof the rules set forth in the LIE, clarifying the scope of the sectorial opening establishedtherein and the administrative simplifications.35

36C H A P T E R I IFurthermore, in 1993, with the adoption of the North American Free Trade Agreement(Tratado de Libre Comercio de América del Norte, NAFTA), Mexico entered a newstage with regard to the regulation of foreign investment. In this new stage, in orderto attract foreign investment, Mexico executed numerous international treaties thatgrant certain rights to foreign investors, such as national treatment, most-favorednationtreatment, fair and equitable treatment, full protection and safety standards,freedom to transfer, right to prompt, adequate, and effective compensation in thecase of expropriation, and access to international arbitration as a mechanism to guaranteecompliance with the above-mentioned rights.As of this date, Mexico has executed 25 Bilateral Investment Treaties (BITs) and 11Free Trade Agreements containing a chapter guaranteeing the reciprocal protection ofinvestments.In this respect, our country has executed BITs with Germany, 1 Argentina, 2 Australia, 3Austria, 4 South Korea, 5 Cuba, 6 Denmark, 7 Spain, 8 Slovakia, 9 Finland, 10 France, 11 Greece, 12India, 13 Iceland, 14 Italy, 15 The Netherlands, 16 Panama, 17 Portugal, 18 United Kingdom, 19Czech Republic, 20 Sweden, 21 Switzerland, 22 Trinidad and Tobago, 23 Uruguay, 24 and the EconomicUnion of Belgium and Luxembourg. 25 Of these, all are in force except those executedwith Slovakia and India, which have not yet been approved by the Senate.__________1Published in the Official Federal Gazette (Diario Oficial de la Federación), March 20, 2001.2Official Federal Gazette, August 28, 1998.3Idem, June 12, 2007.4Idem, March 23, 2001.5Idem, August 9, 2004.6Idem, May 3, 2002.7Idem, November 30, 2000.8Idem, March 19, 1997.9Entered into on October 22, 1999.10Official Federal Gazette, November 30, 2000.11Idem, November 30, 2000.12Idem, October 11, 2002.13Entered into on May 21, 2007.14Official Federal Gazette, June 6, 2006.15Idem, January 17, 2003.16Idem, June 10, 2000.17Entered into on October 11, 2005.18Official Federal Gazette, January 8, 2001.19Idem, July 25, 2007.20Idem, March 25, 2004.21Idem, July 27, 2001.22Idem, August 20, 1998.23Idem, September 12, 2007.24Idem, August 9, 2002.25Idem, March 19, 2003.

Investment protection chapters contained in Free Trade Agreements signed by Mexicoinclude the following:• Chapter XI of NAFTA; 26• Chapter XVII of the Free Trade Agreement between the United Mexican States andthe Republic of Colombia and the Republic of Venezuela (TLC G3); 27• Chapter XIII of the Free Trade Agreement between the United Mexican States and theRepublic of Costa Rica; 28• Chapter XV of the Free Trade Agreement between the United Mexican States andthe Republic of Bolivia; 29• Chapter XVI of the Free Trade Agreement between the Government of the UnitedMexican States and the Government of the Republic of Nicaragua; 30• Chapter IX of the Free Trade Agreement between the Republic of Chile and theUnited Mexican States; 31• As part of decision 2/2000 of the EU-Mexico Joint Council of the Free Trade Agreementbetween the United Mexican States and the European Union; 32• Chapter XVII of the Free Trade Agreement between the United Mexican States andGuatemala, El Salvador, and Honduras (Northern Triangle-CA3); 33• Chapter III of the Free Trade Agreement between the United Mexican States and Iceland,Norway, Liechtenstein, and Switzerland; 34• Chapter XIII of the Free Trade Agreement between the United Mexican States andUruguay; 35• Chapter VII of the Agreement to Strengthen the Economic Association between theUnited Mexican States and Japan. 36Although these investment protection chapters cannot be equated with the BITs, dueto the legal context in which they have been executed, when compared it can be seenthat both their content and particularly their purpose are very similar, since they confervirtually the same protection rights, differing only in superficial aspects.37Foreign Investment Regulation__________26Idem, December 20, 1993.27Idem, January 9, 1995.28Idem, January 10, 1995.29Idem, January 11, 1995.30Idem, July 1, 1998.31Idem, July 8, 1999.32Idem, June 26, 2000.33Idem, March 14, 2001.34Idem, June 29, 2001.35Idem, July 14, 2004.36Idem, March 31, 2005.

1. The Foreign Investment Law38C H A P T E R I IIn order to present a basic panorama of the rules applicable to all foreigners who wishto invest in Mexico, in this chapter we will first discuss the rules set forth in the LIE inregard to the acquisition of real estate in Mexico and the trusts through which foreignindividuals and entities can acquire the use and benefits of real estate located in therestricted zone alluded to in section I of Article 27 of the Mexican Constitution.We will also examine the rules applicable to both foreign investment in Mexican companiesand the investment of foreign entities, alluding expressly to the requirements withwhich they must comply in order to engage routinely in business in Mexico.Finally, reference is made to the National Foreign Investment Registry (Registro Nacionalde Inversiones Extranjeras, RNIE), particularly the obligations applicable to Mexicancompanies having foreign or neutral investments, foreign individuals or entities that routinelydo business in the Mexican Republic, and the trusts by virtue of which rights aregranted to foreign investment. The economic activities that are subject to restriction pursuantto the rules set forth in the LIE will be analyzed in a special section because of therelevance of this topic for foreign investors.1.1. Acquisition of Real Estate1.1.1. Acquisition of real estate by foreign individuals or entitiesThe right of foreigners, whether individuals or entities, to acquire real estate in Mexicanterritory depends on the location of such real estate:a) Restricted zone. Real estate located within the so-called restricted zone, which is a62-mile strip along the borders and a 31-mile strip along the beaches of Mexico,cannot be directly owned by foreigners under any circumstances.However, foreigners can acquire rights to the use and benefits of real estate locatedwithin the restricted zone through a trust with the permission of the ForeignRelations Ministry (Secretaría de Relaciones Exteriores, SRE). In this case, it is the creditinstitution that, as fiduciary, acquires rights over the real estate; the foreigner, asbeneficiary, has the right of use and enjoyment thereof, including any fruits or productsobtained and, in general, any proceeds resulting from any profit-yielding operationor exploitation, through third parties or the fiduciary institution. The durationof these types of trusts is 50 years, which may be extended with the authorization ofthe SRE;b) Unrestricted zone. Real estate located outside of the restricted zone can be directlyacquired by foreigners, whether individuals or entities, provided that (1) prior tothe acquisition a writ is presented to the SRE in which the foreigner agrees to beconsidered a Mexican national with respect to such property and not to invoke the

protection of its/his/her government (“Calvo Clause”), and (2) the SRE grants thecorresponding permission.1.1.2. Acquisition of real estate by Mexican companies with foreign investmentFor Mexican companies with foreign investment, to be able to acquire rights over real estatelocated in Mexican territory, they must have a Calvo Clause in their company by-laws. Furthermore,the type of rights that these companies can acquire—either direct ownership orrights of use or enjoyment of the real estate—depends on where the real estate is located.a) Restricted zone. In the case of real estate located in the restricted zone, the purposefor which such property will be used must be taken into account:• Residential purposes. Mexican companies with foreign investment cannot acquiredirect ownership of real estate located in the restricted zone when it will be usedfor residential purposes, that is, for housing for the use of the owner or thirdparties. In this case, such companies may only acquire the rights of use or enjoymentof the real estate through a trust with the prior permission of the SRE;• Non-residential purposes. Mexican companies with foreign investment can acquiredirect ownership of real estate located within the restricted zone provided suchproperty will be used for non-residential activities. In this case, a notice must befiled with the SRE after the acquisition;b) Unrestricted zone. There is no restriction on Mexican companies with foreign investmentacquiring ownership of real estate located outside of the restricted zone, providedtheir by-laws contain the Calvo Clause.The above-described rules applicable to the acquisition of real estate by foreigners orMexican companies with foreign investment can be summarized as follows:39Foreign Investment RegulationForeign individualsor entitiesMexican companies withclause admitting foreigners:a) Residential purposesb) Non-residential purposesRestricted zoneAcquisition of rights of useand enjoyment through atrust; permission requiredAcquisition of directownership; permissionrequiredAcquisition of directownership; notice to SREUnrestricted zoneAcquisition of directownership; permissionrequiredAcquisition of directownership; Permission notrequiredAcquisition of directownership; permission notrequired

1.2. Forms of Investing in MexicoForeigners who wish to engage in economic and commercial activities in Mexico can doso through the incorporation of a Mexican company or by investing as partners or shareholdersin existing Mexican companies.Foreign entities can also become established in Mexico through branches or representativeoffices.40C H A P T E R I I1.2.1. Investment in Mexican companiesAny foreign individual or company can become a partner or shareholder of a Mexicancompany without needing any permission, provided such company does not engage inactivities in which foreign investment is restricted or excluded.In the case of newly created Mexican companies, it is sufficient to include the CalvoClause in their bylaws. When foreigners wish to invest in companies already incorporatedwhose bylaws contain a clause excluding foreigners, such clause must be substitutedfor by a Calvo Clause and the SRE notified of such a change.1.2.2. Direct investment by foreign entitiesEntities legally incorporated abroad can become established in Mexico through differentforms, depending on the activities in which they will engage in the country:a) Commercial operations. Foreign entities intending to engage routinely in commercialactivities in Mexico can become established in national territory as a branch oran income-earning representative office. In both cases they must obtain authorizationfrom the Secretary of Economy (Secretaría de Economía, SE) and register withthe Public Registry of Commerce (Registro Público del Comercio).These foreign entities legally established in the country may engage in all typesof business activity and commercial operations, except with regard to those activitiesin which foreign investment is restricted or excluded under the LIE;b) Intermediary operations. Foreign entities may also establish a non–income earningrepresentative office when their only purpose is to have an entity in Mexico thatprovides informational services and promotes the activities, products, or servicesthat the foreign company provides abroad.For foreign entities to establish a non–income earning representative office, anauthorization from the SE is also required, but it is not necessary to register it inthe Public Registry of Commerce.A non–income earning representative office does not engage in commercialoperations and its only purpose is to put the foreign company in contact withclients in Mexico. Any contracts resulting from such contact must be executeddirectly by the foreign company with the Mexican clients. Furthermore, it is the

foreign company that must issue invoices and carry out the other acts resultingfrom its commercial relationship with clients in Mexico. The non–income earningrepresentative office is not authorized to represent the foreign company legally incommercial acts or to assume legal obligations in its name. The non–income earningrepresentative office is only an intermediary between the foreigner and theMexican client, and its activities may not earn any income. The foreign companymust provide its non–income earning representative office with the necessaryresources to carry out its purpose, including the payment of the rent for the officeand administrative and personnel expenses.1.3. National Foreign Investment RegistryThe National Foreign Investment Registry (Registro Nacional de Inversiones Extranjeras,RNIE) is an agency of the SE and a source of statistics and figures on the flows of foreigninvestment in Mexico and the economic sectors and regions in which it is located.By law, the following persons and entities are required to be registered in the RNIE:a) Mexican companies having foreign investments (including Mexicans havinganother nationality and residing outside of Mexico), neutral investments, or both,either directly or through a trust;b) Foreign individuals or entities (including Mexicans having another nationalityand residing outside of Mexico) that routinely engage in business activities inMexico;c) Trusts over stock or ownership interests, real estate, or neutral investments, grantingrights in favor of foreign investment (including Mexicans having anothernationality and residing outside of Mexico).41Foreign Investment RegulationMexican companies and foreign individuals or entities registered in the RNIE mustcomply with the following obligations in relation to such Registry:1.3.1. Annual renewal. Economic-financial reportMexican companies and foreign individuals or entities registered in the RNIE must renewtheir registration annually by filing an annual economic-financial report.The time limit for filing the annual economic-financial report depends on the letterwith which the name of the person or entity filing the report begins:• From A to D: during April of each year;• From E to J: during May of each year;• From K to P: during June of each year;• From Q to Z: during July of each year.

42C H A P T E R I I1.3.2. Information on income and expenditures. Quarterly reportMexican companies and foreign individuals and entities registered in the RNIE must filea quarterly report on the value of their income and expenditures, provided that the resultof the total income or expenditures in the respective quarter has changed, negatively orpositively, by more than three thousand times the general minimum wage in force in theFederal District. Otherwise there is no obligation to file the quarterly report. The followingperiods are understood as quarterly: from January to March, from April to June,from July to September, and from October to December.The information that should be taken into account for determining the value of theincome and expenditures of the respective quarter are the following:a) New contributions or withdrawals therefrom that do not affect the capital stock,specifying the account in which the accounting entry is registered;b) The withholding of profits of the last fiscal year and the use of accumulated withheldprofits;c) Loans to pay to or to collect from:• Subsidiaries residing abroad;• A parent company abroad;• Foreign investors residing abroad who are partners or shareholders;• Foreign investors residing abroad who are part of the corporate group to whichthe company belongs.In the case of foreign individuals and entities, only information referring to their operationsin Mexican territory should be considered in quarterly reports.1.3.3. Notice of changes to information previously providedNotice must be given when information previously provided to the RNIE is changed.Among the changes that must be reported to the RNIE are the following:a) Any change of name;b) Change of tax domicile or change of domicile of the principal offices or establishmentof the person or company registered;c) Any change to the corporate bylaws of the companies registered;d) Any increase or reduction of capital stock of registered companies;e) A change of the legal representative of the person or company registered, authorizedbefore the RNIE;f) Any change of the shareholding structure of the registered companies;g) Any change in the name of the partners or shareholders of the registered companies.1.3.4. CancellationMexican companies registered with the RNIE must request the cancellation of their

egistration in the event that the foreign investment, neutral investment, or both arewithdrawn.Foreign individuals and entities must request the cancellation of their registration inthe event they cease to engage routinely in business in Mexico.Finally, the importance of presenting the above-indicated reports and notices to RNIEwithin the time periods established for each case in the LIE and in its regulation must beemphasized, given that fines can be imposed on the registered persons or companieswho fail to file in a timely fashion.1.4. Economic Activities Subject to RestrictionAs a general rule, there are no legal restrictions on foreign individuals and entities engagingin economic activities in Mexico, either directly or as partners or shareholders inMexican companies.However, the LIE specifies certain activities in which foreign investment is not allowedand others in which it is limited.In this section we will discuss the activities that are reserved or subject to a specificregulation. We will also refer to the concept, regulation, and scope of neutral investment,a mechanism through which foreign investment can participate in certain reserved orspecially regulated activities.1.4.1. Reserved activitiesForeign individuals and entities and Mexican companies having foreign investment cannotparticipate in activities related to the strategic areas that by law are reserved to theMexican State, or in activities that are reserved exclusively for Mexicans and Mexicancompanies with a clause in their bylaws excluding foreigners.a) Activities reserved to the Mexican State. The activities set forth in the laws governingthe following strategic areas are reserved exclusively to the State:• Petroleum and other hydrocarbons. Activities relative to transportation, storage,and distribution of gas other than liquid petroleum;• Basic petrochemicals. The following are considered basic petrochemicals:ethanol, propane, butane, pentane, hexane, heptane, raw material for lampblack,gasoline, and methane, when the latter comes from hydrogen carbidesobtained from deposits located in national territory and is used as raw materialin petrochemical industrial processes;• Electricity. This does not include the generation of electricity for self-supply, cogeneration,or small production; generation by independent producers for saleto the Federal Electricity Commission (Comisión Federal de Electricidad, CFE);generation of electricity for export, derived from co-generation, independent43Foreign Investment Regulation

44C H A P T E R I Iproduction, or small production; nor energy for use in emergencies resultingfrom interruptions in the public power grid service. Also not included is theimport of power by individuals or entities exclusively for self-supply;• Generation of nuclear power;• Radioactive minerals;• Telegraphs and radiotelegraphy;• Mail service;• Issuance of banknotes and minting;• Control, supervision, and oversight of ports, airports, and heliports;b) Activities reserved for Mexicans. The economic activities and companies mentionedbelow are reserved exclusively for Mexicans or Mexican companies having a clausein their bylaws excluding foreigners:• National land transport of passengers, tourists, and cargo, not including messengerand parcel services;• Retail sale of gasoline and distribution of liquid petroleum gas;• Provision of radio broadcasting and other radio and television services, otherthan cable television;• Credit unions;• Development bank institutions, in accordance with the applicable law;• The provision of professional and technical services expressly indicated in theapplicable laws.Foreign investment is not allowed in the above-mentioned activities and companies,directly or through trusts, agreements, partnership agreements or bylaws, pyramidschemes, or any other mechanism that grants them any control or share.Notwithstanding the above, there is a mechanism through which foreign investmentcan participate in certain activities reserved for Mexicans: neutral investment, which isanalyzed in Point 1.5 of this chapter.1.4.2. Activities and acquisitions subject to a specific regulationThere are certain economic activities and companies in which foreign investment is notexcluded but is limited to a certain proportion, ranging from 10 to 49 percent. Thereare also certain sectors in which even when the foreign investment is limited to 49 percent,it is possible to surpass such percentage with an authorization of the National ForeignInvestment Commission (Comisión Nacional de Inversiones Extranjeras, CNIE).In order to determine the percentage of foreign investment in the economic activitiessubject to maximum limits of investment, the foreign investment made in such activitiesindirectly through Mexican companies with a majority of Mexican capital is not counted,provided the latter are not controlled by the foreign investment.

a) Limited activities. In the economic activities and companies mentioned below, foreigninvestment is limited to the indicated percentages, which cannot be surpassedunder any circumstances, except through the mechanism of neutral investment,which is discussed in Point 1.5 of this chapter:• Up to 10 percent: producers’ cooperatives;• Up to 25 percent:• National air transport;• Air taxi transport;• Specialized air transport;• Up to 49 percent:• Insurance companies;• Bonding companies;• Money exchange firms;• Public bonded warehouses;• Financial leasing companies;• Factoring companies;• Special-purpose financial institutions;• The companies referred to in Article 12 bis of the Securities Market Law(Ley del Mercado de Valores);• Pension fund management companies;• Companies manufacturing and selling explosives, firearms, cartridges, munitions,or fireworks, not including the acquisition and utilization of explosivesfor industrial and extractive activities or the preparation of explosive mixturesfor the carrying out of such activities;• Printing and publishing of newspapers for circulation exclusively in nationalterritory;• Series “T” shares of companies owning agricultural, livestock, and forestrylands (series “T” shares only represent capital contributed in agricultural,livestock, or forestry lands, or capital to be used for the acquisition of suchlands);• Fishing operations in fresh and coastal waters and in the exclusive economiczone, not including aquaculture;• Comprehensive port administration;• Port pilotage services to ships for interior navigation operations, accordingto the applicable law;• Shipping companies engaged in the commercial exploitation of ships forinterior navigation and cabotage, except for tourist cruise ships and theexploitation of dredgers and naval artefacts for port construction, conservationand operation;45Foreign Investment Regulation

46C H A P T E R I I• Suppliers of fuel and lubricants for ships and aircraft and rail equipment;• Concession holding companies pursuant to the terms of Articles 11 and 12of the Federal Telecommunications Law (Ley Federal de Telecomunicaciones);b) Limited activities in which 49 percent can be surpassed with an authorization from theCNIE. Foreign investment can hold a percentage greater than 49 percent in the economicactivities and companies mentioned below if they obtain a favorable decisionsof the CNIE:• Port services for ships carrying out interior navigation operations, such as towing,tying up, and launching;• Shipping companies engaged in the exploitation of ships exclusively in hightraffic;• Concession or permit holding companies of airfields for service to the public;• Private services of preschool, elementary, junior high, high school, or collegeeducation or combinations thereof;• Legal services;• Credit information companies;• Securities ranking institutions;• Insurance agents;• Cellular telephony;• Construction of pipelines for the transportation of oil and its derivatives (notincluding construction, operation, and ownership of pipelines, installations,and equipment, regarding the transportation and distribution of natural gas);• Perforation of oil and gas wells;• Construction, operation, and exploitation of railways that are a general meansof communication and provision of rail transport services to the public.It should be emphasized that the favorable decision of the CNIE is only required for foreigninvestment to be greater than 49 percent in the economic activities and companieslisted above when the total value of the assets of the companies involved at the time ofsubmitting the acquisition request surpasses the amount that the Commission determinesannually.1.5. Neutral InvestmentNeutral investment is a mechanism through which foreign investment can participate incertain reserved or specially regulated activities.The LIE defines neutral investment as investment in Mexican companies or in authorizedtrusts that will not be taken into consideration for determining the percentage offoreign investment in the capital stock of Mexican companies.

1.5.1. Neutral investment represented by instruments issued by trust institutionsThe SE has the power to authorize trust institutions to issue neutral investment instruments,which will only grant, with respect to companies, pecuniary rights to their holdersand, if applicable, limited corporate rights, without granting to their holders the rightto vote in their general ordinary meetings.Furthermore, the SE can authorize the creation or modification of all types of neutralinvestment trusts, as well as the transfer of stock thereto, regardless of the activity thatthe company conveying its shares in trust engages in.1.5.2. Neutral investment represented by special series of sharesThe investment in non-voting stock or stock with limited corporate rights is consideredneutral, provided advance authorization is obtained from the SE and, when applicable,from the National Banking and Securities Commission.Companies already incorporated or to be incorporated, regardless of the activity theyengage in, must obtain the advance authorization of the SE to issue special series of stockas neutral investment.1.5.3. Neutral investment made by international development financing institutionsInternational development financing institutions are considered to be those foreignentities whose principal purpose is to promote economic and social development ofdeveloping countries by the contribution of temporary venture capital, granting of preferentialfinancing, or technical assistance of different types.These institutions can invest through neutral investment in the capital stock of Mexicancompanies, provided they are recognized in advance by the CNIE.Furthermore, these institutions can invest in the capital of Mexican companies thatengage in reserved or specially regulated activities, provided they obtain a favorabledecision of the CNIE.47Foreign Investment Regulation

CHAPTER IIIRequirements for Establishinga Company in MexicoFirst, it should be mentioned that the Civil Code (Código Civil) regulates the establishmentand operation of civil partnerships (sociedades civiles) and the General Law of CommercialCompanies (Ley General de Sociedades Mercantiles, LGSM) regulates the establishment andoperation of business entities (sociedades mercantiles).The civil partnership is a company in which the partners combine their resources andefforts for a common purpose that is for profit but is not considered commercial trade.Conversely, business entities can be defined as companies in which the partners or shareholdersagree to combine the resources or efforts for a common purpose that is for profitand is considered commercial trade.In this chapter we will discuss business entities, particularly the stock corporation(sociedad anónima) and the limited liability company (sociedad de responsabilidad limitada),as well as the establishment in Mexico of a branch of a foreign company throughwhom commercial activities can be carried out.We shall also discuss the establishment of a non–income earning representative officethrough which foreigners can have a presence in Mexico without engaging in commercialtransactions.491. Types of CompaniesThe LGSM recognizes as business entities the general partnership (sociedad de nombrecolectivo), the limited liability partnership (sociedad en comandita simple), the limitedliability company (sociedad de responsabilidad limitada), the stock corporation (sociedadanónima), the limited liability stock partnership (sociedad en comandita por acciones),and the cooperative (sociedad cooperativa). The LGSM regulates the operations of the

50C H A P T E R I I Iabove-mentioned companies, except for the cooperative which, due to its nature, isgoverned by a special law.The above-mentioned companies are considered Mexican, since they are incorporatedin Mexico under Mexican law, regardless of the nationality of their partners orshareholders or the source of their capital. It is important to note that the LGSM allowsgeneral partnerships, limited liability partnerships, limited liability companies, stockcorporations, and limited liability stock partnerships to be formed as variable capitalcompanies. As such they have a fixed minimum capital that cannot be less than thelegal minimum and a variable capital that can be increased by subsequent contributionsof the partners/shareholders or by the admission of new partners/shareholders anddecreased as the result of a partial or total withdrawal of contributions with a minimumof formalities.The business entities regulated by the LGSM can be divided into two large groups:partnerships and stock companies. In partnerships, the personal characteristics of thepartners are taken into account and, therefore, the inclusion or exclusion of partners,or the exercise of the right of withdrawal of a partner, are treated or regulated in a specialmanner. Furthermore, these types of companies are intuitu personae and the numberof partners is limited. Partnerships recognized or regulated by the LGSM are thegeneral partnership, the limited liability partnership, the limited liability stock partnership,and the cooperative. Stock companies are those for which investment of largesums of capital is required and therefore, regardless of the personal characteristics of theshareholders, they are invited to invest in the business through the contribution of capital.The stock company par excellence regulated by the LGSM is the stock corporation(sociedad anónima).Above we have referred to partnerships and stock companies and we have specifiedfive of the six types of companies that the LGSM regulates, deliberately excluding referenceto the limited liability company (sociedad de responsabilidad limitada), is neither apure partnership nor a pure stock corporation, but rather mixed, its existence and regulationhaving characteristics of both types of companies: intuitu personae elements of thepartners and elements of stock companies.The types of business entities most common in Mexican law are, based on the numberof companies formed, first, the stock corporations, and next the limited liabilitycompanies. This is due to the fact that both the shareholders in a stock corporation andthe partners in a limited liability company have limited liability before the companyand third parties. The liability of the partners or shareholders in either a limited liabilitycompany or a stock corporation is limited to the amount of the contributions madeby the partners or shareholders to the capital of the company, while the liability of the partnersin partnerships is unlimited, joint and secondary, and therefore the assets of thepartners could be affected.

Given that the limited liability company and the stock corporation are the types ofbusiness entities most common in Mexico, further on we will make special mention oftheir operations and characteristics.2. Formation of CompaniesThe formation of all types of business entities and any amendments to their bylaws mustbe carried out before a certifying public officer, who may be either a notary public or acommercial notary.The articles of incorporation of companies should contain:a) The names, nationality, and domicile of the partners/shareholders;b) The purpose of the company;c) The business or corporate name. The business name is formed with the name ofone or more of the partners in the case of partnerships and without restriction inthe case of stock corporations. The limited liability company can be given either abusiness name (the name of one or more of the partners) or a corporate name. TheForeign Relations Ministry (Secretaría de Relaciones Exteriores, SRE) is the agencyresponsible for authorizing the use of business or corporate names;d) The duration of the company;e) The amount of capital stock the company has, which must be in Mexican currency;f) An indication of what each partner or shareholder contributes in money or in kind;the value given to the in-kind contributions, and the criteria used to make suchvaluation. When the company has variable capital, the fixed minimum capitalestablished shall be indicated;g) The business address or domicile of the company, which is the town or city wherethe company is established;h) Under what form of administration the company will be managed and the powersof the managers;i) How the profits and losses will be distributed among the members of the company,taking into account that the profits or losses among the partners/shareholderswho contribute capital must be distributed in proportion to their contributions tothe capital of the company;j) The amount of the reserve fund, taking into account that, pursuant to the LGSM,from the profits shown in the financial statements each year, 5 percent should beseparated for the reserve fund (legal reserve) until such fund reaches one-fifth ofthe capital stock;k) Under what circumstances the company will be dissolved early;l) The bases for liquidating the company and the manner of choosing the liquidators.51Requirements for Establishing a Company in Mexico

2.1. Power of Attorney for the Formation of a Company and Holdingof the First Partners or Shareholders Meeting52C H A P T E R I I IFor the formation of a company, the partners or shareholders must appear before anotary public or commercial notary, either personally or through an attorney-in-factwith sufficient powers.In the event that one or more of the partners or shareholders are foreigners, theyshould grant a power of attorney for their representation in the company’s formationprocedure by a Mexican national or a foreigner legally in the country. The foreign partnersor shareholders who are individuals may also appear personally at the formation ofthe company if they have the appropriate visa document.The above-mentioned power of attorney must be granted before a notary publicauthorized to practice in the domicile of the foreign partner or shareholder and subsequentlylegalized in the Mexican consulate of such domicile or apostilled in accordancewith the Hague Convention of October 5, 1961. Once the power is legalized, it must benotarized before a notary public in Mexico. If the power has been apostilled it does notneed to be notarized before a notary public in Mexico.At the time of the formation of the company, with the presence of the partners or shareholdersor their representatives, the first partners or shareholders meeting is held, atwhich the designation of the administrative bodies of the company is agreed upon; theofficers, the oversight bodies, and the secretary of the company are appointed; and powersare granted to the board members or sole manager, the appointed officers, and anyother parties that will in the future take action on behalf and in representation of the company.These resolutions are recorded in what in practice are called transitory articles, andthey are added by the notary public to the end of the corporate bylaws in the documentknown as articles of association or incorporation (escritura constitutiva).The powers of attorney that are generally granted upon the formation of a companyor thereafter for the running and management of the company are divided into the followingcategories:a) Powers for litigation and collections, which are generally granted to the personswho will attend matters before governmental agencies, process permits and licensesfor the company, request registrations, appear before judicial authorities, andrespond to and file all types of claims. These powers are also generally granted tothe external lawyers of the company;b) Powers for administrative acts, which are granted to the persons who will sign contractson behalf of the company, such as lease agreements, loans, employmentagreements, etc.;c) Powers for acts of ownership, with which powers are granted to sell fixed assetsof the company. In view of the importance of these powers, we recommend not

granting them as general powers, but rather as special powers for acts of ownershipat the time they are needed for a particular transaction and/or specific asset.This measure protects the company from any unauthorized sale of the fixed assetsthat could be harmful to the company and the attorney-in-fact, so that the latter,when exercising the special power, can subsequently prove that he/she had thenecessary authority;d) Powers to subscribe, endorse, and guarantee negotiable instruments. With thispower of attorney, powers are granted to the attorney-in-fact to be able to openbank accounts and investment accounts for the company and sign checks andother negotiable instruments;e) Any special powers that the company requires according to its needs;f) Powers to grant and revoke powers. It is important to mention that we do not recommendthat the attorneys-in-fact have the power to grant powers, since in thatcase the company and the partners or shareholders will lose control over the powersgranted by the company. In extreme cases, when it is necessary to give an attorneyin-factthe power to grant powers, we recommend that the powers granted to theattorney-in-fact be limited in purpose or in time. In this way this power will eventuallyexpire.The above-mentioned powers can be granted to be exercised individually by the attorney-in-factor it may be required that they be exercised jointly by two or more attorneysin-fact,depending on the desired control. Furthermore, the exercise of the powers can belimited to certain amounts or it can be required that above certain amounts they mustbe exercised jointly by two or more attorneys-in-fact.The general director and officers of the company must have sufficient powers to managethe daily operations of the company. It is suggested that there always be an adequatenumber of attorneys-in-fact for them to be able to expeditiously attend all the matters ofthe company in the absence or unavailability of any other attorney-in-fact.3. RegistriesOnce the company is formed, the certifying public officer will issue official transcriptsor public instruments (testimonios) formalizing the bylaws and transitory articles of thecompany, and with such documents the company should carry out or obtain the followingregistrations:a) Registration of the articles of incorporation in the Public Registry of Commerce(Registro Público de Comercio) of the domicile of the company;b) Registration of the company before the National Foreign Investment Registry (RegistroNacional de Inversiones Extranjeras, RNIE), if there are foreign shareholders;53Requirements for Establishing a Company in Mexico

54C H A P T E R I I Ic) Registration of the company before the Ministry of Finance and Public Credit (Secretaríade Hacienda y Crédito Público, SHCP) to obtain its Federal Taxpayers Registry(Registro Federal de Contribuyentes, RFC) number;d) Registration of the company before the Importers and Exporters Registry (Padrónde Importadores y Exportadores), if the company intends to engage in imports andexports;e) Registration of the company in the Mexican Business Information System (Sistemade Información Empresarial Mexicano, SIEM);f) Registration of the company before the Registry of Companies and Establishmentsof the General Office of Statistics and Geography (Registro de Empresas y Establecimientosde la Dirección General de Estadística y Geografía) of the SHCP;g) As soon as the company hires any employee, it must register as an employer andregister its employees before the Mexican Social Security Institute (Instituto Mexicanodel Seguro Social, IMSS), the National Fund For Workers Housing Institute(Instituto del Fondo Nacional de la Vivienda para los Trabajadores, INFONAVIT) and theRetirement Savings System (Sistema de Ahorro para el Retiro, SAR), as well as registeras a tax withholder before the SHCP;h) It is also important to protect in Mexico the industrial and intellectual propertyrights of the company and/or the shareholders, such as trademarks, patents, industrialdesigns, utility models, and copyright.4. The Limited Liability Company(Sociedad de Responsabilidad Limitada)The limited liability company is a company formed among partners who are only obligatedto pay their contributions, and the ownership interests they obtain will not be representedby negotiable instruments, payable to order or to bearer.This type of company, as indicated previously, can exist under either a corporate nameor a business name, and such name must be followed by the words Sociedad de ResponsabilidadLimitada or its abbreviation, S. de R.L.The failure to indicate that a company is a limited liability company can result in allthe partners being held liable without limitation, jointly and secondarily, for the obligationsof the company.4.1. Requirements for Forming a Limited Liability CompanyThe minimum capital with which a limited liability company may be formed is $3,000.00(3 thousand pesos 00/100, Mexican currency). The minimum number of partners thecompany may have is 2 and the maximum 50.

4.2. Ownership InterestsThe ownership interests will be in multiples of $1.00 (1 peso 00/100, Mexican currency)and no partner can hold more than one ownership interest, unless the ownershipinterests grant different rights. When the limited liability company has variable capital,the partners may have two ownership interests: one ownership interest representing thefixed capital and another representing the variable capital.When the company is formed and for each capital increase thereafter, at least 50 percentof the capital must be fully subscribed and paid. In capital increases the partnerswill have, in proportion to their share of the company capital, preference to subscribethe capital increases declared, unless this right has been cancelled in the articles of associationor is cancelled by resolution of the partners meeting that declares the capitalincrease. When the company capital is increased, the ownership interest of the partnerwho subscribes and pays the capital increase will increase in value.The consent of the partners representing the majority of the company capital isrequired for the transfer of ownership interests, as well as for the admission of new partners.If the partners meeting authorizes the transfer of an ownership interest to a thirdparty foreign to the company, the partners will have a preferential right for 15 days fromthe date on which the transfer of the ownership interests has been authorized, to purchasethe ownership interest being transferred, in proportion to their share in the companycapital.The company must keep a special partner registry book, which will be maintained bythe board of managers or the sole manager of the company, who will be personally andjointly and severally responsible for its existence and its accuracy. The name and addressof each partner will be registered in the partner registry book along with the indicationof each one’s contributions and the transfer of ownership interests. The transfer of ownershipinterests will not become effective with respect to third parties until it has beenregistered in this book.4.3. Supplementary Contributions and ObligationsWhen the company bylaws so stipulate and the partners meeting so resolves, the partnersshall make supplementary contributions and execute supplementary obligations to thelimited liability company. The supplementary contributions are cash loans or assets thatserve to increase the means of action of the company or liquidate company debts; supplementaryobligations are not defined by the LGSM, but such law prohibits supplementaryobligations consisting of personal work or services of the partners. The supplementaryobligations may consist of obligations on the partners to transform certain assets or sellto the company all or part of the products that the partners manufacture or sell.55Requirements for Establishing a Company in Mexico

4.4. The Management of the CompanyOne or more managers will be responsible for the management of the limited liabilitycompany. Such managers may be partners or they may be from outside of the company.When just one manager is appointed, such manager will be called the sole manager,and when two or more managers are appointed, they will form a board ofmanagers.The appointment of the managers is temporary and, unless otherwise agreed, the partnersmeeting can revoke their appointment at any time, appointing others. When for anyreason no managers have been appointed, it will be understood that the management ofthe company is the responsibility of the partners.If the limited liability company is managed by a board of managers, the resolutionswill be adopted by a majority of votes of the appointed managers.56C H A P T E R I I I4.5. The Partners MeetingThe partners meeting in the limited liability company is the supreme body of the company.The resolutions are adopted in the partners meeting, on the first call, by a majorityof votes of the partners representing at least half of the company capital, unless thebylaws require a greater majority. On the second call, the partners meeting can adoptresolutions by a majority of votes, whatever the proportion of the capital represented.Every partner has the right to participate in the decisions of the meetings and enjoysone vote for each peso he contributed to the company or multiple thereof.The partners meetings will be held in the company domicile at least once a year duringthe period stipulated in the articles of association. The meetings will be called by themanagers, and if they do not do so, by the oversight body, and if the latter fails to do so,by the partners representing more than one-third of the company capital.Unless otherwise agreed, the calls to meetings will be made by certified letters withacknowledgement of receipt and shall contain the agenda and be sent to each partner atleast eight days prior to the date of the meeting.The articles of association may indicate the cases in which the holding of a partnersmeeting is not necessary. In this case the partners can send the text of the resolutions ordecisions by certified mail. However, if partners representing more than one-third of thecompany capital so request, a partners meeting must be called, even if the articles ofassociation only require a vote by mail.The partners meeting has the authority to:a) Discuss, approve, amend or reject the general balance sheet for the closed fiscal yearand take, for such purposes, the measures it considers appropriate;b) Undertake the distribution of profits;

c) Appoint and remove managers;d) Designate, if applicable, the oversight board;e) Resolve on the division and redemption of the ownership interests;f) Require, if applicable, supplemental and additional contributions;g) File against the company bodies or the partners the corresponding actions to claimdamages and lost profits;h) Amend the articles of association;i) Consent to the transfer of ownership interests and the admission of new partners;j) Decide on the increases and reductions of the company capital;k) Decide on the dissolution of the company;l) Decide all other matters corresponding to it pursuant to the law or the articles ofassociation.Except as agreed otherwise, the amendment of the articles of association may beresolved by the majority of the partners representing three-fourths of the company capital;however, when it involves a change in the corporate purpose or the imposition ofrules increasing the obligations of the partners, a unanimous vote is required.In practice, in the case of closed companies and those in which the partners belongto the same group, the partners meetings are held without the actual physical meetingof the partners or their representatives, in which case the partners or their representativesindicate the resolutions that should be adopted, such as the approval of thefinancial statements for the immediately prior fiscal year, approval of the certification ofthe oversight board in the event the company has appointed such a body, approvalof the board’s or sole manager’s report, and the ratification or change of members ofthe board of managers. For these purposes the partners or their representatives shouldsend a simple proxy letter designating one or more representatives. Once the aboveinformation is received, the partners meeting minutes are prepared which are sent forthe approval of the partners or their representatives and, once such draft minutes areapproved, they are transcribed into the partners meeting minute book. The minutesare signed by the acting chairman and secretary, who are generally the persons thatrepresented the partners.If the above-mentioned partners meeting minutes contain appointments or revocationsof appointments of members of the board of managers, of members of the oversightboard or of officers of the company, as well as the revoking and granting of powersor any resolution that amends the articles of association or any other act that by law mustbe recorded in a public instrument, such resolutions must be certified before a certifyingpublic officer and subsequently registered in the Public Registry of Commerce of thedomicile of the company.57Requirements for Establishing a Company in Mexico

4.6. The Oversight BoardIf the articles of association so establish, the company can have an oversight boardformed by one or more partners or persons outside of the company. The function of theoversight board will be to ensure the adequate administration of the company in orderto report to the partners meeting any relevant point regarding the management of thecompany and its accounting records.5. The Stock Corporation (Sociedad Anónima)58C H A P T E R I I IThe LGSM defines the stock corporation simply and clearly as a company existing undera corporate name and composed exclusively of shareholders whose liability is limited tothe payment of their shares. The name can be freely chosen and will always be followedby the words Sociedad Anónima or its abbreviation, S.A.5.1. Requirements for the Incorporation of a Stock CorporationThe following is required for the incorporation of a stock corporation:a) That there are at least two shareholders and that each of them subscribes at leastone share;b) That the capital stock is not less than $50,000.00 (50 thousand pesos 00/100,Mexican currency);c) That at least 20 percent of the value of each share payable in cash be paid; andd) That the value of each share to be paid in kind, in whole or in part, be paid in full.The articles of incorporation of the stock corporation should contain, in addition tothe requirements indicated in Point 2 of this chapter:a) The paid portion of the capital;b) The number, par value, and nature of the shares into which the capital stock isdivided, except when they are shares without par value;c) The form and the terms in which the unpaid portion of the shares must be paidwhen they are assessable shares;d) The share of the profits granted to the founders of the company;e) The appointment of one or more examiners; andf) The powers of the general meeting and those granted for the validity of their deliberations,as well as for the exercise of the rights to vote, to the extent the legal provisionscan be freely modified by the shareholders.

5.2. The StockThe shares into which the capital stock of a stock corporation is divided will be representedby negotiable instruments payable to order that serve to prove and transfer thestatus and rights of shareholder.Stock corporations must keep a stock registry book that contains:a) The names, nationality and domicile of the shareholder;b) The indication of the shares belonging to each shareholder, stating the number,series, class and other specifics;c) The RFC or tax identification number of the shareholders;d) The indication of the amount paid by each shareholder; ande) Any transfers made.The LGSM requires that the company only consider as owners of the shares those whoappear registered as such in the stock registry book, and that the company register insuch registry book, at the request of any stockholder, any transfers made.Stock corporations cannot issue shares for an amount less than their par value, andthey are prohibited from acquiring their own shares. The shares are of equal value andconfer equal rights. However, in the articles of incorporation it can be stipulated thatthe capital be divided into several classes of shares with special rights for each class.In accordance with the LGSM and the doctrine, the shares of a stock corporationcan be:a) Non-assessable stock (acciones liberadas). Stock fully subscribed and paid;b) Assessable stock (acciones pagadoras). Stock fully subscribed and partially paid, atleast 20 percent;c) Contribution stock (acciones de aporte). Stock that has been paid in whole or in partby contributions in kind. This stock must remain deposited in the company fortwo years. If during this period it appears that the value of the in-kind goods is 25percent less than the value at which they were contributed, the shareholder mustpay the difference to the company;d) Performance stock (acciones de trabajo). Stock that, if so established in the articles ofincorporation, can be issued to persons who render services to the company; theymust contain rules with respect to the form, value, inalienability and other particularconditions applicable to them;e) Limited-voting stock (acciones de voto limitado). As a general rule, each share has theright to one vote. However, it can be established in the corporate bylaws that a partof the shares only has the right to vote in the extraordinary meetings held toaddress certain matters. As compensation for the limitation on the corporate rights,they will receive a cumulative preferred dividend of 5 percent;59Requirements for Establishing a Company in Mexico

60C H A P T E R I I If) Restricted circulation stock (acciones de circulación restringida). Stock that to be transferredmust have the authorization of the board of directors, when such is establishedin the articles of incorporation. The board of directors can deny theauthorization, designating a buyer of the stock;g) Treasury stock (acciones de tesorería). Stock that in a variable capital corporation ispreserved in the treasury of the company until the board of directors of the companydecides to put it in circulation. They are shares issued and unsubscribed; theywill be subscribed by the shareholder when put in circulation;h) Dividend certificates (acciones de goce). When the articles of incorporation so authorize,the company may redeem its stock with distributable profits. Only fully paidstock will be redeemed and the certificates of the redeemed stock will be cancelledand in their place dividend certificates will be issued. The dividend certificates areentitled to the liquid profits, after the dividend indicated in the articles of incorporationhas been paid to the non-redeemable stock.5.3. Management of the CompanyThe stock corporation shall be managed by a sole director or a board of directors consistingof two or more members, which will be appointed by the ordinary shareholdersmeeting. The shareholders meeting can also appoint one or more alternate board memberswho act in the absence of the proprietary board member. The position of boardmember is personal, temporary and revocable and shareholders or persons outside ofthe company can be appointed, regardless of nationality.For the board of directors to function legally at least half of its members must attendand its resolutions will be valid when they are adopted by the majority of those present.In case of a tie, the chairman of the board of directors has a tie-breaking vote. The bylawsof the company can establish that resolutions adopted outside of a board meeting willhave the same validity as if they were adopted in a meeting, provided that all the boardmembers confirm them in writing.When the company is managed by a board of directors, the shareholders holdingstock representing 25 percent of the capital stock can appoint one board member. Thispercentage is 10 percent in the case of companies who register their stock on the StockExchange.The sole director and the members of the board of directors are jointly and severallyliable to the company for the actual existence of the contributions of the shareholders;for compliance with the legal and statutory requirements established with respect to thedividends paid to the shareholders; for the existence and maintenance of the accounting,control, recording, filing or information systems required by law; and for the timelyfulfillment of the resolutions of the shareholders meetings, among other things.

5.4. Oversight of the CompanyEvery stock corporation must appoint, in a general ordinary shareholders meeting, oneor more examiners. The appointment of the examiners is temporary, revocable andremunerated and shareholders or persons outside of the company can be appointed.However, persons barred from engaging in commerce, employees of the company,employees of those companies that are shareholders of more than 25 percent of the capitalstock, employees of the companies in which the company is a shareholder of morethan 50 percent and blood relatives of the sole director or the board members in a directline without limitation of degree, as well as siblings, cousins and brothers- and sistersin-lawof the sole director or the board members, cannot be appointed as examiners.The restriction in the law on who can be appointed examiners of a company is intendedto guarantee the quality and independence of the oversight work required from theexaminers. In practice, in stock corporations, members of the accounting firm thataudits the financial statements of the company are appointed as examiners.The shareholders representing 25 percent of the capital stock can appoint an examinerand in the case of companies whose stock is registered on the Stock Exchange, theshareholders representing 10 percent will have such power.The powers and obligations of the examiners include, among others, to ensure the creationand maintenance of any guarantee that has been requested from the sole director,the board members, the directors and the managers of the company; to request from thesole director and the board members monthly information that includes at least a statementof the financial situation and a statement of results; to carry out an examination ofthe operations, documents, and records in order to render an opinion to the meeting; torender annually to the general ordinary shareholders meeting a report with respect to thetruthfulness, sufficiency, and reasonableness of the information presented by the soledirector or by the board of directors to the shareholders meeting; to have added to theagenda of the board of directors and shareholders meetings the points they consider necessary;to call shareholders meetings; to attend with voice but not vote the board of directorsand shareholders meetings; and to scrutinize without restriction and at any time theoperations of the company.5.5. The Shareholders Meeting61Requirements for Establishing a Company in MexicoThe LGSM recognizes the existence of several types of meetings: general meetings andspecial meetings. General meetings may be ordinary or extraordinary, depending on thematters addressed and not, as some erroneously state, on the time during which theymeet. In the extraordinary meetings the quorum for both their convening and for adoptingresolutions is higher than those for an ordinary meeting.

62C H A P T E R I I IThe general shareholders meeting is the supreme body of the company; it canresolve and ratify all the acts and operations of the company and its resolutions willbe carried out by the person the meeting designates, or in the absence of a designation,they will be carried out by the sole director or the board of directors. Thus itshould be understood that the shareholders meeting is a deliberative body and thatthe sole director or the board of directors, as applicable, are bodies that execute theresolutions of the meetings.The general ordinary, general extraordinary, and special shareholders meetings mustbe held in the corporate domicile; otherwise they will be null and void, except in thecase of an Act of God or force majeure, in which cases the meetings can be held outsideof the corporate domicile.The corporate bylaws may establish that the shareholders representing all of the votingshares, or of the special category of shares involved, may adopt resolutions unanimouslyand in writing outside of a meeting. The resolutions so adopted will have the same validityas if they had been adopted by the shareholders in a general or special meeting.The shareholders can be represented in the meetings by representatives, that mayeither belong to the company or not; however, the LGSM prohibits the sole director, themembers of the board of directors and the examiners from representing shares in meetings.This is in order to prevent them from approving their own actions in prejudice tothe shareholders or from hiding relevant information from the shareholders with regardto their actions. Unless otherwise stipulated in the bylaws, the shareholders meetingsshould be presided over by the sole director or the chairman of the board of directors,and in their absence the meetings will be presided over by the person selected by themeeting itself. For every general meeting, minutes should be drafted to be transcribedinto the respective book and signed by the chairman and the secretary of the meetingand by any examiners that attend.When for any reason the minutes of a meeting cannot be transcribed into the minutebook of the company, the minutes shall be notarized before a notary public. Minutes ofgeneral extraordinary shareholders meetings must also be notarized.5.6. The General Ordinary Shareholders MeetingGeneral ordinary shareholders meetings are those held to address any matter that is notreserved by law or by the corporate bylaws to the extraordinary shareholders meeting.The ordinary shareholders meeting should be held at least once a year within the fourmonths following the close of the fiscal year, that is between January 1 and April 30 ofeach year. In the general ordinary shareholders meetings, the following matters will beaddressed, as well as any other matter that is indicated on the agenda and that in accordancewith the LGSM is not reserved to the extraordinary shareholder meetings:

a) Discussion, approval, or modification of the report of the sole director or the boardof directors, taking into account the examiners’ report;b) Appointment of the sole director or the board of directors and the examiners;c) Determination of the emoluments corresponding to the sole director, the members ofthe board of directors, and the examiners, when they have not been set in the bylaws.5.6.1. Report of the sole director or the board of directorsThe sole director or the board of directors in the stock corporation must present anannual report to the shareholders, which shall include a report on the progress of thecompany during the fiscal year, as well as the policies followed by the board or soledirector and, if applicable, on the principal existing projects, and a report declaring andexplaining the principal accounting and information policies and criteria followed in thepreparation of the financial information.5.6.2. Financial statementsIn addition, the sole director or the board of directors must present annually to the shareholdersthe financial statements that show the financial situation of the company as of thedate of the close of the fiscal year; the results of the company during the fiscal year, dulyexplained and classified; the changes in the financial situation during the fiscal year; thechanges in the items composing the corporate assets and liabilities occurring during thefiscal year; and the notes that are necessary to complete or clarify the above information.5.6.3. Report of the examiner or oversight boardBy law, the examiner must render annually to the shareholders meeting a report with respectto the truthfulness, sufficiency and reasonableness of the information presented by the boardor sole director. This report should include an opinion as to whether the accounting andinformation policies and criteria followed by the company are adequate and sufficient, takinginto consideration the particular circumstances of the company; if these policies and criteriahave been consistently applied in the information presented by the board or soledirector; and if, as a result of the above, the information presented by the board or sole directoraccurately and sufficiently reflects the financial situation and the results of the company.The board or sole director’s report and the financial statements, as well as the examiner’sreport, must be made available to the shareholders in the stock corporation at least15 days prior to the date of the meeting at which they will be discussed.63Requirements for Establishing a Company in Mexico5.7. The General Extraordinary Shareholders MeetingAccording to the LGSM, the extraordinary shareholders meeting may be held at any timeto address the extension of the duration of the company, the early dissolution of the

company, the increase or decrease of the capital stock, the change of corporate purpose,the change of nationality of the company, the transformation of the company, the mergerwith another company and spin-off from the company, the issuance of privilegedstock, the redemption by the company of its own shares and the issuance of dividendcertificates, the issuance of bonds, any amendment to the articles of incorporation andthe other matters for which the law or the bylaws require a special quorum.5.8. Call to Meetings64C H A P T E R I I IThe call to a shareholders meeting must be made by the sole director, the board of directors,or the examiners. The call to a general shareholders meeting, which should containthe agenda, is given by publication of a notice in the official gazette of the entity of thedomicile of the company or in a newspaper of major circulation in such domicile at least15 days prior to the date of the meeting. The report of the sole director or board of directorsmust be made available to the shareholders in the offices of the company. The resolutionsadopted by the general shareholders meeting will be null and void if the call tosuch a meeting was not made in accordance with the above requirements, unless at thetime the resolutions were adopted all of the shares of the capital stock were represented.In the case of stock corporations that belong to the same group of shareholders, inpractice a call to the ordinary or extraordinary shareholders meetings is not made, sincethe shareholders will be represented by an attorney-in-fact appointed through a simpleproxy letter, designating as representatives Mexican individuals or persons having theappropriate Mexican visa. Once the proxies are received by the shareholders and theirrepresentatives, the shareholders meeting minutes will be prepared, including thedesired resolutions, and these minutes will be sent for the approval and comments of theshareholders and their proxies. If the minutes contain resolutions that must be notarizedby law, their notarization will be requested, and once the public document recordingsuch resolutions is issued, it will be registered in the Public Registry of Commerce of thedomicile of the company in the cases when such is necessary.5.9. QuorumFor a general ordinary shareholders meeting to be considered legally convened on thefirst call, at least half of the capital stock must be represented and the resolutions willonly be valid when adopted by the majority of the votes present. If the general ordinaryshareholders meeting cannot be held due to the lack of a quorum, a second callwill be made for a subsequent date, indicating that it is a second call, and the meetingwill be convened with any number of shares represented therein; the resolutionswill be adopted by a majority of votes present.

In the case of general extraordinary shareholders meetings, unless the bylaws indicatea higher percentage, at least three-fourths of the capital stock must be represented, andresolutions will be adopted by the vote of the shares representing half of the capital stock.If the general extraordinary shareholders meeting cannot be held due to the lack of aquorum, a second call will be made for a subsequent date, indicating that it is a secondcall. In this case, resolutions can be adopted with the favorable vote of the number ofshares representing at least half of the capital stock.6. Public Registry of CommerceBy law the public instruments of the company that record the following points, among others,must be registered in the Public Registry of Commerce: the granting and/or revokingof general powers; the appointment, revocation, and/or resignation of managers, officers,examiners and members of any oversight board; the amendment of the corporate bylaws;and resolutions for liquidation, merger, transformation, and spin-off of the company.7. Establishment of a Branch of a Foreign Company in MexicoForeign companies can do business in Mexico through the establishment of a branch,and for that the foreign company must obtain the authorization of the Foreign InvestmentBureau (Dirección General de Inversión Extranjera) of the Ministry of Economy (Secretaríade Economía, SE) in order to be able to register their corporate bylaws in the PublicRegistry of Commerce of the domicile of the location where it will be established. Thisregistration is necessary given that the LGSM establishes that foreign companies may onlydo business once they are registered in the Public Registry of Commerce.7.1. PowersIn practice, in order to open a branch in Mexico, a foreign company must adopt a resolutionapproving the establishment of the branch in Mexico and granting powers to thelegal representatives that will handle the operations of the branch. This resolution mustbe certified before a notary public commissioned in the domicile of the foreign companyand subsequently legalized by the Mexican consulate of such domicile or apostilledin accordance with the Hague Convention of October 5, 1961, if the foreign companybelongs to a country that has signed such convention. After the legalization or apostille,the resolution to open the branch and the corresponding granting of powers to the representativesmust be translated into Spanish by an authorized translator in Mexico and,if the legalization was done by the Mexican consulate, the document must be notarizedin Mexico before a certifying public officer.65Requirements for Establishing a Company in Mexico

7.2. Authorization of the Foreign Investment Bureau66C H A P T E R I I IThe Foreign Investment Law (Ley de Inversión Extranjera, LIE) establishes that foreignentities that wish to do business routinely in Mexico must obtain an authorization fromthe Foreign Investment Bureau. In order to obtain this authorization, a petition requestingthe establishment of a branch in Mexico and the registration of the current bylawsof the company must be filed before the bureau. The articles of incorporation of the foreigncompany, its current bylaws, a certificate issued by a legal expert in the country ofresidence of the foreign company (can be a notary public or a lawyer) indicating that thecompany was legally incorporated under the laws of such country, and the receipt forthe payment of the fees established in the Federal Fees Law (Ley Federal de Derechos),must be attached to such petition for authorization, and must be certified by notary publiccommissioned in the domicile of the foreign company, legalized by the Mexican consulateor apostilled if the country is a member of the Hague Convention and translatedinto Spanish by an authorized translator.The Foreign Investment Bureau will verify that the incorporation of the foreign companyand its current bylaws do not violate any public order principles established underMexican law and, if they do not, issue the corresponding authorization.Every petition for authorization presented before the Foreign Investment Bureau thatcomplies with the above-mentioned requirements must be authorized within 15 businessdays from the date of its presentation and if no resolution is issued within such period,the authorization will be considered granted.7.3. Legalization and RegistrationOnce the authorization for the establishment of a branch in Mexico has been issued bythe Foreign Investment Bureau, such authorization must be legalized before a Mexicancertifying public officer together with the resolution to open the branch issued by theforeign company, its articles of incorporation and current bylaws. The document issuedby the Mexican certifying public officer must be registered in the Public Registry of Commerceof the domicile where the branch will be established and from that moment theforeign company may do business in Mexico through its branch.7.4. ObservationsIt is important to mention that the procedures for opening a branch of a foreign companyin Mexico are more complicated and more expensive than the establishment of asubsidiary company by which commercial operations will be carried out in the country.Therefore the majority of foreign companies who wish to do business in Mexico do so

through a subsidiary, which can be incorporated based on explanation in Point 2 andsubsequent points of this chapter.8. Non-Income Earning Representative OfficeThe establishment of a non–income earning representative office is recommended forthose foreign companies who only wish to have a representative in Mexico, since theywill not engage in commercial transactions and their activity will be limited to the identificationof potential clients or acting as a point of contact between the foreign companyand Mexican clients.In order for a non–income earning representative office not to be considered a permanentestablishment subject to the strict tax regulations of the country, its representativesin Mexico must abstain from engaging in any commercial activities and thereforefrom executing contracts, importing or exporting merchandise or assuming risks onbehalf of the foreign company.8.1. PowersIn order to open a non–income earning representative office in Mexico, the foreign companymust adopt a resolution approving the establishment in Mexico of such office andgrant powers of attorney to the legal representatives in Mexico. The powers granted to therepresentatives in Mexico should be limited to the execution of contracts for the operationsof the office, such as the execution of the lease agreement for the office, the hiringof personnel, the registration and cancellation of employees before the applicable authorities,the contracting of telephone services, among others.The resolution to open the non–income earning representative office must be certifiedby a notary public commissioned in the domicile of the foreign company and subsequentlylegalized in the Mexican consulate of such domicile or apostilled in accordancewith the Hague Convention of October 5, 1961 if the foreign company is incorporated ina country that is a member of such convention. The resolution to open the non–incomeearning representative office, once legalized or apostilled, must be translated into Spanishby an authorized translator and, if legalized before the Mexican consulate, notarizedbefore a certifying public officer in Mexico.67Requirements for Establishing a Company in Mexico8.2. Authorization of the Foreign Investment BureauThere is an unresolved debate as to whether or not the authorization of the Foreign InvestmentBureau is required to open a non–income earning representative office. The LGSMestablishes that foreign companies may only do business in Mexico after registration in the

Public Registry of Commerce, which registration can only take place if authorized by theSE. Furthermore, the LIE establishes that foreign entities that intend to do business routinelyin the Mexico must obtain authorization from the SE. Based on this, and given that thenon–income earning representative offices do not routinely do business in Mexico, thereare those who argue that the authorization of the Foreign Investment Bureau is not requiredfor the opening of a non–income earning representative office; however, in must be mentionedthat in practice some authorities do require that such authorization be obtained.8.3. Contracting a Mexican Accounting Firm68C H A P T E R I I IThe non–income earning representative office, even though it will not be engaging incommercial transactions, must have a taxpayer identification number (RFC), since by lawit will have to withhold income tax for its employees and file periodic declarations beforethe tax authorities. Therefore, and in order to be able to adequately manage its payrolland the registration and removal of its employees before IMSS, we recommend that aMexican accounting firm be contracted to help the non–income earning representativeoffice with these matters.8.4. Registration of the Non–Income Earning Representative Officebefore the Ministry of Finance and Public CreditAs stated previously, the non–income earning representative office must be registered inthe taxpayers’ registry (RFC) since it will withhold income tax for its employees. In orderto obtain the federal taxpayers registry number, the following basic documents must bepresented: a certificate of tax residency of the foreign company, translated into Spanishby an authorized translator, which must be issued by the competent tax authorities inthe domicile of the foreign company and must certify the place of tax residence and taxidentification number of the foreign company, the public instrument issued by a Mexicannotary public recording the powers granted by the foreign company to its legal representatives,and proof of the tax domicile in Mexico.It is important to mention that in practice the tax authorities may request additionaldocuments, depending solely on the requirements established by the governmentalemployee who receives and processes the request for registration in the RFC. The additionaldocuments that may be required are the articles of incorporation of the foreigncompany, certified by notary public commissioned in the domicile of the foreign company,legalized or apostilled and translated into Spanish by an authorized translator,and/or the public instrument issued by a Mexican certifying public officer recording theauthorization granted by the Foreign Investment Bureau of the Ministry of Economy forthe opening of the non–income earning representative office in Mexico.

CHAPTER IVOffices and Industrial PlantsOne of the most important decisions a company must make when investing in Mexicois determining where to establish its office or industrial plant.In order to make the correct decision it is very important to know the law applicableto both acquiring and leasing real estate. Furthermore, it is essential to know whatauthorizations must be obtained in order to install the type of business or industry inthe place chosen to house the industrial plant or office.691. Acquisition of Real EstateAs was indicated in chapter II of this book, the restrictions on the acquisition of realestate by foreign individuals, foreign companies, and Mexican companies with foreigninvestment must be taken into account.Along with the above, it is equally important to determine the best location to acquireproperty in Mexico before making the purchase. In order to make that determination,the following should be taken into account:a) Which states of the Mexican Republic offer tax incentives for companies that wishto become established in their territory. To obtain this information the Ministry ofEconomic Development of each state should be contacted;b) Whether the property has adequate access roads;c) Whether there is access to utilities and a sufficient water supply;d) Whether it is near suppliers and clients.Once the property to be acquired has been chosen, the buyer should:a) Review the title to the property, which must be registered before the appropriatePublic Registry of Property. The title deed for real estate consists of a public

70C H A P T E R I Vinstrument granted before a notary public that records the acquisition by the ownerof the property;b) Verify in the appropriate Public Registry of Property that the property is free ofliens or encumbrances by obtaining a liens certificate. In Mexico, all real estateavailable for private ownership must be registered in the Public Registry of Propertyof the state in which it is located. In the Public Registry of Property all transferof the property will be registered, as well as any encumbrances upon it, such asmortgages or attachments. In order to verify that a property is registered under thename of the person who claims to be the owner and that the property is free ofencumbrances, a liens certificate must be obtained. Such a certificate is issued bythe Director of the Public Registry of Property;c) Check the National Agrarian Registry and obtain an agrarian certificate. In thisregard it is very important to take into account that ejidal lands are not subject toprivate ownership, and therefore any contract by which ejidal land is acquired willbe null and void and unenforceable since the ejidal lands cannot be sold. For thisreason, in the case of any acquisition of land in rural zones, it is essential to verifyin the National Agrarian Registry that the land to be acquired is not subject toagrarian regulation;d) Verify that the property has the land use (uso de suelo) zoning classificationrequired by the buyer in order to carry out its activities. In order to verify the zoningof the property, it is very important to obtain from the municipality or, in thecase of the Federal District, from the corresponding political subdivision, a zoningcertificate. The zoning classifications vary from municipality to municipality, howeverthey can be divided into the following types:• Residential. In this zone generally only residential dwellings are permitted;• Commercial. In this zone the installation of all types of businesses is generallypermitted, such as stores, restaurants, banks, etc.;• Industrial. Under this type of zoning the installation of all types of industry ispermitted.Each of the zoning types mentioned above have different subclassifications thatvary from municipality to municipality. Therefore, it is very important to verify thatthe type of business that you wish to establish corresponds to the zoning classificationof the property;e) Request receipts recording the payment of real estate taxes for the last five years,in order to ensure that there are no amounts pending payment or, if necessary,request a tax certificate from the treasury;f) Request the receipts for the last five years recording the payment of water servicesto ensure no amounts are due or, if necessary, request from the treasury a certificateevidencing no charges in this regard are due;

g) Do a topographical site survey and request a plot plan in order to confirm that thereal area of the property, and the metes and bounds, coincide with the area establishedin the public instrument recording the ownership of the property;h) Verify that the property has sufficient water for your production processes. If a newwell must be drilled, determine the possibility of obtaining such a permit from theNational Water Commission. If the well already exists, verify that it is legal and upto date in payment of the corresponding fees;i) Test soil samples to confirm there is no contamination present. This testing shouldbe carried out by a laboratory accredited by the Entidad Mexicana de Acreditación,A.C. (EMA), recognized by the Ministry of Environment and Natural Resources forcarrying out such tests;j) If the property is inside an industrial park or subject to a condominium propertysystem, carefully review the industrial park or condominium rules and check theamount to be paid in maintenance fees.Pursuant to the laws applicable in each of the states of the Mexican Republic, the purchaseand sale or alienation of real estate must be recorded in a public instrument.Therefore it is important for the buyer to contract a notary public, preferably of the locationof the real estate, in order to execute the purchase and sale before such person.Among the obligations of the notary is to verify that the property is free of liens and thatnothing is owed for water services or real estate taxes.2. Leasing Property in MexicoAs in the case of an acquisition, it is very important before leasing any property to verifythe following:a) That the property has the zoning required to be able to install the business orengage in the desired activities;b) That the property has the services that the tenant requires to operate its business,such as water and power;c) That the person who claims to be the owner of the property is in fact the owner.In this case it is important to obtain a liens certificate on the property and to reviewthe property title deed;d) If the property is subject to a condominium property system, it is important toreview the rules that apply to the building, as well as the rules for the payment ofmaintenance fees;e) If the property to be leased is an industrial plant, it is important to have a soil testdone by an EMA-accredited laboratory in order to verify that the soil and subsoil ofthe building is not contaminated.71Offices and Industrial Plants

Pursuant to the civil codes of each of the states of the Mexican Republic, in order for alease agreement to be valid, it must be executed in writing. Although the civil codes of thestates generally establish the obligations of the landlord, it is advisable that the followingobligations be included in the lease agreement that is executed:a) The obligation to deliver to the tenant the leased property with all its appurtenancesand in a condition to serve for the use agreed to. In this case we recommendsigning a delivery-reception document at the time of the delivery of theproperty in which the conditions under which it is received are described in detail;b) The obligation to preserve the leased property in the same condition during thelease and make all the necessary repairs in order for the leased property to alwaysbe in good condition;c) Liability for any damages and losses suffered by the tenant as a result of hiddendefects in the leased property.72C H A P T E R I VIf the tenant must carry out works and adjustments to the property, we recommendthat such works be authorized in writing by the owner before the lease agreement is executed.In this case it is important that the designs and other documents describing theworks to be carried out be attached to the letter authorizing the works.It is also important that the duration of the lease be sufficient to allow the tenant torecuperate the investment made in the property. Furthermore, the obligation of the landlordto pay liquid damages if the contract is terminated or rescinded before its expirationdate for causes attributable to the landlord should be included.

CHAPTER VLabor Law1. Labor ContractsContracting is one of the most important issues in labor law, since it is from contractsthat all the rights and obligations of an employment relationship emanate, regardless ofthe form in which the relationship is established.In Mexico there are two types of labor contracts: the individual employment contractand the collective contract. The individual contract is normally between a worker and anemployer, and the interest is individual. In contrast, the collective contract is establishedcommonly between unions and employers, and it involves a group interest. Article 20 of theFederal Labor Law (Ley Federal del Trabajo, LFT) distinguishes between the concepts of individualemployment agreement and a simple labor relationship and establishes that thelabor relationship, whatever act originates it, is the provision of personal, subordinated workto a person in return for the payment of wages, while the individual employment agreement,whatever its form or name, is the agreement by which a person is obligated to provide toanother person personal, subordinated work in return for the payment of wages.However, both the individual employment agreement and the labor relationship producethe same effects, since both involve the provision of personal, subordinated servicefor the payment of a wage as a principal characteristic.731.1. Hiring of Personnel for a Limited Time Period, for a Specific Pieceof Work, or for an Indefinite Time PeriodThe most common contracts recognized by labor law are contracts for a limited timeperiod, for a specified piece of work, or for an indefinite time period. Below we willexplain the differences, the requirements, and the risks in the hiring of personnel for alimited time period, for a specific piece of work, or for an indefinite time period, as wellas how each of these contractual agreements can be terminated.

1.1.1. Individual employment agreement for a specific piece of workThe indication of a specific piece of work in an individual employment agreement canbe stipulated only when the nature of the work to be done so requires. For such purposes,the work that the temporary worker will do must be clearly specified in the contract,stating what the job consists of and in what stage or until what stage the temporaryworker will be needed.74C H A P T E R V1.1.2. Individual employment agreement for a limited time periodIn this contract, the time period for which the employment will last must be specified,including the date of termination. The cases in which this type of contract can be executedare listed below:a) When the nature of the work to be done requires such a contract; for example, thehiring done by hotels in high-occupancy seasons, such as Christmas or New Year’s,in order to adequately respond to the work load during that period;b) When the purpose is the temporary substitution of another worker; for example,when a worker is on maternity leave, she can be temporarily replaced by anotherworker during that period. In this situation, the principal element is the temporarysubstitution;c) In other cases of special types of work named in the law: musicians, actors, athletes,and certain professionals, among others.1.1.3. Contract for an indefinite time periodThe employment contract for an indefinite time period is the general rule in relation toother contracts recognized by the LFT. In the event that the duration of a contract for aspecific piece of work or a limited time period is not specified, it will be considered anindividual employment agreement for an indefinite time period. This contract will be ineffect as long as the worker has the physical and mental capacity to do his/her job in anormal fashion and as long as the employer continues to require his/her services.1.2. Essential Elements and Elements Required for IndividualEmployment Agreements to Be ValidAs with all contracts, individual employment contracts have essential elements and elementsrequired to be valid.1.2.1. FormLabor law has attempted to simplify to a minimum the formalities that a labor contractmust contain, to the point that the lack of a document does not deprive a worker of therights established in labor law. Thus, Article 21 of the LFT indicates that “the existence of

a contract and therefore an employment relationship will be presumed between the personthat provides services and the one that receives them.” Therefore, the existence of alabor relationship is sufficient for a worker to enjoy corresponding labor rights, whetheror not there is a written contract.Regardless, terms and conditions of employment should be put in writing as a generalrule, for the benefit and protection of both parties. If they are not put into writing, theemployer can be fined; furthermore, in the case of a dispute with the worker, the employerwill have the burden of proof regarding the terms and conditions governing theemployment. If the employer does not have sufficient evidence, the terms and conditionsindicated by the worker in his/her claim will be accepted as true.It should be mentioned that there are minimum conditions that must be establishedin employment contracts that cannot be less than those set forth in the LFT, but can besuperior thereto.Thus, the law states that individual employment agreements shall contain (i) the identificationinformation of the worker, such as his/her name, nationality, age, gender, maritalstatus, and residence; (ii) the address of the employer; (iii) the duration of the laborrelationship (that is, whether the employment is for a specific piece of work, a limitedtime period, or an indefinite time period); (iv) the service or services to be provided bythe worker (that is, the tasks he/she will perform, which should be specified in as muchdetail as possible); (v) the place or places where the worker will do the work, and theduration of the work shift; (vi) the form and amount of the salary the worker will bepaid; (vii) the day and place that such salary will be paid; and (viii) whether or not theworker will be trained in accordance with established plans and programs, or under programsthat may be established by the company, in accordance with the law.In addition, other terms and conditions of employment may be stated such as days off,days of vacation, and other benefits agreed to with the worker.75Labor Law1.2.2. SalaryWith respect to the payment of the salary, regardless of whether or not the amount isstated, the employer will be obliged to pay at least the minimum wage. The minimumwage is established by the National Minimum Wage Commission, which is made up ofrepresentatives of employers, workers, and the government. This commission will determinethe wage that will apply in each of the three geographic areas into which the MexicanRepublic is divided. Such areas are composed of one or more municipalities,without there necessarily being territorial continuity among them.For 2007 the daily minimum wage varied, depending on the zone, between 47.60pesos in zone C and 50.57 pesos in zone A (equivalent to approximately USD $4.35 andUSD$4.63, respectively). Although the amounts for 2008 have not yet been publishedas of this date, an increase of around 4 percent is expected.

76C H A P T E R V1.2.3. CapacityIn Mexico it is prohibited for minors under 14 to work. In order for minors between14 and 16 years old to work, they must have completed their compulsory educationand have authorization from their parents or guardians or, in their absence, from theunion to which they belong, from the Conciliation and Arbitration Board, from the laborinspector, or from the political authority, unless an exception is made that is approvedby the corresponding authority, stating that school and work are compatible for thisminor.Those over 16 can freely offer their services, but with certain requirements:• The obtaining of a medical certificate verifying aptitude for the work, in the caseof minors over 14 but under 16, as well as their submission to periodic medicalexaminations ordered by the labor inspector;• The prohibition of the use of child labor for dangerous or unhealthy work;• The requirement that the work shift of those under 16 not exceed six hours perday, which shall be divided into maximum periods of three hours, with at least onehour of rest between those two periods;• The prohibition on the use of minors under 16 to work overtime, on Sundays, andon official holidays;• The provision to minors under 16 of an annual paid vacation period of at least 18business days.1.2.4. Absence of deceit or fraudDeceit by the worker of the employer regarding his/her skills, capacities, and abilities atthe time of hiring is a cause for the rescission of the individual employment agreementby the employer. However, this cause of rescission will expire if not asserted by theemployer within 30 days from the date of hire of said worker.1.2.5. Lawfulness of the work performedThe primary illegal labor relationships are described in Article 5 of the LFT:a) Child labor. When children under 14 are employed; when 16-year-old minorswork overtime; when industrial nightshift work is permitted or work is done after10:00 P.M. by children under 16;b) Work shift. When minors are assigned a work shift longer than that permitted bythe LFT, except in the cases of an accident or imminent risk, in which case the workshift may be extended for the time strictly indispensable to avoid damages or inextraordinary circumstances; however, the prolongation of a work shift may neverexceed three hours per day or happen more often than three times per week. Inaddition, a work shift that is considered excessive in the judgment of the Conciliationand Arbitration Board is illegal;

c) Salary. When the salary paid to the worker is less than minimum wage; when thesalary, although not less than minimum wage, is not what the worker shouldreceive, given the amount and quality of work done, in the judgment of the Conciliationand Arbitration Board; when a salary is paid to workers for a periodgreater than one week; when a salary is paid in a location intended for recreationor in a restaurant, cafeteria, café, tavern, or store (other than to the workers ofthese establishments); when the employer withholds the salary of the worker as afine; when the worker is paid a salary less than another worker in the same companyfor equally efficient work, in the same class of work, or for the same shift, orwhen pay is based on age, gender, or nationality;d) Workers’ rights. When the employers require that their workers buy their goods ina particular place; when a worker signs any waiver of his/her rights or prerogativesgranted by labor regulations.In all these cases it will be understood that labor law or supplemental rules governinstead of the invalid clauses of the labor contract. An invalid clause is understood as anyclause that involves the waiver of workers’ rights or a decrease in such rights, regardlessof what has been agreed to by the parties.1.3. Provision of Services outside of the Normal Residence of the Workeror outside of the Mexican Republic77Labor LawThe most important regulations to take into account when personnel are hired to provideservices outside of their town of residence or of the Mexican Republic are the following:a) The terms and conditions of employment should be established in writing, and allthe requirements for such circumstances set forth in the LFT must be compliedwith. Such requirements include that the employer must pay the expenses fortransportation, repatriation, and relocation to their place of origin, as well as payingfor food for the worker and his/her family; that the worker will have the rightto enjoy the benefits granted by the social security institutions to foreigners in thecountry to which the worker will provide services, and that the worker is entitledto enjoy decent and sanitary housing;b) The employer must guarantee the worker a domicile within Mexico for legal purposes;c) The written document containing the terms and conditions of employment will besubmitted to the approval of the Conciliation and Arbitration Board, who shalldetermine the size of bond or deposit it considers sufficient to guarantee compliancewith the obligations contracted by the parties. Once the employer proves

efore the Board that it has complied with the contracted obligations, the Boardwill order the cancellation of the bond or the return of any deposit;d) The written document must be stamped by the consulate of the nation where theservices will be provided.1.4. Interpretation of Individual Employment AgreementsIn Mexico, respect for the minimum rights and obligations established by the LFT prevailsover the will of the parties. Therefore, in case of doubt, when interpreting labor provisions,the interpretation most favorable to the worker will prevail.1.5. Changes in the Individual Employment Relationship78C H A P T E R VLike many other contracts, an individual employment agreement can be changed, providedthat the change is made in writing, specifying the reasons for the change and the rightson which it is based, and is ratified before the Conciliation and Arbitration Board. However,no agreement, resignation, or severance can call for a waiver of the worker’s rights.Changes to an individual employment agreement can be subjective or objective,regarding either the persons in the relationship or the conditions contemplated therein.1.6. Risks in Hiring Personnel for a Limited Time Period, for a Specific Pieceof Work, or for an Indefinite Time PeriodThe simple fact of hiring a worker will always bring certain risks, regardless of whether it isa temporary or permanent position. However, the risks increase if the hiring is for a limitedtime period or for a specific piece of work, since hiring under a limited time period contractdoes not mean that it in fact complies with the legal requirements established in the LFTand, therefore, if the employer is not able to show why this type of contract was executed,there is the risk that the labor authority will consider that due to the nature of and the timerequired for the jobs, the contract is in fact for an indefinite time period or permanent.As a consequence, if the employer does not have the documentation necessary toprove that the temporary hiring of personnel was appropriate, in the case of a conflict,the employer can be ordered by the labor authority to pay a severance consisting of:a) Three months of salary, with the corresponding integrated daily salary;b) Twenty days of salary for each complete year of employment, with the correspondingintegrated salary. This does not apply in the case of a resignation;c) The seniority premium, consisting of the payment of 12 days of salary for each yearof employment, with a cap of double the minimum wage in the geographic areawhere the company is located;

d) Any benefits owed to the worker in question, such as the proportional part earnedof vacations, vacation bonus, year-end holiday bonus, savings funds, and supermarketvouchers, among others.1.7. Termination of Individual Employment Agreements for a Limited TimePeriod, for a Specific Piece of Work, or for an Indefinite Time PeriodThe LFT limits the causes for terminating an employment relationship to the followingcases:a) Mutual consent;b) The death of the worker;c) The termination of the work or expiration of the contract term;d) Physical or mental disability or manifest incompetence of the worker making itimpossible for him/her to do the work;e) The cases referred to in Article 434 of the LFT that have to do with collective terminationof employment, which we will look at later on.With respect to the termination of individual employment contracts for a specificpiece of work or work for a limited time period, workers must be terminated on the dateor at the end of the term indicated in the contract and must receive payment correspondingto a temporary hiring, which consists of paying the temporary worker only theproportional part earned of vacations, vacation bonus, year-end holiday bonus, and anyother benefit contracted with the worker for the time the employment lasted.It should be mentioned that Mexican law does not recognize as valid a so-called trialperiodemployment agreement under which the employer judges the qualifications ofthe worker for a specific period, after which the employer determines whether or not tooffer a definitive contract.79Labor Law1.8. Principal Obligations of the Employer; Rights and Obligations of Workers1.8.1. Obligations of and prohibitions on employersUnder the LFT, certain obligations and prohibitions are established that should be strictlyadhered to by employers:1.8.1.1. ObligationsThe following are the most important obligations of an employer:a) Provide workers promptly with the tools, instruments, and materials necessary forthe execution of the work. Such tools, instruments, and materials should be ofgood quality and in good condition and should be replaced as soon as they cease

80C H A P T E R Vbeing efficient, provided that the workers have not agreed to use their own tools.The employer is not entitled to require any indemnification or compensation forthe natural wear and tear suffered by the work tools, instruments, and materials;this is a natural consequence of job performance;b) Provide a secure place for the safekeeping of all work instruments and toolsbelonging to the worker, if they need to remain in the work place. However, theemployer may not retain them as an indemnification, guarantee, etc. This obligationis established in order to prevent such instruments from suffering any damagein prejudice to the worker;c) Maintain a sufficient number of seats or chairs, available to the workers, in commercialestablishments, offices, hotels, restaurants, industrial establishments, andother analogous work places. This provision exists because the type of activitiesthat workers perform in commercial establishments, offices, hotels, restaurants andother analogous work places forces them to stand for long periods of time. Therefore,they should be provided seats in order to rest;d) Issue every 15 days, upon the request of the workers, a written record of the numberof days each worker worked and the salary he/she received;e) Issue to any worker (those who request it and those who are terminated), withinthree days, a written record of his/her employment;f) Grant to workers the time necessary to exercise their right to vote in popular electionsand to fulfill jury, electoral, and census duties;g) Allow workers to miss work in order to perform an incidental or permanentcommission for his/her union or the State, provided workers give timely noticeand that the number of such commissions does not harm the operations of thebusiness;h) Inform the union with whom the company has signed a collective bargainingagreement, as well as any other workers who might be eligible, of all newly createdpositions and of all definitive and temporary open positions;i) When more than 100 and less than 1,000 workers are employed, pay for technical,industrial, or practical training, in national or foreign special centers, of one ofthe company’s workers or a child of a worker, chosen both by workers andemployer based on skills, qualities and commitment. When a company has morethan 1,000 workers, it should sponsor three persons in the mentioned conditions;j) Provide training and instruction to its workers, in the terms established in ChapterIII bis of the LFT. The benefit to the company of providing training and instructionto its workers is the improvement in the productivity of the latter;k) Comply with the safety and hygiene rules established in the laws and regulationsin the facilities of factories, workshops, offices and other places where worktakes place, and rules to prevent accidents and illnesses in the work place and, in

general, in the places where work is executed; and have available at all times theindispensable medicaments and first aid materials indicated in the guidelinesissued, so that first aid can be offered opportunely and effectively. Notice mustbe given to the competent authority of every accident that occurs. In addition,the relevant provisions of the safety and hygiene guidelines must be posted visiblyand disseminated in the work place;l) Provide to the workers the preventive medicaments indicated by the health authorityin the places where tropical or endemic diseases exist or when there is dangerof an epidemic;m) Make the deductions requested by the unions of the ordinary union dues, providedthat it is evidenced that they are those established in the union bylaws. Thisobligation is contemplated to avoid that the union leaders demand from theemployers the payment of fees not agreed to;n) Make the deductions of the contributions for the formation and promotion ofcooperatives and employees’ savings and loan associations. These contributionsshould be paid provided the workers expressly and freely agree to it and that it isnot greater than 30 percent of the excess of the minimum wage;o) Allow the labor authorities to inspect and review the company in order to ensurecompliance with the labor regulations, and give them the necessary informationwhen they request it. Employers may require the inspectors or commissioners toshow them their credentials and the instructions they have been given;p) Contribute to the promotion of cultural and sports activities among their workersand provide them with the necessary equipment and tools;q) Make the deductions from the workers’ salary for the payment of loans granted orguaranteed by the Workers’ Consumption Guarantee Fund Institute (Instituto delFondo de Fomento y Garantía para el Consumo de los Trabajadores, FONACOT). Thisobligation allows the worker to acquire goods or pay for certain services by periodicdeductions from his/her salary, which cannot be greater than 10 percent whenthe salary is minimum wage or more than 20 percent for other salaries;r) Provide to pregnant workers the protection established in the regulations. We willdiscuss this obligation more fully later on.81Labor Law1.8.1.2. ProhibitionsIn addition to the above listed obligations, the employer is prohibited from the following:a) Discrimination in hiring workers based on age or gender;b) Requiring employees to purchase articles in a particular store or location;c) Demanding or accepting money from employees as a bribe for hiring them or forany other reason related to the terms and conditions of employment;

d) Obligating workers by coercion or any other means to join or leave the union orgroup to which they belong or to vote for a particular candidate;e) Intervening in any manner in the internal governance of the union;f) Making or authorizing collections or subscriptions in the work establishments orwork place or disseminate political or religious propaganda in the establishment;g) Executing any act that restricts the rights of workers granted to them by law. Ashas been mentioned, workers’ rights are unwaivable and therefore the employercannot execute any act that directly or indirectly restricts those rights;h) Blacklisting workers that leave or are dismissed from the job so that they cannotbe hired again;i) Carrying arms inside the establishments located within population centers orarriving in the establishments in a state of drunkenness or under the influence ofnarcotic drugs.82C H A P T E R V1.8.2. Workers’ rightsBoth article 123 of the Political Constitution of the United Mexican States (ConstituciónPolítica de los Estados Unidos Mexicanos) and the LFT, which is the regulatory law of sucharticle, establish a series of rights that workers enjoy in the performance of their jobs.1.8.2.1. SalaryThe LFT defines the salary as follows: “The compensation the employer shall pay theworker for his/her work.” The salary has the following characteristics:a) It should be remunerative, that is to say it should be proportional to the quantityand the quality of the service provided by the worker and, in addition, be sufficientto ensure a decent standard of living for the worker and his/her family;b) It can never be less than the general or professional minimum wage in effect in theplace where the worker is employed. It is important to also mention that the salarycannot be subject to any setoffs;c) Those workers in the same position, shift and showing the same efficiency must bepaid the same amount;d) The salary payment periods cannot be greater than one week for persons doingmanual labor and 15 days for those doing other types of work;e) The salary should be paid in cash, in currency of legal tender and in the placewhere the workers work.With respect to the manner in which the salary can be negotiated, the following is recognized:a) By unit of time. This type of salary is calculated in function of the time that the workerdedicates to his/her work, regardless of the results he/she obtains therefrom;

) By unit of work. This type of salary is also known as wages paid by the job and iscalculated in function of the results of the work;c) By commission. This type of salary is fixed according to a percentage of the sale priceor by fixed rate for unit sold;d) Lump-sum price. This type of salary is set when the services of a person are used forbuilding or constructing a work, paying a total amount for it.Finally, and as has already been mentioned, the LFT provides for a minimum wage that“is the lowest amount that a worker can receive in cash for the services provided in awork day.” The minimum wage is classified as follows:a) General minimum wage. The wage applicable to one or more geographic areas thatcan extend to one or more states. In Mexico there are three geographic areas (A, Band C), each one with a different minimum wage, based on the cost of living of thestates included in each area;b) Professional minimum wage. The wage applicable to a particular branch of economicactivity or for professions, trades, or special jobs within one or more geographicareas.1.8.2.2. Employee profit sharingWorkers, in addition to the salary they receive, are entitled to receive a portion of theprofits received by the employer. However, article 126 of the LFT establishes that the followingare exempt from the profit-sharing obligation:a) Newly created companies, during their first year of operations;b) Newly created companies engaging in the production of a new product, duringthe first two years of operations. The determination of novelty of the product isbased on the laws to promote new industries. The reason lawmakers establishedthis period is that generally a newly created product represents a risk for the companyand often it requires a significant investment to successfully launch a productinto the market. It is important to note that the merger, transfer, or change ofcorporate name of the company does not imply it is newly created;c) Newly created extractive industries, during the exploration period;d) Private assistance institutions recognized by law that with private goods engagein non-profit humanitarian assistance without designating the beneficiaries individually;e) The Mexican Social Security Institute (Instituto Mexicano del Seguro Social, IMSS) andthe public decentralized institutions with cultural, assistance, or charity purposes;f) Companies that have less capital than the amount set by the Ministry of Labor andSocial Welfare (Secretaría del Trabajo y Previsión Social, STPS) for branches of theindustry, following a consultation with the Ministry of Economy (Secretaría de83Labor Law

Economía, SE). The resolution may be totally or partially reviewed when significanteconomic circumstances justify it.In principal, all workers employed by the company are entitled to share in the profits,however, there are persons who, according to article 127 of the LFT, are excludedfrom profit-sharing, such as:a) Directors, administrators, and general managers of the company;b) Individuals who are owners or co-owners of the companies;c) Technical professionals, artisans, and others who are paid on a fee basis and are notemployees on the payroll;d) Temporary workers, when they have worked less than 60 days during the fiscalyear of the company;e) Domestic workers.84C H A P T E R VIt is important to be aware that the profit-sharing should be paid to the workers within60 days following the date on which the annual income tax must be paid and theamount will be determined by a Mixed Commission composed of employers and workers.This commission will make the calculations to determine the amount of profitsharingcorresponding to each worker taking into consideration the number of daysworked for each worker and the amount of salary accrued during the year.1.8.2.3. Year-end holiday bonusBy nature, the year-end holiday bonus is an extraordinary payment that the LFT imposeson employers and that must be paid annually. This payment consists of 15 days ofsalary and, if applicable, the proportional part thereof, and must be made before December20 of each year.Those workers that have not completed one year of employment, whether or not theyare employed at the time of payment of the year-end bonus, will be entitled to be paidthe proportional part thereof, according to the time they have worked and regardless ofhow much time that was.The base salary for the payment of this bonus is the amount the worker ordinarilyreceives per day worked, that is to say, the daily wage without including any otheremployment benefit the worker receives. In addition, the year-end holiday bonus will bepaid for days actually worked during the calendar year in question.1.8.2.4. Seniority premiumThe seniority premium is another payment the following workers are entitled to receive:a) Permanent employees who voluntarily leave their employment, if they have completedat least 15 years of employment;

) Permanent employees who are dismissed from employment, with or without justification;c) The beneficiaries of the permanent employee that has died, whatever his/herlength of employment, and regardless of whether or not the death was caused bya work-related accident;d) Permanent employees dismissed for causes attributable to the employer.The amount to be paid is equivalent to 12 days of salary for each year of employment(Article 162 of the LFT). The base for the calculation of this benefit cannot be less thanthe minimum wage nor greater than double the minimum wage in the correspondinggeographic area.1.8.3. Workers’ obligationsWorkers have several obligations that can be classified as follows:a) Obedience. The worker must provide his/her services under the direction ofthe employer or its representatives, to which authority the worker will be subordinatein everything concerning the work. The worker must also observethe safety and hygiene measures issued by the competent authorities andthose indicated by the employer for the safety and protection of the personnel.If the worker disobeys an order from the employer or its representativeswithout justification, the employer is entitled to terminate the employment ofsaid worker, without implying any liability for the employer (Article 47, SectionXI, LFT);b) Loyalty. The worker must execute his/her work with the appropriate commitment,care, and attention and in the manner, time, and place agreed;c) Notice of absence. The worker must give notice immediately to the employer, exceptin the case of an act of God or force majeure, of the justified causes that preventhim/her from working;d) Work materials and instruments. The worker shall return unused materials to theemployer and preserve the instruments and tools given to him/her for the work ingood condition; the worker is not responsible for the deterioration caused by theuse of these objects, nor for any caused by an act of God, force majeure or for badquality or defective construction;e) Provide aid. The worker must provide aid whenever necessary, when as a result ofan accident or imminent danger the persons or interests of the employer or his/herco-workers are threatened;f) Medical exams and illnesses. The worker must submit to the medical exams establishedin the internal regulations and other regulations of the company or establishment,to prove he/she does not suffer from any work-related, contagious, or incurable85Labor Law

disability or illness, and must inform the employer of any contagious diseaseshe/she suffers as soon as he/she knows of it;g) Avoid damages. The worker must inform the employer or its representatives of anydeficiencies of which he/she becomes aware in order to avoid damages or losses tothe interests and lives of his/her co-workers or of the employer;h) Protection of secrets. The worker must scrupulously keep the technical, commercial,and manufacturing secrets of the products he/she produces directly or indirectly,or of which he/she has knowledge through the work performed, as wellas reserved administrative matters whose disclosure could harm the company. Itis recommended to include a confidentiality clause in the individual employmentagreements the workers sign with the company to ensure that this is completelyclear.861 C H A P T E R V1.8.4. Workers’ prohibitionsAccording to Article 135 of the LFT workers are prohibited from the following:a) Executing any act that can put at risk their own safety, the safety of their co-workers,or of other persons, as well as of the establishments or places in which they work;b) Being absent from work without a justified cause or without permission from theemployer, or suspending work without the latter’s authorization;c) Taking from the company or establishment work tools or raw or processed materials,or using the tools and instruments supplied by the employer for purposesother than those they are intended for;d) Coming to work inebriated or under the influence of narcotic drugs, except witha medical prescription;e) Carrying any type of arms during work hours, unless such is required for the work;f) Taking collections in the establishment or work place or engaging in any other typeof propaganda during work hours within the establishment.It is important to emphasize that the majority of the above indicated prohibitions, incase of breach by the worker, can be a cause for termination of the employment withoutliability for the employer.1.9. Work ShiftThe maximum work shift is eight hours. The LFT establishes that the work shift is “thetime during which the worker is available to work for the employer.” Such law alsoestablishes that the work shifts may be freely negotiated by the company and its employeesor workers, provided they do not surpass the maximums established therein. Thus,such law indicates that the following types of work shifts may be established:

a) Day shift. The shift between 6:00 a.m. and 8:00 p.m. with a maximum duration of8 hours a day or 48 hours a week;b) Night shift. The shift between 8:00 p.m. of one day and 6:00 a.m. of the next daywith a maximum duration of 7 hours a day or 42 hours a week;c) Mixed shift. The shift including time from both the day and the night shifts, providedthe night period is less than 3 1/2 hours since, if such time is exceeded, theshift will be considered a night shift, and whose duration will be 7 1/2 hours dailyor 45 hours a week.The above cited law establishes that during a continuous work shift the worker willbe granted at least a half hour rest period, and for every six days of work the workerswill enjoy one fully paid day off.The weekly day off should normally be Sunday, but those that work on that daywill be entitled to the payment of an additional premium called the Sunday premium,which consists of the payment of 25 percent of the salary of the ordinary workdays of the week. Apart from the traditional work shifts, the law establishes that theemployers and their workers can divide the work hours in order to allow the latterto have Saturday afternoon off or any equivalent arrangement. Therefore, and giventhat the law does not establish what other shifts would be permitted, case law hasestablished some other possibilities, although they are not necessarily the only onesthat could be used:a) Continuous work shift. The law does not define it, but it refers to an uninterruptedwork shift. This shift imposes a half hour rest period during the work shift for theworker to eat and rest;b) Discontinuous work shift. Its principal characteristic is the interruption of the worksuch that the worker can freely dispose of the intermediate period interruptingthe work shift to eat and rest, during which period the worker is not available to theemployer;c) Overtime shift. This is the shift that is extended beyond the ordinary limits underexceptional circumstances and it cannot exceed three hours per day nor threetimes a week, which is a maximum of nine hours per week;d) Special work shift. Some companies have introduced in their work places thistype of shift, which exceeds the daily work shift without surpassing the maximumduration for the week, so their workers can have one or more days of theweek off;e) Emergency work shift. This shift continues beyond the ordinary limit establishedby the law and therefore such shift may only be used in the case of accidents orimminent danger that threatens the life of the worker, his/her co-workers or theemployer, or the existence of the work place itself.87Labor Law

1.10. OvertimeThe work shift can be freely negotiated by the company and its workers, provided it doesnot surpass the legal maximums. The following is the maximum permitted:a) The day shift should have a maximum duration of 8 hours a day or 48 hours a week;b) The night shift should have a maximum of 7 hours a day or 42 hours a week;c) The mixed shift should have a maximum duration of 7 1/2 hours a day (providedthe nocturnal period does not exceed 3 1/2 hours, since if it does it will be considereda night shift) or 45 hours a week.88C H A P T E R VThe case law has established that if a work shift is negotiated that is less than the maximumlegal shift and the worker works more time than the agreed time without exceedingthe legal maximum, overtime does not have to be paid.The LFT also establishes that the work shifts can be extended under extraordinary circumstances,without exceeding three hours a day or three times a week.This means that a maximum of nine hours of overtime a week can be worked, whichshould be covered at 100 percent of the salary corresponding to the normal work hours,or in other words they must be paid at double the normal work hour salary.It should be emphasized that the LFT establishes that if the overtime exceeds ninehours a week, the workers are not obligated to work it (Article 68). However, if thosenine hours per week are exceeded, the company must pay any such excess time at 200percent plus the normal salary corresponding to the work shift. In addition, the employerwill be subject to a fine from 3 to 155 times the general minimum wage in the placeand time in which the violation has been committed, which can be imposed by the STPSduring its annual inspection of companies.In addition, when the workers work overtime on a permanent basis, this time is consideredby the Mexican Social Security Law (Ley del Instituto Mexicano del Seguro Social)as part of the salary of the worker for purposes of calculating social security dues.1.11. Weekly Days OffMexican law provides that workers will enjoy at least one day off for every six days ofwork. The law also establishes that if the day off is not Sunday, the worker will be entitledto a premium of at least 25 percent above the salary of the ordinary work days.The LFT establishes that workers are not obligated to work on their days off. Nevertheless,if it is necessary for them to do so, the employer must pay the worker, in additionto the salary for the day off, a double salary for working on their day off.If the weekly day off of the worker is Sunday and the worker works on that day, inaddition to paying the salary for the day off, a double salary must be paid. In this case,

the employer should not also pay the worker the mentioned Sunday premium of 25 percentof the salary of an ordinary work day.1.12. National HolidaysIn addition to the weekly days off, the LFT establishes other days that are considered nonworkingdays; they are commonly referred to as días festivos, feriados, or de asueto:a) January 1;b) The first Monday of February in celebration of February 5;c) The third Monday of March in celebration of March 21;d) May 1;e) September 16;f) The third Monday of November in celebration of November 20;g) December 1 every six years, during the transfer of Federal Executive Power;h) December 25;i) Those determined by federal and local electoral laws, in the case of ordinary elections,for purposes of voting.In addition to the above-indicated days, the employer and the workers can contractuallyestablish other days off, such as Easter Thursday and Friday, May 10 for MothersDay, or November 2 for the Day of the Dead.It is important to mention that if due to the type of work done in the company continuouslabor is required, those workers who agree to work on national holidays areentitled to receive a double salary in addition to the salary for the day off.89Labor Law1.13. Vacation and Vacation Premium1.13.1. VacationMexican law establishes the right of workers to enjoy a period of annual paid vacationwhich cannot be less than six days. In order to clarify the number of days of vacationthe workers are entitled to based on the years they have worked, below is a list of thevacation periods corresponding to workers according to the years they have worked forthe company.Years of employment Days of vacation1 year 6 days2 years 8 days3 years 10 days4 years 12 days

Years of employment Days of vacation5 to 9 years 14 days10 to 14 years 16 days15 to 19 years 18 days20 to 24 years 20 daysetc.90C H A P T E R VThose workers who are employed discontinuously and seasonal workers will be entitledto an annual vacation period proportional to the number of days worked in the year.Furthermore, under such law it is not possible to substitute vacation with remuneration.The vacation must be granted within six months following the completion of one yearof employment, and employers must deliver each year to the workers a record showingtheir years of employment, number of days of vacation they have earned, and the dateon which they should take them.1.13.2. Vacation premiumThe LFT establishes the right of workers to receive an amount in addition to their salaryduring their vacation period which must be at least 25 percent of the salary they are dueduring that period. This additional amount is called the vacation premium.1.14. Other Benefits not Contemplated in the Federal Labor LawThe LFT allows the employer and the worker to agree on terms and conditions ofemployment other than those stipulated in the law, provided they are equal to or greaterthan the minimum conditions established therein. Therefore different benefits not contemplatedin the LFT can be agreed between the workers and the employer in order toprovide workers greater benefits for their services. Below we indicate the most commonbenefits granted to workers that are not contemplated in the LFT:• Savings fund;• Supermarket vouchers;• Transportation assistance;• Automobile;• Performance or results bonus.1.15. Rights of Working MothersArticle 170 of the LFT establishes the following rights for working mothers:a) During pregnancy they will not engage in work that requires considerable effortand could be hazardous to their health during the pregnancy, such as lifting,

throwing, or pushing heavy weights, that cause trepidation, that requires them tobe standing long periods or that cause or could cause them to alter their psychologicaland emotional state;b) To enjoy maternity leave of six weeks prior and six weeks following birth, receivingtheir full salary;c) The leave referred to in the above point will be extended for the time necessary inthe event it is impossible to work due to the pregnancy or birth, and they will havethe right to 50 percent of their salary for a period no greater than 70 days;d) During the nursing period they will have two extra rest periods per day, half anhour each, to feed their child, in an adequate and hygienic place designated by thecompany;e) They may return to the position they held provided no more than one year aftergiving birth;f) The maternity leave period, pre- and post-natal, will be counted as time workedfor purposes of seniority.The LFT also provides that in establishments where women work, the employer mustmaintain a sufficient number of seating spaces available for working mothers.1.16. Training and Instruction91Labor LawThe LFT establishes that every worker is entitled to be provided with on-the-job trainingand instruction, according to the plans and programs that will be formulated jointly bythe employer and the union or the workers. Such plans and programs must be approvedby the STPS.For companies that have signed a collective bargaining agreement, the obligation toprovide training and instruction courses to their workers arises within the 15 days followingthe execution of the contract, the contract revision or its extension.When there is no collective bargaining agreement, the obligation of companies to providetraining and instruction to their workers arises within the first 60 days of the odd years.For their part, the workers to whom training or instruction courses are given mustpunctually attend the courses and any activity that is part of the training or instructionprocess, pay attention to the indications of the persons giving the training or instruction,comply with the respective programs, and take the required evaluation exams.The training must be carried out during work hours unless agreed otherwise, and inthe event the worker wishes to receive training in an activity other than the one in whichhe/she works, such will be done outside of work hours. The training or instruction canbe provided within or outside of the company, by personnel of the company or also byspecially contracted instructors, institutions, schools or specialized bodies. The school,

institutions, and teaching personnel providing these types of programs must be authorizedby and registered with the STPS.Finally, it should be mentioned that each company is required to form Mixed Commissionsfor Training and Instruction, which are formed by an equal number of representativesof the workers and the employer. The principal function of these commissionsis to oversee the instrumentation and operation of the system and of all the proceduresestablished to improve the training and instruction of the workers and will suggest themeasures necessary to perfect them; all this should be carried out according to the needsof the workers and the companies.1.17. Extralegal Retirement Benefits92C H A P T E R VThe regulation of retirement benefits in Mexico is very complex. In principle it is not aright the law grants to workers of private companies. In fact, workers will only have theright to retirement benefits when such right is agreed to in the collective bargainingagreement that applies to them, pursuant to the conditions contained therein.This benefit is not always included in the common collective bargaining agreementsof companies; rather generally it is found in the collective bargaining agreements of the bigcompanies such as Teléfonos de México, Petróleos Mexicanos, and Luz y Fuerza del Centro.As with the seniority premium referred to previously, retirement benefits are a rightderived from an extended period of employment. Basically it is a benefit obtained byworkers for having dedicated practically all their lives to the job, providing their servicesto a particular employer.1.18. Termination of EmploymentThe individual termination of employment is covered in Article 53 of the LFT, where itis established that the following are causes for termination:a) The mutual consent of the parties. The consequences of the termination for this causeonly oblige the employer to the payment of the proportional part of all the benefitscontracted and the salaries not paid, but it will not have any indemnificatoryobligation or responsibility. The seniority premium only applies when the workerhas been employed 15 or more years;b) The death of the worker. The Conciliation and Arbitration Board will determine whothe legitimate beneficiary of the deceased worker is in order to avoid a double payment.Such beneficiary will be entitled to be paid the seniority premium and thecorresponding benefits or the proportional part thereof;c) The termination of the work or expiration of the term. In order for this cause to apply,there must be a temporary contract, either for a limited time period or a specific

piece of work. When such temporary employment ends, only the seniority premium,the unpaid salary, and the accrued benefits or the proportional part thereofshall be paid. The worker will not be entitled to any indemnification;d) Physical or mental disability. Disability will be cause of the termination of theemployment when performance of the employment contract is impossible. Itshould be clarified that we are referring to a permanent physical or mental disability;otherwise, the worker will return to his/her job once he/she has recovered.If the inability to continue working is not the result of an occupational hazard,the worker will only be entitled to the payment of one month of salary and the senioritypremium, or if possible and if the worker so wishes, he/she will be entitledto another job compatible with his/her abilities.On the other hand, if the disability arises from an occupational hazard, theworker will be entitled to the payment of three months salary, the seniority premium,and the proportional part of all the benefits contracted.Finally, it is worth mentioning that the LFT establishes as protection for the workerthat if in a labor proceeding the employer does not prove the cause of termination, itwill be obligated to reinstate or indemnify the worker, whichever the latter chooses(articles 48 and 55).93Labor Law1.19. Suspension of EmploymentThe labor law provides for the possibility of suspending the effects of employment withoutliability for the worker or the employer, when one of the following causes occurs:a) The contagious illness of the worker. With this suspension the intention is to protect thehealth of all the other workers of the company in the face of a possible contagion ofan illness contracted by a co-worker (for example, hepatitis, chicken pox, etc.);b) Temporary disability not resulting from an occupational hazard. Above all, it is essentialto have in mind that this is not a physical or mental disability caused by awork-related accident or illness, which has completely different consequences.For this suspension to be appropriate, the disability must be temporary; otherwise,the consequence would be the termination of employment, not its suspension.The worker will have the obligation to give notice to the employer of his/herdisability, and once the disability terminates, he/she must evidence his/her disabilitywith a medical certification;c) The pretrial detention of the worker followed by an acquittal. The suspension appliesfor the simple fact that it is impossible for the worker to go to work. The judgmentmust be an acquittal, since otherwise the employment would be extinguished, thatis, if the court finds the worker guilty, the employment terminates. If the worker

94C H A P T E R Vacted in defense of the employer or its interests, the employer must pay the salarythe worker did not receive;d) The arrest of the worker. This cause is very similar to the above; however, here referenceis made to minor incidents, such as the fact that a worker is arrested for failingto respect pedestrians while in a state of inebriation;e) Performance of constitutional services and responsibilities. This refers to when theworker, in compliance with the Political Constitution of the United Mexican States,provides his/her services as a Mexican citizen;f) The designation of workers as representatives before state bodies. This refers to a workerbeing designated a representative before state bodies such as Conciliation andArbitration Boards, the National Minimum Wage Commission, the National Commissionfor Workers Sharing in Company Profits, and other similar bodies;g) Lack of documents required by laws and regulations. In this case, the missing documentsmust be necessary to provide the service and the lack thereof must be attributableto the worker.In this case employment is suspended in order for the worker to be able toobtain the missing documents and thereafter be able to provide his/her services.Examples of necessary documents to engage in certain activities are a driver’slicense, health certificates, a passport, a professional license, etc.A suspension will take effect as follows:a) In cases regarding a contagious illness of the worker and a temporary disabilitythat is not the result of an occupational hazard, it will become effective when theemployer has knowledge of the illness, or on the date on which the disability ofthe worker is produced, until the period set by IMSS terminates or before, if the disabilityof the worker disappears. The suspension may not exceed the term set in theSocial Security Law for the treatment of diseases that are not the result of an occupationalhazard;b) With regard to the pretrial detention and arrest of the worker, the suspension willbecome effective when the latter shows that he/she was detained by the judicial oradministrative authorities until the date on which the acquittal is issued or thearrest is terminated;c) In the case of performance of constitutional services and responsibilities, as well asthe designation of workers as representatives before state bodies, the suspension isapplicable from the date on which the services or responsibilities should be performedup to a period of six years;d) Finally, in the case of lack of documents attributable to the worker, the suspensionwill begin on the date on which the employer has knowledge of the fact for a periodof up to two months.

The worker will have the obligation to return to work once the suspension is concluded:a) On the day following the date on which the cause of suspension terminates in caseof a contagious disease, temporary disability, arrest, and lack of documents;b) Within 15 days from the termination of the cause of suspension, only for purposesof attending and resolving personal matters in the cases of pretrial detention,performance of constitutional services and responsibilities, and when the workeris designated as a representative before state bodies.1.20. Change of the Employment RelationshipA change of the employment relationship can be made from two different perspectives:a) Change of persons. This refers to the change of persons subject to an employmentrelationship, such as would occur in an employer substitution;b) Change of terms. This refers to a change in the terms and conditions of employment,that is to say in the rights and obligations the workers have towards theemployers and vice versa; for example, the salary, the work schedule, the year-endholiday bonus, etcetera.1.20.1. Legal causes for changesChanges in the terms and conditions of employment can be made at the request of theworker or of the employer.95Labor Law1.20.1.1. Changes at the request of the workerThe LFT establishes that the worker may request from the Conciliation and ArbitrationBoard changes in the terms and conditions of employment when the salary is not remunerativeor the work shift is excessive or economic circumstances concur that justify it(Article 57, Paragraph 1). Thus, a worker can request that the terms and conditions ofemployment be changed:a) When the salary is not remunerative, that is to say when the worker considers itto be insufficient with respect to the position and the activities he/she performs.Unfortunately, in Mexico, the majority of salaries are insufficient; however, theworkers do not go before the labor authorities to request their increase for fear oflosing their job;b) When the work shift is excessive, that is, when the shift is longer than is permittedby law or when the worker is not given any rest period, or when given the typeof work performed, the shift could be considered excessive;c) When there are economic circumstances that justify the change of the terms andconditions of employment.

1.20.1.2. Changes at the request of the employerThe LFT establishes that the employer can request the change when economic circumstancesoccur that justify it (Article 57, Paragraph 2).The terms and conditions of work may also be changed by agreement, which must beapproved by the Conciliation and Arbitration Board, as long as it does not contain anywaiver of the workers’ rights. Otherwise the authority will not approve the agreementsince such rights are unwaivable.96C H A P T E R V1.20.2. Effects of the changesOnce both the worker and employer are in agreement, both parties must comply withthe changes. If the change is made through a procedure before the Conciliation andArbitration Board, the parties will be bound by what the authority has resolved. Thus,once the authority has issued its resolution or the worker and employer have manifestedtheir agreement, the change will become effective.2. Unions and Collective Bargaining AgreementsThe union is the association of workers or employers organized for the study, improvement,and defense of their respective interests.In turn, the collective bargaining agreement is the agreement executed between one ormore workers’ unions and one or more employers or one or more employers’ unions forthe purpose of establishing the conditions under which the work of one or more companiesor establishments will be performed.2.1. Structure and Operation of the UnionsLegally formed unions, that is to say those that are registered, are legal entities with legalcapacity to acquire personal and real property to be used immediately and directly forthe purpose of their formation, and to defend before all the authorities their rights andexercise any applicable actions. Unions have two types of elements that are essential fortheir formation.2.1.1. Substantive elementsa) To be workers or employers, depending on the union;b) The minimum number of employers necessary to form an employers’ union isthree (Article 364, LFT);c) The minimum number of workers necessary to form a workers’ union is 20 inactive service (Article 364, LFT). In addition, workers considered in active servicefor purposes of forming the union shall include those whose employment has been

escinded or terminated within the period between the 30 days prior to the dateof presentation of the request for registration of the union and the date on whichsuch registration is granted;d) That there is no discrimination, that is to say there must be equality between menand women with regard to the formation of a union. This does not mean thatunions of women or of men do not exist, but it cannot be due to a prohibition;e) The minimum age for a worker to be able to join a union is 14 years old (Article362, LFT);f) The minimum age necessary to be able to be an officer of a union is 16 years old(Article 372, LFT);g) Foreigners can be members of a union, but they cannot be officers thereof;h) Confidential workers cannot be members of a union of the rest of the workers;however, they can form their own unions.2.1.2. Elements of formalitya) Registration. This is an administrative act by virtue of which the authority attests tothe formation of a union. It is a declarative act, not a constitutive act, since if therequirements established by the LFT in respect to formation are satisfied, no authoritycan deny the registration. The unions must be registered with the STPS in a caseof federal jurisdiction and with the Conciliation and Arbitration boards in a case oflocal jurisdiction.The registration of the union and its leaders granted by the STPS or by the localConciliation and Arbitration Boards, whichever has jurisdiction, is effective beforeall authorities. The document issued by the authority when a union is registered iscalled a Notation (Toma de nota). With the issuing of this document, all legal effectsare produced before all authorities.Similarly, the LFT provides for what in practice is called automatic registration,which refers to the fact that if the authority with whom the request for registrationis filed does not issue a determination within a term of 60 days, the petitioners canpetition it to issue a determination. If the authority does not do so within the threedays following the filing of the petition, the registration will be considered madefor all legal purposes and the authority will be obligated to issue the Notation withinthe three following days.The registration of the union can only be cancelled in the case of its dissolutionor if it fails to maintain any of the requirements established in the law (Article369, LFT);b) Bylaws. These are the internal regulations of the unions. The bylaws must containthe name, address, purpose, duration, conditions of admission of members, obligationsand rights of the members, reasons and procedures for expulsion, disciplinary97Labor Law

actions, manner of calling a meeting, as well as when the meetings should be heldand the quorum required to meet, procedures for electing the leaders and theirduration in office, rules for the administration of the assets of the union, amountof union dues and manner of payment, rules for the liquidation of the union assets,and any other rules approved by the meeting (Article 371, LFT);c) Election of the management board. The management board of the unions is fundamental,it being responsible for the union’s organization, management, and otheressential functions. One of the primary obligations of the management board of aunion is rendering at least every six months a complete and detailed account of themanagement of the union assets (Article 373, LFT).The members of the management board that are fired by the employer or thatare dismissed for causes attributed to the latter, will continue exercising their functionsunless the bylaws provide otherwise.98C H A P T E R VWhile the unions do have certain rights and powers, it is clear that they also have certainobligations and prohibitions, such as providing the reports requested of them by thelabor authorities; communicating to the authority before whom they are registered,within 20 days, any changes in the management board and amendments of the bylaws;and informing the authority before whom they are registered at least every three monthsof the changes to their membership rolls.With regard to prohibitions, unions may not intervene in religious matters nor pursuecommercial activities for profit.2.2. Types of UnionsThere are several types of unions of both workers and employers, as detailed below.2.2.1. Workers’ unionsWorkers’ unions (Article 360, LFT) can be:a) Trade. Those formed by workers of the same profession, trade, or specialty; forexample, the flight attendants’ union, carpenters’ union, etc.;b) Company. Those formed by workers that work for the same company. In this casethe profession of the worker does not matter, as long as the members belong to thesame company, that is to say they have the same employer;c) Industrial. Those formed by workers who are employed in two or more companiesof the same industrial group. This refers to workers of different companies but thatwork in the same industrial group;d) National industrial. Those formed by workers who are employed in one or morecompanies of the same industrial group, installed in two or more different states;

e) Different trades. Those formed by workers of different professions; they may onlybe formed when in the municipality in question the number of workers of thesame profession is less than 20.2.2.2. Employers’ unionsEmployers’ unions (Article 361, LFT) can be:a) Those formed by employers of one or more fields of work. These are equivalent toindustrial unions;b) The so-called national unions, formed by employers from one or more fields ofwork in different states.2.3. Difference Between the Individual Employment Agreementand the Collective Bargaining AgreementAs we have seen, the individual employment agreement is the contract by which a personagrees to provide to another person subordinated personal labor, in exchange for thepayment of a salary, that is to say, the provision of services in exchange for compensation.In the individual employment agreement, each of the parties has a specific obligation;the worker is obligated to provide a specified service and the employer is obligatedto pay a salary. In contrast, in the collective bargaining agreement the parties do not promiseeither work or compensation; they only establish that if in the future employmentagreements are executed, they will be considered to contain the contents of the collectivebargaining agreement. Thus, in order for a collective bargaining agreement to be carriedout, individual employment agreements must be executed.The collective bargaining agreement cannot be agreed to with conditions less favorableto the workers than those contained in contracts in force in the company or establishment.It should be understood that the collective bargaining agreements cannotcontain employment terms and conditions inferior to those agreed to in the individualemployment agreements, only terms and conditions similar or superior thereto(Article 394, LFT).99Labor Law2.4. Contents of the Collective Bargaining AgreementEvery collective bargaining agreement must contain:a) The names and domiciles of the contracting parties;b) The companies and establishments it covers;c) Its duration or the indication that it is for an indefinite period or a specific work;d) The work shifts;e) The weekly days off and vacation days;

f) The amount of the salaries. This is known as the tabulator, where the positions andthe salary for each one are generally established;g) The clauses regarding training or instruction of the workers in the company orestablishments it includes, and the provisions on the initial training or instructionthat should be provided to those who are newly hired by the company or establishment;h) The basis for the membership and operations of the commission that must beformed according to the LFT;i) The other stipulations the parties agree to.2.5. Formalities of the Collective Bargaining Agreement100C H A P T E R VEvery collective bargaining agreement must fulfill certain requirements or formalitiesthat make it valid:a) It must be executed in writing. The agreement between the union and the companymust be documented and may never be executed verbally;b) It must be executed in triplicate. There must be at least three executed copies ofthe collective bargaining agreement, one to be deposited before the Conciliationand Arbitration Boards and one for each party;c) It must be registered before the authority. The deposit of the agreement before theauthority is extremely important, given that it will take effect as of the date of itsdeposit or presentation before the Conciliation and Arbitration Board, unless theparties have agreed to a subsequent date;d) It must have the salary tabulator attached.2.6. The Name Party to the Collective Bargaining AgreementThe name party refers to the union that is the administrator of the collective bargainingagreement. The LFT establishes certain rules for determining which union is entitled tobe the name party to the collective bargaining agreement when two or more unionsclaim such title in one company.The law indicates that the employer who employs workers who are members of aunion must execute a collective bargaining agreement with the union when the latter sorequests (Article 387).The law also indicates the rules that must be observed if several unions exist withinthe same company:a) If there are two or more company unions or industrial unions or one or more of each,the collective bargaining agreement will be executed with the one having the greatestnumber of members employed by the company. In this case or circumstance

there cannot be two collective bargaining agreements. The workers of the union thatis not the name party to the collective bargaining agreement benefit from the collectivebargaining agreement executed with the union having the majority; however,they do not have to join such a union;b) If there are two or more trade unions, the collective bargaining agreement will beexecuted with the group of trade unions representing the majority of the workersin the trades involved, provided they agree. Otherwise, each union will execute acollective bargaining agreement for its trade;c) If there are two or more trade unions, company unions or industrial unions, thetrade unions may execute a collective bargaining agreement for their trade, providedthat the number of their affiliates is greater than the number of the workersof the same trade who are affiliated with the company or industrial union.Finally, it is important to mention that the right to be the name party to the collectivebargaining agreement is lost with the loss of the majority of the workers, declared by theConciliation and Arbitration Board.2.7. Termination of the Collective Bargaining AgreementThe LFT establishes the following as causes of termination:a) The mutual consent of the parties;b) The termination of the work;c) The close of the company or establishment, provided that in this latter case the collectivebargaining agreement is applied exclusively in the establishment.101Labor LawIn the cases of the dissolution of the workers’ union that is the name party to the collectivebargaining agreement or the termination of the agreement, the terms and conditionsof employment in the company or establishment will continue in force. That is tosay, the collective bargaining agreement is terminated, but the benefits of the workerswill survive.

CHAPTER VIImmigration RegulatorySystem1. IntroductionCurrent trends in human migration worldwide suggest that in the coming years this phenomenonwill constitute one of the most important challenges of our time, with repercussionsfor the internal life of countries.As a country of origin, passage, and destination of immigrants, Mexico has seen a significantrhythm of growth in immigration in the last several decades, and the trend suggeststhat such growth will continue. As a result, the Mexican immigration laws, regulations,and other administrative provisions have become a complicated regulatory system governingthe entry, stay, activities, and departure of foreigners to and from Mexico.In this chapter we will discuss the different ways in which people can legally enter andstay in Mexico, based on the reason for their trip. We will then analyze the different typesof visas under which business people can enter our country, based upon the reason forand length of their stay. Finally, we will examine the types of visas under which foreignerscan be authorized by the National Immigration Institute to work in Mexico and theprocedures in place for requesting these visas.This chapter puts a special emphasis on business people, as well as workers, managers,and technicians who come to Mexico temporarily or permanently.1032. Forms of Legal Entry into the CountryAccording to the General Immigration Law (Ley General de Población), foreigners whocan legally enter the country fall into the following categories:a) Non-Immigrant. This is the foreigner who, with permission from the Ministry of theInterior (Secretaría de Gobernación, SEGOB), enters the country temporarily;b) Immigrant. This is the foreigner who legally enters the country for purposes ofresiding here in anticipation of achieving the status of permanent resident alien.

2.1. Non-ImmigrantWithin the category of Non-Immigrant there are 11 types of visas, classified accordingto the activity that the foreigner engages in in the country, and according to the purposefor which the foreigner enters Mexico. The most relevant for purposes of investors are:104C H A P T E R V Ia) Visitor. This is the foreigner who enters the country to exercise any lucrative or nonlucrativeactivity, as long as it is lawful and ethical, with authorization to remain inthe country for up to one year, with the possibility of requesting up to four extensionsfor an equal amount of time each, with multiple entries and departures.With this type of visa, foreigners can engage in various activities, depending onthe purpose of their stay in the country: they can live from resources brought fromabroad, from earnings produced by these resources, or from any income comingfrom abroad; they can investigate investment options and make such investments;they can engage in scientific, technical, advisory, artistic, athletic or similar activities;or they can enter the country in order to fill executive positions or to attendboard of directors meetings of companies;b) Distinguished visitor. In special cases, and as an exception, courtesy permission maybe granted to enter the country and reside in it for up to six months to internationallyknown researchers, scientists and scholars, journalists, or other prominentpersons. SEGOB can renew this permission when it considers it appropriate;c) Local visitor. The immigration authorities can authorize entry to foreigners whovisit marine ports or border cities for periods not to exceed three days;d) Correspondent. Foreigners who enter the country to engage in journalistic activities,to cover a special event, or to exercise their profession temporarily, will begranted a visa, provided they can show evidence that they will be exercising theirprofession in terms specified by the SEGOB. Permission will be granted for up toone year and extensions for equal time periods may be granted, with multipleentries and departures.Any foreigner who enters the country as a Non-Immigrant can request the entry ofhis/her spouse and of relatives of the first degree. These may be granted entry, providingthey do not have their own visas, with the same immigration status and for the sametime period as the non-immigrant. Their status will be that of “economic dependent.”2.2. ImmigrantImmigrants are granted entry for up to five years. In order to have their visas renewedannually, they are obliged to show to the satisfaction of the SEGOB that they are fulfilling

the conditions that were indicated to them when they were authorized to enter the countryand that they are complying with all other applicable immigration regulations.The following are the nine types of immigrant visas, depending on the activity that theforeigner will engage in in Mexico:a) Retired aliens. These are foreigners who enter the country with the intent of livingon resources brought from abroad; from interest produced from the investment oftheir capital in certificates, securities, or bonds of the State; from national bankinginstitutions or other institutions determined by the SEGOB; or from any permanentincome coming from abroad. The minimum amount of money to be held by themin reserve will be an amount no greater than the equivalent to 400 days of thegeneral minimum daily wage in effect for the Federal District. SEGOB can authorizeretired aliens to work as professors, scientific researchers, or technicians whenit considers such activities would benefit the country;b) Investors. These are foreigners who enter the country to invest their capital in industry,commerce, or services in accordance with domestic laws, provided they contributeto the economic and social development of the country and that they maintain duringthe time of their residency the minimum amount established by SEGOB, which willbe equivalent to 40,000 days of general minimum wage in the Federal District.To maintain this status, the investor must evidence that he/she maintains theindicated minimum amount of investment;c) Professionals. These are foreigners entering the country to exercise a profession. In thecase of professions that require a professional degree to exercise, the regulatory provisionsof article 5 of the Constitution regarding professions must be complied with;d) Persons in positions of trust (cargo de confianza). These are foreigners entering thecountry to assume executive or management positions, or other positions of trust,in companies or institutions established in the country. They are granted a visa,provided that in the judgment of SEGOB there is no duplication of positions and theservice to be provided merits entry into the country;e) Scientists. These are foreigners entering the country to direct or engage in scientificresearch, to disseminate their scientific knowledge, to prepare researchers, or toengage in teaching, when these activities will be carried out in the interest ofnational development in the judgment of SEGOB, taking into consideration the generalinformation provided by the institutions it consults in that respect;f) Technicians and specialists. These are foreigners entering the country to carry outapplied research regarding production or to engage in technical or specialized activitiesthat cannot be done, in the judgment of SEGOB, by residents of the country;g) Family. These are foreigners that enter the country to live as economic dependentsof a spouse or a blood relative who is an immigrant, permanent resident alien, orMexican in a direct line without limit or transversal up to the second degree.105Immigration Regulatory System

106C H A P T E R V IThe foreign children and siblings of immigrants, permanent resident aliens, orMexicans may only be admitted under this category when they are minors, unlessthey can show they have an impediment to working or that they are fulltime students;h) Artists and athletes. These are foreigners who enter the country to engage in artistic,athletic, or similar activities. They may enter, provided that in the judgment ofthe Ministry such activities are beneficial for the country;i) Assimilated persons. These are foreigners entering the country legally to engage inany lawful and honest activity who have been assimilated into the national environmentor have had or have a Mexican spouse or Mexican child and who do notfall under the category any of the other types of visas.The children or siblings of the petitioners may only be admitted on this visawhen they are minors, unless they can show they are unable to work or are fulltimestudents.3. Foreigners Working in MexicoForeigners who wish to or must work in Mexico may request entry as either Non-Immigrantsor Immigrants.Foreigners should choose between the two categories depending on their intentionsfor coming to Mexico. If they are coming only to work for the company that wishes tocontract their services, and once the contract is terminated they will return to their countryof origin, we recommend requesting the category of Non-Immigrant. If they are comingto work in Mexico and wish to establish their permanent residency in Mexico, werecommend requesting the category of Immigrant.The National Immigration Institute, when authorizing a foreigner to be admittedunder the immigration category of Non-Immigrant, will grant him/her a visa documentcalled an FM-3; in order to be admitted under the immigration category of Immigrant, itwill grant a visa document called an FM-2.Below are the requirements for requesting the FM-3 and FM-2 visa documents beforethe National Immigration Institute.3.1. Requirements for Obtaining the Desired Immigration StatusThere are two forms by which the status of Non-Immigrant (FM-3) or Immigrant (FM-2)can be requested:a) By visa obtained from abroad. The request for entry is filed in Mexico, before theNational Immigration Institute and, once obtained, the Ministry of Foreign Relations(Secretaría de Relaciones Exteriores, SRE) sends the ruling of authorization to

the Mexican consulate through which the foreigner wishes to enter, in order forthat consulate to issue to the foreigner his/her FM-3 or FM-2;b) Once the foreigner is in the country, he/she can request a change of immigrationstatus or category.3.1.1. To obtain a visa from abroadIn order to request a visa from outside of the country as a Non-Immigrant Visitor, thefollowing information and documents must be presented:a) Information:i) The complete name of the foreigner, showing the first and middle given names,as well as paternal and maternal last names;ii) His/her home address in his/her country of origin;iii) Nationality;iv) Place and date of birth;v) Marital status;vi) Occupation;vii) Mexican consulate in which he/she wishes to be documented;b) Documentation:i) Photocopy of the current passport issued to the foreigner;ii) Job offer letter issued on the letterhead of the company wishing to hire theforeigner, indicating his/her position and signed by the authorized person ofthe company;iii) Simple photocopy of any current official identification issued to the authorizedperson of the company who signs the letter discussed above;iv) Photocopy of the notarized instrument containing the appointment of theauthorized person of the company who signs the letter discussed above;v) Photocopy of the charter deed of the company that wishes to hire the foreigner;vi) Photocopy of the last monthly tax declaration of the company that wishes tohire the foreigner;vii) In the event that the foreigner does not personally process his/her visa, apower of attorney in duplicate issued to the person or persons who will carryout the process before the National Immigration Institute;viii) Birth certificate issued to the foreigner containing the apostille specified in theHague Convention or legalized by the Mexican consulate closest to the placeof its issuance;ix) Letter addressed to the Institute, signed by the foreigner, expressing the reasonshe/she wishes to acquire permanent residence in Mexico, if he/she isrequesting an FM-2;107Immigration Regulatory System

x) Document verifying the professional capacity of the foreigner, containing theapostille of the Hague Convention or legalized by the Mexican consulate closestto the place of its issuance.The process of obtaining a visa from outside of the country takes approximately fourweeks from the date of presentation of all the required documentation before the NationalImmigration Institute. We recommend this option, since the foreigner will be authorizedto engage in the desired activity in Mexico upon his/her entry into the country.108C H A P T E R V I3.1.2. Relocation of familyIf the foreigner wishes to come to Mexico with his/her spouse and children, the followingdocumentation will also be necessary:a) Birth certificates of his/her spouse and children, containing the apostille of theHague Convention or legalized by the Mexican consulate closest to the place oftheir issuance;b) Marriage certificate containing the apostille of the Hague Convention or legalizedby the Mexican consulate closest to the place of its issuance;c) Record of continued existence of the marriage of the foreigner and his/her spouse,which is a form prepared by the National Immigration Institute that must besigned by the foreigner, his/her spouse and two witnesses;d) Record verifying compliance with the Mexican civil law applicable to family matters,which is a form prepared by the National Immigration Institute that must besigned by the foreigner, his/her spouse and two witnesses;e) Photocopy of the identifications of the two witnesses that sign the records indicatedin points c) and d);f) Photocopy or original of the passport issued to the spouse and children of the foreigner,depending on if an authorization from outside the country or a change ofimmigration status is being requested;g) In the event the foreigner does not personally process his/her visa, a power of attorneyin duplicate also signed by his/her spouse and issued to the person or personswho will carry out the process before the National Immigration Institute.3.1.3. Change of immigration statusIn order to request the authorization for a change of immigration status, the followingdocumentation must be exhibited:a) Original of the current passport issued to the foreigner;b) Original of the current visa, which will be delivered to the foreigner upon his/herarrival in the country;c) Job offer letter issued on letterhead of the company that wishes to hire the foreigner,

indicating his/her position and monthly salary, signed by the person authorized bythe company;d) Photocopy of a current official identification of the person authorized by the companythat signs the letter indicated in the above point;e) Photocopy of the notarial instrument containing the appointment of the personauthorized by the company that signs the letter indicated in the above points;f) Photocopy of the charter deed of the company that wishes to hire the foreigner;g) Photocopy of the last monthly tax declaration of the company that wishes to hirethe foreigner;h) Document verifying the professional capacity of the foreigner, containing the apostilleindicated by the Hague Convention or legalized by the Mexican consulateclosest to the place of its issuance;i) In the event that the foreigner does not personally process his/her visa, a power ofattorney in duplicate issued to the person or persons who will carry out theprocess before the National Immigration Institute.The process of changing immigration status takes approximately four weeks from thedate of presentation of all the required documentation before the National ImmigrationInstitute.SEGOB reserves the right at its discretion to request specific additional documentationin each particular case in order to verify the necessity of having the services of the foreignerin the country and the truth of the information presented.3.2. Benefits of Entering the Country as a Non-Immigrant or as an ImmigrantAs a non-immigrant visitor, the foreigner has the option of temporarily bringing into thecountry a vehicle without paying foreign trade taxes, provided it is returned abroadupon the termination of the authorization.Immigrants and Non-Immigrants can also bring in their household effects withoutpaying import taxes. In the case of Non-Immigrants, however, such household effectsmust be returned upon the termination of their stay in the country, or otherwise the correspondingtaxes will have to be paid. The household goods that can be brought in freeof foreign trade taxes include goods whose value does not exceed the value of the normalhousehold goods of a family in Mexico.109Immigration Regulatory System4. Other Types of VisasIn addition to the above, for purposes of simplifying and improving the control ofvisas, providing better immigration services, and facilitating the review of immigration

110C H A P T E R V Idocuments at points of entry into Mexico, a new visa has been created for tourists, transitoryimmigrants, and visiting business people or visiting members of boards of directors.The nationals of the following countries are subject to the application of this regulatoryregime: Germany, Argentina, Australia, Austria, Belgium, Bermuda, Brazil, Chile,South Korea, Denmark, Spain, Finland, France, Great Britain, Greece, Ireland, Iceland,Israel, Italy, Japan, Liechtenstein, Luxemburg, Monaco, Norway, New Zealand, Portugal,The Netherlands (Holland), San Marino, Singapore, South Africa, Sweden, Switzerland,and Uruguay.Also subject to the application of this regulatory regime are the permanent legal residentsof Canada and the permanent legal residents of the United States of America.Foreigners from these countries can enter Mexico if they do not receive any remunerationwithin the country, under the following visas:a) Tourist. These are foreigners that enter the country for purposes of recreation orhealth, in order to engage in artistic, cultural or athletic activities, with a maximumstay of 180 days without the possibility of extension;b) Transitory immigrants. These are foreigners in transit to another country; they canstay in Mexico for up to 30 days without the possibility of extension. They cannotchange their immigration status or category;c) Visiting business person. The foreigner who comes to Mexico in order to negotiateor sign commercial agreements, verify compliance with such agreements, investigateinvestment options, or make a direct investment in the country. The visitingbusiness person may remain in Mexico for a maximum period of 30 days;d) Visiting board member. The foreigner who enters Mexico to attend board of directormeetings of companies legally incorporated in Mexico, by virtue of appointmentby the shareholders’ meeting. A visiting board member may stay for a maximumof 30 days.Any of these visas can be applied for at the Mexican consulate offices abroad orat the point of entry into the country.The foreigner must specify the type of activity he/she will engage in while inMexico, provide a description of these activities, and provide the name and domicileof the foreign company or business to which he/she belongs, as well as the companyor business in Mexico with which he/she will be carrying out business.The foreigner is strictly responsible for the truth of the data and informationentered on the visa, which must be signed on the back.The foreigner who enters the country as a visiting business person or visitingboard member and wishes to extend his/her stay in Mexico should request a nonimmigrantvisa once the 30 calendar days have expired.

CHAPTER VIITax Regime1. Taxes That Must Be Paid in MexicoMexico has a federal system, copied from that of the United States of America and, justas in all federal systems, there are powers reserved for the Federal Government, powersreserved for the States, and concurrent powers. This federal system is also reflected in theability to impose taxes in Mexico, since in accordance with our Constitution, certaintaxes can only be imposed by the Federal Government, others can only be imposed bythe States, and others can be imposed by either the Federal Government or the States.As a result of the above, tax matters in Mexico can be analyzed from three angles: (a)federal taxes, (b) local taxes, and (c) the international aspect.Federal taxes are generally direct taxes, particularly the income tax, the primary failingof which is the relatively small number of taxpayers who must carry the greatest partof the tax burden.In order to avoid the excessive burden that double taxation can cause taxpayers,the Federal Government has entered into fiscal coordination agreements with each of theStates and the Federal District, through which the Federal Government shares certainrevenues with the States, provided that the States do not impose any tax on specifieditems. As a result, local taxes are minimal, the most common being the real estate tax(for owners of real estate), the payroll tax (on salaries paid to employees), and thereal estate purchase tax.In addition, regardless of who imposes the tax, the tax guarantees contained in ourConstitution must be respected and therefore, only taxes that are set forth in the law, thatrespect the economic capacity of the taxpayer, and that do not establish privileged treatments,are legal; as well, all taxes collected must go towards paying for governmentexpenditure.Mexico’s participation in the international tax context has been very significant, havingexecuted several treaties to avoid double taxation, in accordance with the model of111

the Organization for Economic Cooperation and Development (OECD) and others for theexchange of information and the elimination of tariffs.Below we will discuss very generally the primary federal and local taxes existing inMexico.2. Income TaxIn contrast to other countries, Mexico has not been able to increase the importance ofits indirect taxes such as the Value Added Tax (VAT), and therefore currently the largestportion of tax revenue comes from direct taxes, the most important of which is theincome tax (Impuesto Sobre la Renta, ISR).2.1. Persons Obligated to Pay Income Tax112C H A P T E R V I IAccording to the Income Tax Law (Ley del Impuesto Sobre la Renta, ISR Law), tax residentsin Mexico are obliged to pay income tax on all income (in cash, credit, goods, services,or of any type) earned in Mexico and in any other part of the world.Tax residents of a foreign country only have to pay income tax in Mexico when theyhave a permanent establishment in Mexico or when they obtain earnings that are consideredto come from a source of wealth located in Mexico.In view of the above, the concepts of tax resident and permanent establishment shouldbe clarified.2.1.1. Tax residency in MexicoIndividuals are considered to have tax residency in Mexico when their residential home is inMexico. When individuals have several houses in different countries, they will be consideredto be a resident in Mexico when they have their vital center of interest in the country.Legal entities are tax residents in Mexico when they have established in Mexico the principalcorporate headquarters of their business or their actual center of decision making.Tax residency is a concept that can be affected by the double taxation treaties thatMexico has signed, as these treaties contain specific conflict resolution rules to resolvethe problems that arise when both contracting countries consider the same person to bea tax resident.2.1.2. Permanent establishmentThe general concept of a permanent establishment set out in the ISR Law refers to whena nonresident falls into one of the following three categories:a) Having a place of business in Mexico in which some or all of his/her business activitiesare carried out;

) Having an employee who exercises the power to enter into contracts on behalf andin the name of the nonresident intended for the carrying out of the activities of thenonresident in Mexico;c) Engaging in activities in Mexico through an independent person when such servicesto the nonresident are outside the normal scope of the independent person’sactivities.In addition, certain special cases exist in which trusts, insurers, and real estate constructionor assembly services also create a permanent establishment in Mexico. In thecase of maquiladoras (in-bond manufacturing plants), there are special rules related tothe generation of a permanent establishment in Mexico.The ISR Law also sets out certain circumstances under which a nonresident would notbe considered a permanent establishment, regarding places that store, exhibit, and buygoods and, in general, the use of a place of business only to carry out preparatory or auxiliaryactivities for the activities of the nonresident.It is important to take into account that the double taxation treaties signed by Mexicohave specific rules applying to permanent establishments which, while very similar tothose set out in the ISR Law, must be reviewed if the nonresident is a resident of a countrywith which Mexico has entered into such a treaty.When it is considered that a nonresident has a permanent establishment in Mexico,this fact must be registered in the Federal Taxpayers’ Registry and the nonresident mustcomply with all of the tax obligations as would a tax resident in Mexico. With regard toincome tax, the foreigner will incur such tax as if he/she were a legal entity, but only overincome attributed to the permanent establishment.113Tax Regime2.2. Legal Entities with Tax Residence in MexicoTitle II of the ISR Law, which regulates how legal entities should calculate their taxes,is complex and in many cases there are specific rules for particular situations. Despitethis, in this section we briefly describe the procedure.Income tax is calculated by fiscal years which, as a general rule, coincide with thecalendar year. The income tax rate is 28 percent. There is also a requirement tomake provisional monthly tax payments for the annual tax incurred during the fiscalyear.The first step in determining the taxable base on which the income tax rate is to becalculated is calculating the taxable profit for the previous fiscal year, which is the resultof subtracting the deductions authorized by the ISR Law of that period from the totalincome of that fiscal year. As a second step in calculating the taxable profit, the lossesfrom previous fiscal years may be subtracted.

114C H A P T E R V I I2.2.1. IncomeThe income that legal entities must accrue is the income they receive from any part ofthe world of any type, which includes cash, credit, and services. There are generalrules for determining the time of receipt of the income, which rules depend onwhether they concern income from the alienation of goods, the provision of services,the granting of use or temporary enjoyment of goods, financial leases, or debts notpaid by the taxpayer.The ISR Law specifies that the following are not considered income obtained by alegal entity: income that is the result of a capital increase; income from the paymentof a loss by shareholders; income from stock premiums obtained through the listingof stock issued by the company, or income from using the participation method toappraise the value of its stock; and income obtained from the reappraisal of its assetsand capital. In addition, this code establishes that income obtained from dividendsor profits that are obtained from other legal entities residing in Mexico are notaccruable.2.2.2. DeductionsIn contrast to the general way in which income is defined, deductions are defined specificallyin the ISR Law, and include the following: (a) refunds, rebates, or discounts, (b)cost of sales, (c) investments, (d) uncollectible debts and losses resulting from an Act ofGod, force majeure, or in certain cases from the alienation of goods, and (e) interestaccrued for the fiscal year, without any adjustments.In addition to the fact that deductions are defined specifically, the ISR Law establishesa series of requirements that must be complied with in order to take the deductions,such as: (a) those that are strictly necessary for the purposes of the taxpayer’sactivity, unless they are authorized donations within the limits indicated by the ISRLaw, (b) those covered by documentation meeting certain requirements, (c) thoseduly registered in the accounting records, (d) those complying with the obligationsof withholding and payment of taxes owed by third parties, (e) those that have hadthe Value Added Tax transferred, (f) those having interest on capital loans, and forwhom such loans have been invested in the business, (g) those for which the merchandiseis legally imported into the country, (h) those relating to social welfare paymentsgranted generally to all employees in addition to other requirements, (i) thosefor whom the payments made for technical assistance and royalties are services actuallyprovided, and the payment is made to whoever directly provided said service,and (j) when the requirements for deductions are complied with before the end ofthe fiscal year, except with regard to evidentiary records, which can be obtained upuntil the annual tax return is submitted for the corresponding fiscal year. Furthermore,the Income Tax Law establishes certain items that are not deductible, which

includes a limitation on the deductibility of interest for excess debts known as thincapital or undercapitalization.We consider it important to give special mention to deductions based on investmentsof the sale cost and to the limit on the deduction of interest for excess debt (thin capitalization).The deduction of investments in fixed assets, charges, and deferred expenses is carriedout by depreciation, for which the ISR Law establishes the percentages that must be usedfor such deductions, depending on the good involved.With regard to the sale cost, raw materials and semifinished and finished products arededucted when they are alienated (transferred). In order to determine the amount of thecorresponding deduction, it is necessary to use the absorbent cost system on a historicalor predetermined basis or the system of direct cost, but only on a historical basis.Thin capitalization or undercapitalization was introduced in the ISR Law as of 2005 onthe theory that companies must keep their debt below a reasonable level, which for purposesof the ISR Law is three times the capital of the company. In the event that debtssurpass this amount, the company cannot deduct the payment of interest derived fromthe debts that exceed this amount and that arise from debts contracted with related partiesresiding abroad.2.2.3. LossesTax loss is the difference between the income accrued in the fiscal year and the allowabledeductions, when the amount of the latter is greater than income. The tax loss in a fiscalyear can be subtracted from the tax profit of the following ten fiscal years until it iseliminated.Tax losses cannot be transferred, not even through a merger. Furthermore, when in amerger the surviving company (the purchaser) has losses, these can only be subtracted fromfuture tax profit resulting from the exploitation of the same activities that produced the loss.In the case of a change of partners or shareholders that have control of a company, itmay also be the case that the application of the tax loss of said company will be limitedand that the mentioned loss can only be subtracted from future tax profit resulting fromthe exploitation of the same activities that produced the loss.115Tax Regime2.2.4. ConsolidationThe ISR Law allows for the possibility of consolidating the losses and earnings of Mexicancompanies belonging to the same group. In order to consolidate it is necessary tocomply with certain requisites established by the ISR Law, among which is the priorauthorization of the tax authorities.The minimum consolidation period is five years and in the event that this option ischosen, all Mexican companies belonging to said group must be included.

2.2.5. DividendsThe aim of the ISR Law is for income tax to be paid only once, so if a dividend is distributedfrom the profits account of a company that has already paid tax thereon, no newtax need be paid, since the profit has already been taxed at the corporate level.On the other hand, when dividends are distributed from company profits on which taxhas not been paid, the company distributing them must apply the general income tax rateon the amount of the pyramided dividend (by multiplying it by the factor of 1.3889).2.2.6. Market valueThe ISR Law establishes that in the event that transactions are carried out at less thanmarket value, at cost or below cost, the tax authorities can change the tax profit or loss,estimating the price at which they believe the transaction should have been carried out.116C H A P T E R V I I2.2.7. Transfer pricingLegal entities with a tax residence in Mexico and a permanent domicile in the countrywho carry out transactions with related parties who are nonresidents must determinetheir income by taking into account the consideration that would have been paid amongindependent parties (“arm’s length transactions”).Two or more parties are considered to be related when one of them participatesdirectly or indirectly in the administration, control or capital of the other or when a personor a group of persons participates directly or indirectly in the administration, control,or capital of both companies.In order to determine if the price of the transaction used is that which would havebeen agreed between independent parties, any of the following methods may be used:(a) comparable price, (b) resale price, (c) added cost, (d) profit sharing, (e) surplus afterprofit sharing, and (f) transactional margins of operating profit.The Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations,approved by the Regulation Board of the Organization for Cooperation and EconomicDevelopment (OECD) in 1995, or any substitute thereof, should be used for theinterpretation of transfer pricing regulation, provided such guidelines are consistentwith Mexican law.2.2.8. Preferential tax regimesThe Mexican government has decided to ensure that the nature and content of investmentsmade in Preferential Tax Regimes (also known as tax havens) are revealed, suchthat income coming from these regimes will be considered taxable from the moment itis generated, even if such income, dividends, and profits have not yet been distributed.Income falling under any of the three following categories is considered to be incomecoming from a Preferential Tax Regime: (a) income not taxed abroad, (b) income taxed

abroad but at a tax rate less than 75 percent of what would have been paid in Mexico,and (c) income generated through transparent legal entities or figures.The tax authorities have the authority to determine the existence of simulation in legalacts exclusively for tax purposes in cases of (a) income related to a Preferential TaxRegime, (b) transfer pricing, and (c) income determined to have come from a source ofwealth within the country.2.3. Nonresidents Who Obtain Earnings from a Source of Wealth Locatedin MexicoAs discussed previously, non-residents must pay Mexican income tax when they have apermanent residence in Mexico or when they obtain earnings that are considered tocome from a source of wealth in Mexico.It is very important to point out that Mexico has signed double taxation treaties withdifferent countries, the application of which depends on the tax residence of the actualbeneficiary of the income. These treaties establish treatment exceptions that reduce oreliminate the tax, and therefore is it essential to review the possible application of saidtreaties in all transactions.2.3.1. Treatment set out in the ISR LawAs a general rule the tax imposed under these circumstances is calculated on gross incomeand it is paid through the withholding made by the person making the payment. Thereare certain exceptions in which the nonresident is allowed to choose to pay on a net basis(income minus deductions), for which is it necessary to have a representative in Mexico.We can say that the most representative types of income that can be considered tocome from an income source located in Mexico are the following:a) Income taxed at a rate of 40 percent, obtained as a result of representational transactions(commission, brokerage, agency, distribution, consignment or appraisal, and ingeneral, income for undertaking another’s interest) that residents of Preferential TaxRegimes obtain, when the one paying is a resident or has a tax domicile in Mexico;b) Income taxed at a rate of 25 percent;i) Income received for fees and the provision of independent services when theservice is provided in Mexico;ii) Remuneration to members of boards of directors for auditing, consulting orof any other kind, when it is paid by Mexican companies;iii) Income received for granting the temporary use or enjoyment of real estatelocated in Mexico;iv) Income obtained from time-share tourist service contracts when the propertyshared is in Mexico;117Tax Regime

118C H A P T E R V I Iv) Income received for granting the temporary use or enjoyment of movablegoods when: (1) these goods are used in the country and for commercial,industrial, agricultural, livestock or fishery activities or (2) when the materialdelivery of the goods occurs in Mexico;vi) Income received for the provision of technical assistance distinct from thetemporary use or enjoyment of patents, certificates of invention or improvement,manufacturing trademarks and commercial names, when the goods orrights that are being paid for are enjoyed in Mexico or when this is paid by atax resident or permanent establishment in Mexico;c) Income that is taxed, at the election of the taxpayer (provided certain requisites arecomplied with), at a rate of 25 percent of gross income or at the general rate of 28percent of net income (taking into account certain deductions allowed by theIncome Tax Law);i) Income from the alienation of real estate located in Mexico;ii) Income from the alienation of shares and securities (that represent the ownershipof goods) when: (1) they are issued by a Mexican company, or (2) morethan 50 percent of the book value of the shares or securities comes directly orindirectly from real estate located in Mexico;iii) Income from services in Mexico of construction work or building constructionor for inspection or supervision thereof. In the event that the service lastsmore than 183 days, a permanent establishment is generated;iv) Income from: (1) artistic or sporting activities or the presentation of publicshows in Mexico, (2) the promotion of such activities or shows, or (3)the provision of services, the granting of the use and enjoyment of goods,or the alienation of goods related to such activities or shows;d) Income that at the election of the taxpayer (provided that certain requisites arecomplied with) is taxed at a rate of 25 percent of the profit or at the general rateof 28 percent of the profits of the month after subtracting the losses from the restof the transactions of such month executed with the same institutions or persons:Financial transactions derived from capital when one of the parties is a residentor has a permanent establishment in Mexico and they involve shares and securities(that represent ownership of goods) when: (1) they are issued by a Mexicancompany; or (2) more than 50 percent of the book value of the shares orsecurities comes directly or indirectly from real estate located in Mexico;e) Income that at the election of the taxpayer (provided that certain requisites arecomplied with) is taxed at a rate of 25 percent of the total amount of the transactionor at 40 percent of the profit obtained:A debt for equity swap made by a person distinct from the original creditorwhen the debtor is Mexican;

f) Income that is taxed at the general rate of 28 percent;i) Income from advertising and royalties, for the temporary use or enjoyment ofpatents or certificates of invention or improvement, manufacturing trademarksand commercial names, when the goods or rights for which they arepaying are enjoyed in Mexico or when this is paid by a tax resident or permanentestablishment in Mexico;ii) Income from the discharge of debts by the creditor or when the debts are paidby another person provided that the creditor that granted the pardon is a residentor permanent establishment in Mexico;iii) Income obtained through the granting of the right to participate in a businessinvestment or any kind of payment for entering into or participating in anykind of legal transaction when it is carried out in Mexico;iv) Income from indemnifications or liquidated damages when the payer is a residentor permanent establishment in Mexico;v) Income obtained for the alienation of commercial credit when the latter isattributable to a resident or permanent establishment in Mexico;g) Income that, depending on the amount, may be exempt or have the tax rate of 15percent and 30 percent applied;i) Salaries and wages when the service is provided in Mexico;ii) Pensions, retirement funds, retirement assets, and lifetime benefits or otherforms of retirement when the payments are made by tax residents in Mexicoor permanent establishments in Mexico or when the contributions are theresult of a subordinate personal service provided in Mexico;h) Income taxed at a rate of less than 25 percent;i) Income from shipping contracts when they involve coastal trade in Mexico,the applicable rate being 10 percent;ii) Royalties for the temporary use or enjoyment of railway cars, which is taxedat the rate of 5 percent;iii) Income from winning prizes when the lottery, raffle, drawing, betting game orcompetition is held in the country; it is taxed at a rate of 1 percent when astate tax does not exist for this income or said tax exists but does not exceed6 percent, and at a rate of 21 percent in all other cases;i) Interest. Interest is taxed in Mexico when capital is sold or invested in Mexico or whenit is paid by a resident or permanent establishment in Mexico. The applicable ratedepends on who grants the loan, the nature of the debtor and what the loan is for;i) Exemptions: (1) loans granted to the Federal Government, Bank of Mexicoand coming from bonds issued by them, (2) loans granted or guaranteed byforeign financial institutions engaged in promoting exports by means of grantingloans or guarantees with preferential conditions provided that the term for119Tax Regime

120C H A P T E R V I Ipaying the credit is three years or more, and (3) loans granted to institutionsauthorized to receive donations, provided they are granted or guaranteed withpreferential conditions by foreign financial institutions;ii) At a rate of 4.9 percent: (1) interest on income from negotiable instruments offeredto the investing public from loans from lending institutions, special purpose financialinstitutions, or secondary financial institutions, as well as those offeredthrough banks or securities firms in a country with which Mexico has a doubletaxation agreement, and (2) interest paid to foreign financial institutions in whichthe Federal Government has a capital investment. The income from interest mentionedin the previous section will be subject to a 10 percent tax rate when itdoes not comply with certain requisites established in the Mexican legislation;iii) At a rate of 10 percent: (1) interest paid to financial institutions belonging toForeign States, (2) interest paid to foreign banks, including investment banks,(3) interest paid to entities that sell or invest capital in Mexico coming fromsecurities issued and sold abroad to the investing public, (4) interest from negotiableinstruments sold by banks or securities firms in a country with whichMexico has not signed a double taxation treaty, and (5) interest paid for theacquisition of a right to collect an owed debt of any kind.The income from interest mentioned in the previous paragraph may be subjectto a tax of 4.9 percent when the actual beneficiary of the interest is a foreignerwith tax residency in a country with which Mexico has signed a doubletaxation agreement and provided certain requisites are complied with;iv) At a rate of 15 percent when the interest is paid to reinsurance companies andinterest that has been agreed to as interest on financial leasing contracts;v) At a rate of 21 percent, interest paid to: (1) credit institutions other than thosementioned previously, (2) foreign suppliers for the alienation of machinery andequipment which form part of the fixed assets of the purchaser, and (3) for thefinancing of machinery and equipment which form part of the fixed assets ofthe purchaser and in general for working capital loans or commercialization;vi) In other cases of income from interest, the general tax rate of 28 percent applies.Certain exceptions apply to some of the above income, and therefore it is necessary toanalyze each case individually.2.3.2. Double taxation treatiesAs we have already stated, in the case of foreign tax residents it is necessary to checkwhether one of the double taxations treaties signed by Mexico may apply. At the end ofthis chapter there is a table which shows the treaties entered into by Mexico and thosebeing negotiated as of 2007.

Once it is determined that one of the double taxation treaties signed by Mexico isapplicable, then it must be seen if the relevant treaty stipulates rate reductions, exemptionsor special treatment and the requirements in order to be entitled to them. At theend of this chapter there is a table which shows the withholding rates for dividends,interest and royalties in the double taxation treaties entered into by Mexico as of 2007.3. Single Rate Business Tax3.1. GeneralOn October 1, 2007 the law covering the Single Rate Business Tax (Impuesto Empresariala Tasa Única, IETU) was published in the Official Federal Gazette (Diario Oficial de laFederación) and it will enter into force on January 1, 2008.This tax is characterized basically by the following aspects:a) It takes the place of the Asset Tax (Impuesto al Activo, IMPAC) and therefore, theIMPAC law is repealed as of fiscal year 2008. As was the IMPAC, the IETU is a complementarytax to the Income Tax (Impuesto Sobre la Renta, ISR) and in fact, the lawprovides for the crediting of the ISR to the IETU;b) It taxes at a fixed rate the taxable profits resulting from business activities, under acash flow scheme;c) To determine the taxable base it provides for limited deductions to accruableincome, but in order to coordinate its determination with that of the ISR, it also providesfor the application of direct credits against the IETU;d) Its payment is calculated by fiscal year and is paid by a declaration that must befiled within the same time period as the ISR;e) To define most of its concepts, the IETU law refers to the concepts of the ISR law andthe Value Added Tax law, there being a correlation among these laws.121Tax Regime3.2. Persons Subject to the Tax and Activities TaxedIndividuals and entities with tax residence in Mexico, as well as residents abroad with apermanent establishment in the country, are obligated to pay the IETU on the income theyobtain, regardless of where it is generated, as a result of the following activities:a) Alienation of goods;b) Provision of independent services;c) Granting of the temporary use or enjoyment of goods.Residents abroad with a permanent establishment in the country must pay the IETU forincome attributable to said establishment resulting from the mentioned activities.

However, the law exempts the following persons from the application of the IETU: (a)the Federal Government, the States and the Federal District, Municipalities, AutonomousConstitutional Bodies and State-Owned Entities; (b) those not subject to the ISR in certaincases; (c) authorized donees; (d) individuals and entities with income obtained fromfarming, livestock, forestry, or fishing for the income that is exempt under the ISR Law; (e)entities whose shareholders are pension and retirement funds residing abroad; and (f)individuals who engage on an irregular basis on acts that are taxed by the IETU.3.3. RateThe rate to be applied for the IETU is 17.5 percent of taxable profit (taxed income minusauthorized deductions). As a transitory provision, the rate for fiscal year 2008 will be16.5 percent and for 2009 it will be 17 percent.122C H A P T E R V I I3.4. Taxable Base3.4.1. IncomeIn order to calculate the result, the IETU law establishes three different classes of taxpayerincome for this tax: (a) taxed income, (b) exempt income, and (c) income not subjectto this tax.Taxed income is the income that the taxpayer must accrue in order to apply the authorizeddeductions. In general terms, this type of income is income derived from the executionof the activities taxed under this tax, as well as the amounts that are charged to apurchaser for taxes or fees charged to the taxpayer, the amounts that are paid to the taxpayeras normal or late payment interest, contract penalties or any other concept, includingadvances or deposits.Taxes that have been transferred are not considered within this income and specialrules are established for income related to: (a) advances or deposits returned to the taxpayerand previously deducted, (b) amounts received from insurance companies for paymentsunder a policy, (c) financial institutions, and (d) exchanges and payments in kind(market value or appraisal value).For purposes of its calculation, the taxed income is understood as obtained when theamounts charged are actually collected, in accordance with the VAT law.The law establishes generally that the following income is exempt from the IETU: (a)income derived from alienation of partnership interests or stock, documents pending collectionand negotiable instruments, (b) income resulting from the alienation of nonredeemablereal estate certificates of participation that are alienated by individuals on anirregular basis or on the stock market by trusts engaged in real estate construction or acquisition,(c) income resulting from the purchase and sale of Mexican or foreign currency,

except for money exchange firms, and (d) the income of individuals not earned on aregular basis.Finally, in order to avoid the decrease of the taxable base through unjustified deductions,the lawmaker established the existence of income not subject to this tax whichshould not be taken into consideration at all for the calculation of the payment of thetax. Included in such income are royalties between related parties and interest that is notincluded in the price, as well as derivative financial operations, when the underlyingoperation is not taxed by the IETU.In relation to royalties between related parties, only the payments between related partiesfor the temporary use or enjoyment of industrial, commercial, or scientific equipmentwill be taxed income and therefore authorized deductions. Royalty paymentsbetween independent parties are considered taxed.3.4.2. DeductionsBased on the above classification of the taxpayer’s income under the IETU, in order todetermine the result the authorized deductions should be applied. In very general terms,all expenditures resulting from the execution of the activities subject to the tax can bededucted and the following are the requirements for doing so:a) That they correspond to the activities subject to the tax;b) That they are strictly indispensable;c) That they comply with the deductibility requirements established in the ISR law;d) That they have been actually paid.123Tax RegimeSome authorized deductions are regulated separately, as with the deduction of investments.In fact, this special regulation is one of the concepts that make the bases for thepayment of the IETU and the ISR different.Investments made from January 1, 2008 on, will be deducted in their entirety (100percent) in the fiscal year in which they are actually paid, while in the ISR law it is providedthat investments are deducted by depreciation in each fiscal year, applying thepercentages authorized by said law.With respect to new investments and inventories of fiscal years prior to 2008 that arenot yet totally deducted for the ISR, the IETU provides for a system that permits the taxpayerto have a partial benefit, except in the case of new investments made during thelast quarter of 2007, which can be deducted in their entirety in three parts during threefiscal years beginning in 2008.3.4.3. Credit for excess deductionsWhen the deductions authorized in a fiscal year are greater than the taxed income, thetaxpayer has the right to the credit against the IETU determined by the amount resulting

from applying the factor 0.175 (0.165 for 2008 and 0.170 for 2009) to the differenceresulting from such deductions and income. This credit can be credited against the ISRor against the payment (provisional and annual) of the IETU of the 10 following fiscalyears until exhausted, being gradually adjusted for inflation.If the taxpayer does not use such a credit in the fiscal year in which it had the right todo so, it will lose the right to apply it in subsequent fiscal years in the amount that itcould have credited it.124C H A P T E R V I I3.4.4. Credit for wages and salariesWages and salaries are expenditures resulting from a subordinated personal service andtherefore they are not subject to the IETU, and may not be deducted. However, the lawestablishes a credit that the taxpayer may apply against the tax of the fiscal year for suchpayments, partially recognizing the economic effect of such expenditures. 1The credit is determined with respect to expenditures for contributions to social securityand income taxed under the ISR for wages and salaries, as well as for concepts consideredequivalent to these, but excluding expenditures for wages and salaries that areexempt from ISR, such as social welfare payments.The application of this credit has a ranking below that of the credit for excess deductionsreferred to above, and it may only be used against the tax generated in the fiscalyear in which the credit was obtained.3.4.5. Crediting of the ISRSince the IETU is a tax complementary to the ISR, the new law provides for the creditingof the ISR of the same fiscal year, the latter being understood as the amount actuallypaid in terms of the ISR law. For these purposes, also considered as ISR paid is theamount paid for dividends when they do not come from CUFIN, as well as the ISR paidabroad with respect to income taxed by the IETU. The ISR is not considered actuallypaid when it has been covered through credits (except for taxes on cash deposits) andlegal reductions.3.5. Provisional Payments of the IETUThe provisional payments for the IETU of the fiscal year must be made monthly by declarationthat will be filed at the same time as the provisional payments of the ISR. Thesepayments shall be made on the basis of accrued income and deductions as of the month__________1The tax credit will be determined based on applying the factor equivalent to the IETU rate to all the amountsresulting from payments for salaries, payments considered equivalent to salaries, and contributions to socialsecurity.

in question. They will be calculated by subtracting from the total accrued income of theperiod from the beginning of the fiscal year until the last day of the month the paymentis made, the authorized deductions corresponding to the same period. The correspondingtax rate will be applied to the result, less the provisional payments made.Finally, to calculate the provisional payments of the IETU, just as in its annual determination,the proportional application of certain additional credits previously explainedin relation to the annual payment is allowed.In the event it is not possible to totally or partially credit the provisional paymentsagainst the IETU, the amount can be offset against the ISR of the fiscal year and a refundcan be requested when, after making such an offset, there will be a balance in favor ofthe taxpayer.3.6. Powers of the AuthoritiesThe law specifically establishes the power of the tax authority to presumptively determinea tax liability for the IETU, determining the accrued income and applying the documenteddeductions thereto and the corresponding tax rate.In any case, the taxpayer can choose to have the tax authorities apply, instead of theabove, the coefficient of 54 percent on the presumptively determined income and the correspondingtax rate to the result.125Tax Regime3.7. Special RulesWe believe the above provides a general description of the regulation of the IETU. However,the same law establishes special regulation of the following matters: companies thatconsolidate fiscally, the members of nonprofit entities, trusts, financial system and derivativefinancial operations and the small taxpayer regime, among others.These special regulations are set forth in several chapters of the law, but we will notenter into such detail for purposes of this study.4. Value Added TaxValue Added Tax (VAT) is an indirect tax designed to tax consumption. For the purposesof determining this tax, a distinction is made between the passive subject or the one obligatedto pay the tax and the affected subject.For purposes of VAT, the seller of goods, the provider of services or whoever grants theuse or enjoyment of goods, must transfer the VAT incurred to the person acquiring orreceiving them, expressly and separately. Transfer is understood to mean the charge thatthe person obligated to pay the VAT should make to the person receiving the goods, the

services or the temporary use and enjoyment of goods, for an amount equivalent to thetax incurred.4.1. Persons Subject to Payment of the VAT, Acts and Activities Taxed, and Rate126C H A P T E R V I IIndividuals and legal entities that carry out in Mexico any taxable acts or activities aresubject to the payment of this tax. The tax residency of the individuals or entities is irrelevant,and therefore, in some cases, nonresidents may also have to pay the tax if theycarry out any of the acts or activities mentioned in the next paragraph, in which casethere would be an obligation to withhold the tax for the one who pays it, if the latter isa tax resident in Mexico.In accordance with Article 1 of the VAT law, the carrying out, within Mexico, of thefollowing acts is taxed with said tax: alienation of goods, provision of independent services,the granting of the temporary use or enjoyment of goods and the importation ofgoods or services. The VAT law defines the circumstances under which each taxed actor activity is considered to have been carried out within national territory.The alienation of goods is considered to have been carried out within Mexico if saidgood is in the country at the moment of being sent to the purchaser and, if it is not sent,if the material delivery of the good by the alienator is carried out in the country. Therefore,in the case of the alienation of goods located abroad and sent on consignment toMexico to the purchaser, VAT will not be incurred when the purchase and sale is perfectedafter said goods have been imported into Mexico.4.2. Taxable Base and Applicable RatesIn the case of alienation of goods, provision of services, and granting of temporary useor enjoyment of tangible goods, the taxable base consists of, among other things, theprice paid as well as any other amount charged to the purchaser, to the one who receivesthe services or to the one who grants the use or enjoyment of tangible goods for othertaxes, rights, normal or penalty interests, liquidated damages, or any other concept.With regard to the importation of tangible goods, the taxable base of VAT will be thevalue used to calculate the general import tax, plus the amount of said tax and any otheramount that must be paid for said importation. Other taxes that may be incurred forimporting tangible goods into Mexico are the Special Tax on Production and Services(STPS) and the Tax on New Cars.As a general rule, VAT must be calculated and paid by applying the rate of 15 percentto the taxable base. Exceptionally, a rate of 10 percent will apply when the actstaxed are carried out by residents in border regions, and provided the material deliveryof goods or the provision of services is carried out in this border region. In the case

of importing, a rate of 10 percent will also apply if the goods or services are alienatedor provided in said region.Finally, the VAT will be calculated by applying a rate of 0 percent on those acts oractivities expressly stipulated by the VAT law. The following activities, among others,are taxed at a rate of 0 percent: export of goods, alienation of patented medicines anddietary products, books, newspapers and magazines that the taxpayers themselvespublish, etc.4.3. Difference between Activities Taxed at a Rate of Zero Percentand Exempt ActivitiesAs an exception to the general rule, the alienation of certain goods, the provision of certainservices and the granting of the temporary use or enjoyment of certain goods aretaxed with VAT calculated by applying a rate of 0 percent to the taxable base of the tax.The application of said rate to certain acts or activities is a rate of general benefit for theeconomic agents who carry out transactions taxable by the VAT law. It is a preferential taxrate both horizontally and vertically.There is a horizontal tax preference because it benefits taxpayers who carry out actsor activities subject to the 0 percent rate, as the tax is not transferred to the final consumersof the goods or services commercialized by them and it allows them, on theother hand, to offset or even request the refund of the amount of tax paid by them inobtaining the necessary inputs for the production and commercializing of said goodsand services. On the other hand, it is a vertical preferential rate because it benefits thefinal consumer of the goods and services affected by said rate, since their price doesnot reflect any VAT tax.On the other hand, the carrying out of certain acts or activities within Mexico isexempt from VAT, in which case taxpayers cannot offset the VAT that was transferred tothem nor request the respective refund (e.g., sale of books, newspapers, and magazines).In these cases, the VAT that was transferred to them for the acquisition of goods or servicesor the payment for the importing of goods, can only be deducted for purposes ofthe Income Tax.127Tax Regime4.4. VAT Incurred Based on Cash Flow and Payment of VATIn order to determine the moment at which VAT is incurred, the relevant law uses a cashflow system, which is to say that said tax is incurred when the consideration or paymentfor the alienation of goods, the provision of a service, or the granting or temporaryuse of tangible goods, is received. Exceptionally, the VAT for interest will beincurred as it accrues.

128C H A P T E R V I IIn other words, the carrying out of certain acts or activities within Mexican territorygives rise to VAT. However, VAT is incurred and therefore must be paid at the momentwhen consideration is received and up to the amount of such consideration.Except in the case of carrying out taxed acts or activities incidentally, VAT should becalculated and paid by the calendar month, through a tax return that should be filed inthe authorized offices by the 17 th day of the month immediately following that in whichthe payment was made.The amount of VAT to be paid is the difference between the VAT corresponding to thetotal of taxable acts and activities carried out during the month concerned and the taxthat can be offset for the same period.If in calculating the VAT the taxpayer has a credit balance because the tax that can beoffset is greater than the VAT incurred during the month concerned, it can be offsetagainst the VAT corresponding to subsequent months until it is used up. A refund canalso be requested, provided that the request is for the refund of the total credit balance,or it can be offset against other taxes in accordance with the stipulations of the FederalTax Code (Código Fiscal de la Federación).4.5. Offsetting VATThe payers of this tax are entitled to subtract from the VAT they owe the VAT that wastransferred to them and that they paid for the purpose of importing goods and services,an act that is known as offsetting.Not all VAT that was transferred to the taxpayer or that the taxpayer paid for the importationof goods or services can be offset. Taxpayers can only offset VAT that was transferredto them for the acquisition of goods or services or the granting of the temporary use orenjoyment of goods that are strictly essential for the carrying out by such taxpayers of actsor activities taxed with VAT at the rate of 15 percent, 10 percent or 0 percent.If the taxpayer incurs expenses for carrying out in Mexican territory acts or activitiesthat are exempt, the VAT that was transferred to the taxpayer and the payment for theimportation cannot be offset under any circumstances.In the cases in which the taxpayer simultaneously carries out acts or activities that aretaxable and exempt, the VAT that was transferred to the taxpayer and that the taxpayerpaid for the importation corresponding to strictly essential expenses can be offset 100percent, as long as it can be identified with the taxed activities. If this is not possible, thetaxpayer can offset the VAT that was transferred to it and that was paid for the importationin the proportion that the total value of the taxed activities represents in the totalvalue of the activities carried out in the month concerned.In those cases in which the taxpayer carries out exempt and taxed acts or activities,the transferred VAT and the VAT paid for the importation of items considered investments

y the ISR Law can be offset in function of the customary use of said investments. If theinvestments can be identified only with the carrying out of either taxed acts or activitiesor exempt activities, they may be completely offset or not, depending on the case.If the investments are used for carrying out exempt or taxed activities without distinguishingbetween the two, the transferred VAT and the payment for the importation canonly be offset in the proportion that the taxed activities represent in the total value of theactivities that the taxpayer carries out in the month concerned, a proportion that may besubject to adjustments in the event that in subsequent months said proportion changesby more than 3 percent. The proportion that is determined should be applied withrespect to all the investments acquired or imported within a period of at least 60 monthscounted from the time of the offset.In those cases in which there is VAT transferred or paid for the importation of goods orservices or the granting of the use or enjoyment of goods or investments (made withoutdistinction to taxed or exempt activities), the taxpayer may choose to offset said tax forthe amount resulting from multiplying said tax by the proportion that represents thevalue of its taxed activities corresponding to the year immediately prior to the one forwhich the offsettable tax is calculated with respect to the total activities carried out duringthat period.4.6. Exportation of Goods or Services129Tax RegimeIn principle, the alienation of goods in Mexican territory is an activity subject to the VAT.However, the alienation of goods in Mexican territory that is carried out for exportationis subject to the VAT at a rate of 0 percent, which allows the taxpayers to offset the VATthat was transferred to them by their suppliers or that it paid for the importation ofgoods and that meets the requirements set out for offsetting. The taxpayer can evenrequest a refund of any credit balance that may exist.Despite the above, through miscellaneous tax provisions, certain alienations carriedout within Mexican territory of goods imported under certain customs regimes or ofnational or nationalized merchandise can benefit from the application of the 0 percentrate. The underlying reason for this is that it concerns the alienation of goods that,although not exported directly by export declaration, will be incorporated into otherproducts that will eventually be exported.In effect, the so-called IMMEX (in-bond manufacturing) companies that import merchandiseinto Mexico under the temporary importation regime can alienate such merchandiseto nonresidents as long as the merchandise is delivered within the country toanother IMMEX company or to companies in the automotive industry or car or auto partsmanufacturing industry, for its introduction into the customhouse deposit regime. Saidgoods can also be alienated to other IMMEX or Foreign Trade companies.

130C H A P T E R V I IIn addition, the alienation of national or nationalized merchandise by national suppliersto nonresidents, when it is delivered in Mexican territory to an IMMEX companyor to companies in the automotive industry or car or auto parts manufacturing industryfor its introduction into a customhouse deposit regime, will incur VAT at a rate of0 percent.Finally, the foreign merchandise imported into Mexico under the bonded warehousecustoms regime can be alienated by applying the rate of 0 percent to IMMEX companiesor companies in the automotive industry or car or auto parts manufacturing industry forits introduction into a customhouse deposit regime.In all of the cases discussed above, in order for the 0 percent rate to be applicable tothe value of the alienation, it will be necessary to carry out certain “virtual” customsoperations of return or exportation and of temporary importation or of the introductionto customhouse deposit. In addition, it will be necessary to comply with all the additionalspecific requirements indicated in the miscellaneous tax provisions.5. Special Tax on Production and ServicesThe Special Tax on Production and Services, is a tax on the importation into Mexicoand the alienation of certain specific goods in Mexican territory. Equally, the provisionof services, such as commission, sales promotion, agency, representation, consignment,and distribution, are taxed as long as the sale of the taxed goods is procuredthrough them.This is an indirect payment, in view of the fact that it tends to tax the final consumerof the goods whose importation or alienation is taxed. While this tax has some similaritiesto VAT, the circumstances under which payers of this tax can offset the tax transferredto them is considerably limited, in addition to the fact that in the majority of casesthe taxpayer or the one obliged to pay the STPS cannot expressly and separately transferit to the person affected or the consumer.5.1. Persons Subject to the Payment of STPS; Taxed Acts and ActivitiesIndividuals and legal entities in Mexican territory who engage in any expressly taxableacts or activities are obliged to pay STPS. The alienation in Mexican territory and thedefinitive importation into Mexico of goods shown in the following table are taxed withSTPS in accordance with the rate indicated for each one of them.The STPS also taxes the provision in Mexican territory of services of commission,sales promotion, agency, representation, financial brokerage, consignment, and distributionthrough which the above-mentioned goods are alienated, except for gasolineand diesel.

GoodsA. Alcoholic Beverages and Beer1. With an alcohol content of up to 14° G.L.2. With an alcohol content of more than 14° G.L. and up to 20° G.L.3. With an alcohol content of more than 20° G.L.B. Alcohol, denatured alcohol, and noncrystallizing honeyC. Processed Tobaccos1. Cigarettes2. Cigars and other cut tobaccos3. Hand made cigars and cut tobaccosD. GasolineRate25%30%50%50%160%160%30.4%Determinableon the basisof variableelements131E. DieselDeterminableon the basisof variableelementsTax Regime5.2. Payment of STPS, Crediting, and OffsettingNormally, the STPS must be calculated and paid monthly by the 17 th of the month immediatelyfollowing the month for which the calculation is made. The STPS owed by thetaxpayer will be the difference between, on the one hand, the total amount of the considerationeffectively obtained for the alienation or provision of services taxed duringthe month concerned and on the other hand, the tax paid for the importation of goodsand the tax that can be offset.As a general rule, the amount of STPS determined cannot be offset. However, it ispossible to offset the STPS that has been transferred to the taxpayer, expressly and separately,by the acquisition of the goods mentioned in section A of the above chart orthat which the taxpayer paid for the acquisition of said goods. Furthermore, STPS paiddue to the import into Mexico of the goods mentioned in sections A, C, D, and E canalso be offset. In order to make use of said offsetting, it is necessary, among otherthings, that the person attempting to offset it be a taxpayer who incurs STPS in relationto that which the taxpayer intends to offset and that the STPS expressly transferred thatis being offset and the STPS against which it is to be offset correspond to goods of the

same class, which are understood to be those grouped within the same section, exceptfor beer and coolers, which are considered to be in a different class from other beveragesthat contain alcohol.If in the monthly tax return there is a credit balance, the taxpayer can only offsetit against the tax owed in the following monthly payments up until it is used up. Ifthe balance is not offset in the corresponding month or in the two following months,when it could have been offset, the right to offset it will be lost up to the applicableamount.In the case of manufacturers, producers, bottlers or importers that alienate the goodsreferred to in sections A, B, and C through commission agents, sales promoters, agents,or distributors, they must withhold and pay the STPS on the consideration correspondingto the latter, unless the amount of said consideration is included in the price of alienationof the goods.132C H A P T E R V I I5.3. Alienations and ExemptionsThe obligation to pay STPS arises when the respective consideration is received and onthe amount charged. As a general rule the taxable base of STPS is the value of the agreedconsideration, using in its absence the market value or appraisal value, to which the specificrate corresponding to that type of good will be applied.As an exception, the producers or importers of cigars will calculate STPS correspondingto the alienation on the basis of the sale price to the retailer. In the case of cigarettes andcigars and other processed tobaccos the subsequent alienations carried out by producers,manufacturers or importers will be exempt from the tax.The following (among other) items, are exempt from STPS: the alienations of beer, coolers,cigars, and other processed tobaccos provided that the alienator is not the manufacturer,producer, bottler, distributor, or importer of the goods.Finally, the alienation for exportation of any type of good contemplated in the STPS lawis exempt from this tax.5.4. Importation of GoodsOnly the importation into the country under a definitive importation customs regimeis taxed by the STPS. For this purpose the tax is calculated taking into account the valueused for the purposes of the general import tax plus the amount of the other chargesand fees that must be paid for said importation, except the VAT.The STPS incurred for the importation of goods is paid together with the GeneralImportation Tax, which is to say before the merchandise customs clearance isprocessed.

5.5. Specific Obligations of STPS TaxpayersProducers and importers of cigars must register with the fiscal authorities a price list foreach of their products to be sold, indicating the price to the wholesaler, to the retailer,and the recommended price for sale to the public.Importers of alcoholic beverages must place on such products certain distinctive marksindicating tax control (tax stamps and seals) prior to the entrance of the merchandise intoMexican territory. Tax stamps can only be placed on the goods when they are before customs,in a general customs warehouse (customhouse deposit) or in a bonded warehouseor duty-free area. Without said distinctive marks the products cannot be removed.Importers and exporters of the goods referred to in sections A, B, C of the above chartmust be registered in the appropriate sectorial importers and exporters registry, kept bythe Ministry of Finance and Public Credit.6. Tax on Cash Deposits6.1. GeneralOn October 1, 2007, the decree creating the Tax on Cash Deposits (Impuestos a losDepósitos en Efectivo, IDE) was published in the Official Federal Gazette, which will enterinto force as of July 1, 2008.The purpose of this tax is to create a mechanism for combating the black market, identifyingand taxing those persons that engage in commercial activities and receive paymentsin cash that are subsequently deposited in the banking institutions of the country.Among the most important characteristics of the IDE are the following:133Tax Regime6.2. Persons Subject to the Tax, Items Taxed, and Tax RateThe persons obligated to pay this tax are the individuals and entities that receive cashdeposits in Mexican or foreign currency in any type of account they hold in any of theinstitutions of the financial system. The cash deposits will be taxed at the rate of 2 percenton the total amount.Cash deposits are considered to be those having such nature according to the GeneralLaw on Negotiable Instruments and Credit Operations (Ley General de Títulos yOperaciones de Crédito, LGTYOC), as well as cash acquisitions in the form of cashier’schecks. However, the LGTYOC only refers to “bank money deposits” consisting of thedeposit of money in Mexican or foreign currency, its ownership being transferred tothe one receiving it, the latter being obligated to return the amount deposited in thesame specie.

Not considered cash deposits and therefore not taxed are deposits received byelectronic transfers, account transfers, negotiable instruments, and other documentsand systems agreed upon by the financial system institutions; thus all transfersthat do not fit under the concept of cash bank deposits alluded to previouslyare excluded.Financial system institutions are those considered as such by the ISR law, among whichare savings and loan companies, banking, insurance and bond institutions, financialgroup holding companies, public bonded warehouses, retirement fund administrators,financial leasing companies, credit unions, popular financial companies, variable rentinvestment companies, debt instrument investment companies, financial factoringcompanies, brokerage firms, money exchange firms, and special purpose financialinstitutions. Mutual fund management companies and investment company stock distributionservices companies will also form part of the financial system.134C H A P T E R V I I6.3. ExemptionsThe IDE will not be paid for the first 25,000.00 pesos (2,296 US dollars) that are receivedduring each month of the fiscal year in one or more accounts of the same account holderin the same financial system institution. On the excess, the tax will be determinedapplying the rate indicated in the above section.As a general rule, the cash deposit will be considered made in favor of the registeredaccount holder. As an exception and by written communication to the financial institution,the account holder can request that the amount of the exemption and of the tax bedistributed among the persons that appear as coholders of the account and in the proportionrequested.6.4. Tax CollectionThe tax corresponding to the cash deposits made during the calendar month will be collectedby the financial institutions themselves on the last day of the correspondingmonth and will be delivered to the Federal Treasury no later than the third business dayfollowing the date of collection.The total amount of the monthly tax will be collected, at the election of the institution,from any of the accounts that the taxpayer has open with it. If time deposits aremade without the depositor having another type of account open, the tax will be collectedby the institution after the due date of any of the time deposits.If the taxpayer’s funds are not sufficient to cover the corresponding tax, the tax orthe balance will be collected when the taxpayer next makes a deposit in the financialinstitution.

The financial institutions must keep the Tax Administration Service (Servicio de AdministraciónTributaria, SAT) duly informed with respect to the taxes not collected for lackof funds or failure of the institution itself. Otherwise they will be jointly and severallyliable with the taxpayer with respect to the uncollected amounts.6.5. Compulsory CollectionIf from the information that the financial institutions provide to the SAT it is found thatthere are tax amounts pending collection, the tax authorities will automatically determinethe corresponding tax liability, give notice to the taxpayer, and grant the taxpayera term of 10 business days to respond, in the understanding that once that periodexpires, the payment and collection of the tax liability plus adjustments for inflation andsurcharges will be ordered.6.6. Crediting, Offsetting, and Refunds (Annual)The IDE paid during the fiscal year can be credited first against the ISR to be paid by thetaxpayer. If the IDE is greater, the difference can be credited against the ISR withheld fromthird parties and, if there is still a difference, it can be offset against the federal taxesowed by the taxpayer pursuant to the Federal Tax Code.If there is still a difference, the taxpayer can request the return of this tax.It is important to specify that the right to a credit will be lost if it is not taken, suchbeing possible with respect to a fiscal year and up to the amount allowed. In addition,the right to a credit is nontransferable with respect to who paid the IDE by either assignmentor merger.135Tax Regime6.7. Crediting, Offsetting and Refunds (Monthly)It is also possible to credit the IDE that has been paid (by collection) in a specific monthagainst the provisional payment of the ISR corresponding to that month.As with the annual tax, if the tax paid in a month is greater than the amount of thecorresponding provisional payment for the ISR, the difference can be credited against theISR withheld from third parties in that month. If there is still a difference, it may be offsetagainst the federal taxes of the taxpayer and, if there is still a balance in the taxpayer’sfavor, the taxpayer may request its refund.In contrast to the case with the fiscal year tax, a refund will only be possible if it is certifiedby a registered public accountant complying with the requirements established bythe SAT according to general rules.

6.8. Crediting Option (Monthly)136C H A P T E R V I ITaxpayers can choose to credit, against the amount of the provisional payment of the ISRcorresponding to a specific month, an amount equivalent to the estimated amount of theIDE that they would pay the following month.Once the amount of the IDE actually paid in the month in question (by collection fromthe financial institutions) is determined, the comparison with the tax credited in thatmonth will be made.Obviously, if the IDE credited was greater than that actually paid, the difference mustbe paid together with the provisional payment of the ISR corresponding to the monthfollowing the one in which it was credited. If such difference exceeds 5 percent or moreof the IDE actually paid, the difference must be paid with adjustments for inflation andsurcharges.If on the other hand, the IDE that is credited is less than the amount actually paid, thedifference can be credited, offset or requested as a refund as explained above.7. Local TaxesAccording to the Political Constitution of the United Mexican States, the Federal Government,the States, and the Federal District have the power to impose or create taxeswithin the scope of their respective jurisdictions.The Federal Government can create taxes exclusively on matters indicated in Article 73of the Constitution, among which are foreign trade and enjoyment and exploitation of thenatural resources of the subsoil and of national waters, as well as on banking institutionsand insurance companies, concessioned public services or those exploited directly by theFederal Government, and in addition, special taxes on electricity, the production and consumptionof processed tobaccos, etc.For their part, the States can, through the legislatures, establish taxes necessary forcovering their budgets, provided that they are not imposed in areas exclusive to the Federationand have not been expressly prohibited in the Constitution.With regard to the Federal District, Article 122 of the Constitution establishes that theCongress of the Union can only legislate in areas that are not expressly conferred on theLegislative Assembly of the Federal District, and the same principle authorizes the Assemblyto approve the taxes necessary to cover its budget.Despite the above, there are areas in which the Federal Government as well as theStates and the Federal District can impose taxes. In order to avoid local and federaltaxes on the same things, the Fiscal Coordination Law was issued, which allows forthe execution of Fiscal Coordination Agreements, in which the states agree not toimpose local taxes on that which the Federal Government has already taxed and the

Federal Government is obliged to grant the states a certain share of the Federal Government’srevenue.Thus, each state legislature can establish different classes of taxes complying with thelimitations described. Some examples of local taxes are: real estate tax, real estate transfertax, tax on local income, tax on public shows, lottery and gambling tax, payroll tax,motor vehicle use and possession tax, and acquisition of used vehicles tax.In this chapter, we will only briefly describe the most common local taxes established inthe state and Federal District laws, on the understanding that while there are significantsimilarities that allow them to be described as a whole, the information contained hereinshould be complemented with the contents of each law. Similarly, the possibility of thestates and the Federal District imposing certain bond taxes without violating the FiscalCoordination Agreements entered into with the Federal Government will be discussed.7.1. Real Estate TaxThis tax is established by the state legislatures or by the Legislative Assembly of the FederalDistrict. In the case of the states, the municipalities within the state will receive therevenues resulting from these taxes.In general terms, the taxable base of the real estate tax is the cadastral value of realestate (land and buildings). Those obligated to pay it can be the owners or even the possessorsof said assets.Each law in particular will indicate specifically the form in which the cadastral valueof the land will be calculated, which may vary depending on whether buildings exist,whether the land is used for residential purposes or some other use, or whether the landis leased or not.As a general rule, the tax is calculated by applying the corresponding rate to the determinedcadastral value, while the range of tax rates is between 0.25 percent and 1.5 percent.The tax so calculated is normally paid bimonthly.Certain land is exempt from the payment of real estate tax, among which is the propertyof foreign governments and property used for diplomatic purposes in the country,in accordance with the Vienna Convention on Diplomatic Relations.137Tax Regime7.2. Payroll Tax or Tax on Remuneration for Services RenderedThere are two different systems regarding the causation of this tax. One indicates thatindividuals and legal entities are obliged to pay this tax when they make, within the territoryof the state or the Federal District, expenditures in cash or in kind as a considerationfor services rendered (wages). Thus, the tax must be paid if the expenditure forsaid concepts is made within the respective territory.

138C H A P T E R V I IThe other system imposes this tax on individuals and legal entities that make expendituresfor such concepts for work carried out within the territory. That is to say, thetax must be paid if the payments come from work provided within the territory. In thislast case, and in the case of outsourcing, normally it is required from individuals andlegal entities that contract with companies domiciled outside the territory of the statethat withholds and delivers the corresponding tax, a situation which should be takeninto account at the time of choosing suppliers.Expenditures consisting of salaries and wages, overtime, premiums and bonuses,remunerations, gratuities, holiday bonuses, employer contributions to a savings fund,etc., are considered within the taxable base of this tax. Obviously, each local code willdetermine the items that are included in the taxable base for purposes of this tax.Normally, the tax is calculated by applying to the taxable base a tax rate of 2 percentand it must be paid by means of a tax return that must be presented by the 17 th of themonth immediately following the month in which the payment is made.7.3. Real Estate Transfer TaxThis is a tax or charge on real estate property and therefore, according to the Constitution,in the case of the states, the municipalities therein will receive the revenues resultingfrom such tax. Individuals and legal entities that purchase real estate situated withinthe territory of a state or the Federal District are obliged to pay this tax. This tax is a levyon whoever purchases land or land with buildings attached. Each code in particular willdefine what concepts are considered a purchase, and it is possible to include other conceptsnot traditionally considered as a purchase.The calculation of the tax is made based on the highest value among the value of thetransaction, the cadastral value, and the value of the appraisal. In some cases, a predeterminedrate is applied to this taxable base, or a rate or percentage which will dependupon the particular state.In general terms, if the transfer of the property is recorded in the public deed beforea Notary Public, the latter is obliged to calculate and pay the respective tax.7.4. Local Income TaxThis tax comes from the resolutions adopted in the National Treasury Convention heldat the end of 2004, where the states and the Federal Government met for the purposeof trying to change the country’s fiscal policy.The objective of this tax is to increase the states’ resources. The states can, therefore,if they think it advisable, impose a local tax on the income of individuals without therebyviolating the fiscal coordination agreements.

Taxable income is income that individuals receive for the provision of professional services,for granting the temporary use or enjoyment of real estate, for the transfer of realestate, or for business activities. In all cases the minimum tax rate is 2 percent and themaximum, 5 percent.Lastly, in order to calculate the taxable base of the tax, the same income and deductionsmust be taken into account as those set out in the ISR Law for income similar toincome contemplated in the cited bond taxes.139Tax Regime

Chart 1.States that Have Fiscal Agreements with Mexico, 2007 1CountryIn ongoingdiscussionDate signedApproved byMexican senateApproved bythe other stateDate decreepublished in OFG 2Argentina 3 Nov. 26, 1997 April 29, 1998 ✓June 19, 1998Aruba 3✓Australia Sep. 9, 2002 Oct. 7, 2003 ✓Dec. 30, 2003140C H A P T E R V I IAustria April 13, 2004 Sep. 28, 2004 ✓Oct. 28, 2004Barbados✓Belgium Nov. 24, 1992 June 1, 1994 ✓June 15, 1994Bermuda 3✓Brazil Sep. 25, 2003 April 1, 2004May 28, 2004Canada April 8, 1991 July 8, 1991 ✓Aug. 15, 1991Canada 6 Mar. 16, 1990 July 8, 1991 ✓Aug. 15, 1991Chile April 17, 1998 Nov. 5, 1998 ✓Dec. 30, 1998China✓__________1Source: Ministry of Treasury and Public Credit, Revenue Subsecretary, Assistant Bureau of InternationalTreaties. This is only a diagram for quick reference. If specific information is required the respective treatyshould be consulted.2Official Federal Gazette.3In order to avoid double taxation in the area of international transport.

Official languages Date entered into force Applicable from Date treaty publishedin OFGSpanish Jan. 15, 2004 Jan. 1, 2005 Mar. 19, 2004Spanish Dec. 31, 2003 Jan. 1, 2004 4 Feb. 13, 2004English July 1, 2004 5Spanish Jan. 1, 2005 Jan. 1, 2006EnglishGermanSpanish Feb. 1, 1997 Jan. 1, 1998 Jan. 6, 1997FrenchDutch141Tax RegimeSpanishPortugueseSpanish May 11, 1992 Jan. 1, 1992 July 17, 1992FrenchEnglishSpanish April 27, 1992 Jan. 1, 1993 July 15, 1992FrenchEnglishSpanish Nov. 12, 1999 Jan. 1, 2000 May 12, 2000__________4With regard to taxes established in accordance with Articles 10 (dividends), 11 (interest), and 12 (fees),concerning the sums paid or offset from this date onwards.5With regard to other taxes.6In the area of Exchange of Information.

States that Have Fiscal Agreements with Mexico, 2007 (continued)CountryIn ongoingdiscussionDate signedApproved byMexican senateApproved bythe other stateDate decreepublished in OFG 2Czech Republic April 4, 2002 Sep. 18, 2002 ✓Nov. 13, 2002Denmark June 11, 1997 Oct. 28, 1997 ✓Nov. 26, 1997142C H A P T E R V I IEcuador July 30, 1992 May 25, 1994 ✓June 15, 1994Finland Feb. 12, 1997 Oct. 28, 1997 ✓Nov. 26, 1997France Nov. 7, 1991 Dec. 18, 1992 ✓Dec. 29, 1992Germany Feb. 23, 1993 May 27, 1993 ✓June 16, 1993Greece April 13, 2004HungaryIceland✓✓Indonesia Sep. 6, 2002 April 29, 2003 ✓June 26, 2003India✓Ireland Oct. 22, 1998 Dec. 14, 1998 ✓Dec. 30, 1998Israel July 20, 1999 April 28, 2000 ✓Aug. 11, 2000__________7Publication of the Table of Errata.8Change to the treaty.

Official languages Date entered into force Applicable from Date treaty publishedin OFGSpanish Dec. 27, 2002 Jan. 1, 2003 Jan. 28, 2003CzechEnglishSpanish Dec. 22, 1997 Jan. 1, 1998 May 27, 1998DanishEnglishSpanish Dec. 13, 2000 Jan. 1, 2001 April 4, 2001143Spanish July 14, 1998 Jan. 1, 1999 Aug. 11, 1999FinnishEnglishSpanish Dec. 31, 1992 Jan. 1, 1993 Mar. 16, 1993FrenchTax RegimeSpanish Dec. 30, 1993 Jan. 1, 1994 Mar. 16, 1994German May 6, 1994 7June 15, 1994 8Spanish Oct. 28, 2004 Jan. 1, 2005IndonesianEnglishSpanish Dec. 31, 1998 Jan. 1, 1999 Aug. 9, 2000EnglishSpanish May 9, 2000 Jan. 1, 2000 Aug. 11, 2000HebrewEnglish

States that Have Fiscal Agreements with Mexico, 2007 (continued)CountryIn ongoingdiscussionDate signedApproved byMexican senateApproved bythe other stateDate decreepublished in OFG 2Italy July 8, 1991 May 25, 1994 ✓June 15, 1994Japan April 9, 1996 April 29, 1996 ✓May 14, 1996144C H A P T E R V I IKorea Oct. 6, 1994 Dec. 16, 1994 ✓Jan. 10, 1995Lebanon✓Luxemburg Feb. 7, 2001 April 25, 2001 ✓June 4, 2001Malaysia✓Netherlands Sep. 27, 1993 June 22, 1994 ✓July 6, 1994Netherlands Antilles 9New ZealandNicaragua✓✓✓Norway Mar. 23, 1995 Nov. 14, 1995 ✓Dec. 20, 1995Panama✓Poland Nov. 30, 1998 April 26, 1999 ✓May 17, 1999Portugal Nov. 11, 1999 April 28, 2000 ✓Oct. 20, 2000__________9In order to avoid double taxation in the area of international transport.

Official languages Date entered into force Applicable from Date treaty publishedin OFGSpanish Mar. 10, 1995 Jan. 1, 1996 Mar. 29, 1995ItalianSpanish Nov. 6, 1996 Jan. 1, 1997 Jan. 6, 1997JapaneseEnglishSpanish Feb. 13, 1995 Jan. 1, 1996 Mar. 16, 1995KoreanEnglish145Spanish Dec. 27, 2001 Jan. 1, 2002 Feb. 6, 2002EnglishFrenchTax RegimeSpanish Oct. 13, 1994 Jan. 1, 1995 Dec. 31, 1994DutchSpanish Jan. 23, 1996 Jan. 1, 1997 Aug. 26, 1996NorwegianSpanish Aug. 28, 2002 Jan. 1, 2003 Oct. 18, 2002PolishEnglishSpanish Jan. 9, 2001 Jan. 1, 2002 April 3, 2001PortugueseEnglish

States that Have Fiscal Agreements with Mexico, 2007 (continued)CountryIn ongoingdiscussionDate signedApproved byMexican senateApproved bythe other stateDate decreepublished in OFG 2Romania July 20, 2000 Oct. 31, 2000 ✓Nov. 28, 2000Russia June 7, 2004 Sep. 28, 2004Oct. 28, 2004146C H A P T E R V I ISingapore Nov. 9, 1994 April 26, 1995 ✓June 13, 1995Slovak RepublicSouth Africa✓✓Spain July 24, 1992 May 27, 1993 ✓June 16, 1993Sweden Sep. 21, 1992 Dec. 15, 1992 ✓Dec. 17, 1992Switzerland Aug. 3, 1993 June 1, 1994 ✓June 15, 1994ThailandUkraine✓✓United Kingdom June 2, 1994 July 6, 1994 ✓July 25, 1994United States Sep. 18, 1992 July 12, 1993 ✓Sep. 8, 1994 11 Jan. 10, 1995Sep. 9, 2002 11 April 29, 2003Aug. 5, 1993 11June 3, 2003 11United States 12 Nov. 9, 1989 Dec. 19, 1989 ✓Sep. 8, 1994 11 Jan. 10, 1990Jan. 10, 1995 11__________Venezuela Feb. 6, 1997 ✓10Entered into force retrospectively.11Modifications to the treaty.

Official languages Date entered into force Applicable from Date treaty publishedin OFGSpanish Aug. 15, 2001 Jan. 1, 2002 Dec. 12, 2001RomanianSpanishRussianEnglishSpanish Sep. 14, 1995 Jan. 1, 1996 –English Aug. 23, 1996147Spanish Oct. 6, 1994 Jan. 1, 1995 Dec. 31, 2004Tax RegimeSpanish Dec. 18, 1992 Jan. 1, 1993 Dec. 10, 1993EnglishSpanish Sep. 8, 1994 Jan. 1, 1995 Oct. 24, 1994FrenchSpanish Dec. 15, 1994 April 1, 1994 10 Mar. 15, 1995EnglishSpanish Dec. 28, 1993 Jan. 1, 1994 Feb. 3, 1994English Oct. 26, 1995 Oct. 26, 1995 Jan. 25, 1996 11July 3, 2003 July 22, 2003 11Spanish Jan. 18, 1990 Jan. 18, 1990 Jan. 23, 1990English Oct. 26, 1995 11 Oct. 26, 1995 Jan. 25, 1996 11__________Spanish12In the area of Exchange of Information.

Chart 2.Retention Rates for Dividends, Interests, and Fees in the DoubleTaxation Treaties Entered Into by Mexico, 2007 1CountriesDividends 2Between companies Portfolio Paid to banks duringthe initial periodAustralia 0% with 10% 15%of the shareholding10% if they come fromor if they are paid by banksor equipment;Belgium 5% with 25% 15% For 5 years, 15%;of the shareholding15% general148C H A P T E R V I ICanada 10% with 25% 15% —of the shareholdingChile 5% with 20% 10% —of the shareholdingCzech Republic10% 10% with exemptionsDenmark 0% with 25% 15% —of the shareholdingEcuador 5% — For 5 years, 15%;15% generalFinland —Exclusively tax residents__________1Source: Ministry of Treasury and Public Credit, Revenue Subsecretary, Technical Management of InternationalTreaties. This is only a diagram for quick reference. If specific information is required the respectivetreaty should be consulted.2Mexico does not tax dividends.

Interests 3Paid to banks duringa later periodbonds/share certificatesor for purchasing machinery15% generalFeesTax applicable Treaty rate of tax Tax applicableby clause M.F.N. 4 by clause M.F.N.— 10% —10%, for 5 years; — 10% —15% generalin certain cases15% general 10% 5 15% 10% 615% general — 15% —— 10% —5% of the net — 10% —amount to banks;15% general149Tax Regime10% to banks; — 10% —15% general10% as well for title — 10% —interests negotiatedin the recognizedstock marketand suppliers;15% general__________3When a general rate is shown, it is applicable for all interests. In some cases there are exemptions.4Clause MFN: Clause of Most Favored Nation.5Apply the 10% rate of the Mexico-United States treaty from January 1, 1994.6Apply the 10% rate of the Mexico-Sweden treaty from January 1, 1993.

Retention Rates for Dividends, Interests, and Fees in the Double Taxation Treaties Entered Intoby Mexico, 2007 (continued)CountriesDividends 2Between companies Portfolio Paid to banks duringthe initial periodFrance Taxed exclusively Taxed exclusively —in the country in the countryof residence of residence5%, 15% 7Germany 5% with 10% 15% For 5 years, 15%;of the shareholding15% general150C H A P T E R V I IIreland 5% with 10% of the 10% —shareholding withthe right to voteIsrael 5%; 10% 10% —with 10% of theshareholding 10Italy 15%—Japan 5% with 25% 15% —of the shareholding 11Korea 0% with 10% 15% For 5 years, 10%of the shareholding__________7Taxed exclusively in place of residence for individuals and companies when those receiving the dividendsis a company whose capital is contained in less than 50 percent of residents of third-party States and contain10 percent or more of the company which distribute them, as long as the company who received thedividends is contained in less than 50 percent by residents in third States. The rate of 15 percent applieswhen the company receiving the dividend is the effective beneficiary of them and contains less than 10 percentof the distributing company.8Apply the rate of 5 percent for interests paid to banks and insurance companies and for the derivatives ofbonds and negotiated titles in the approved stockmarket and 10 percent to the interests paid by banks andsuppliers of the Mexican–United Kingdom Treaty.

Interests 3Paid to banks duringa later periodFeesTax applicable Treaty rate of tax Tax applicableby clause M.F.N. 4 by clause M.F.N.15% general 5%, 10% 8 15% 10% 9To banks and insurance — 10% —and pension funds 10%;15% general5% to banks; — 10% —10% general10% general — 10% —151Tax Regime15% general 10% 15% —10% also to insurance — 10% —companies, for titlesnegotiated in therecognized stockmarket and suppliers;15% general5% to banks; — 10% —10% general__________9A tax rate of 10 percent is applied with the treaty with Sweden from January 1, 1993.10The rate of 10 percent is applicable if the company resident in Israel and the reductions for which they paydividends are subject to a lesser rate than the lowest Israeli business rate.11The rate of 5 percent applies if they have the shareholding at least 6 months before the end of the fiscal year.Taxed exclusively in the country of residence in certain cases.

Retention Rates for Dividends, Interests, and Fees in the Double Taxation Treaties Entered Intoby Mexico, 2007 (continued)CountriesDividends 2Between companies Portfolio Paid to banks duringthe initial periodLuxemburg 5% (in the case 15% —of Luxemburg),8% (in the caseof Mexico) with 10%of the shareholding152C H A P T E R V I INetherlands 5% with 10% 15% For 5 years alsoof the shareholdingto insurance institutionstaxed exclusively in theand for interests comingresidence in the casefrom titles negotiatedof the Netherlandsin a stockmarket,approved 10%;15% generalNorway Taxed only in the 15% 4 years,residence with 25%15% generalof the shareholdingPoland 5% with 25% 15%of the shareholding10% also for insurancederived from titlesstock market;Portugal10%10% generalRomania 10% — 15% generalSingapore Taxed exclusively in the residence—Spain 5% with 25% 15% For 5 years, 15%;of the shareholding15% general__________12A tax rate of 10% is applied following the treaty with Sweden from January 1, 1993.

Interests 3Paid to banks duringa later periodFeesTax applicable Treaty rate of tax Tax applicableby clause M.F.N. 4 by clause M.F.N.10% general — 10% —Also for insurance — 10% —companies and comingfrom titles negotiatedin a stockmarketapproved 5%;10% paid by banksand suppliers;15% general10% to banks; — 10% —15% general153Tax Regimecompanies, and interestsnegotiated in a recognized15% general— 10% —10% general — 10% —15% general — 105% —5% to banks; — 10% —15% general10% to banks; 5% 12 10% —15% general

Retention Rates for Dividends, Interests, and Fees in the Double Taxation Treaties Entered Intoby Mexico, 2007 (continued)CountriesDividends 2Between companies Portfolio Paid to banks duringthe initial periodSweden 5% with 10% 15% For 5 years,of the shareholding15% generalwith the right to voteSwitzerland 5% with 25% 15% For 5 years,of the shareholding15% general154C H A P T E R V I IUnited KingdomOnly taxable in residence10% for the first3 years as well as forinsurance companiesand for interest comingfrom titles negotiatedin a recognized stockmarket;15% generalUnited States 5% with 10% 15% for first 5 years; 10% for the first 5 yearsof the shareholding 10% afterwards as well as for insurancewith right to vote; 6companies and for0% complying with negotiated titles in thecertain requirementsrecognized stock market;by virtue of 2nd15% paid by banksAdditional Protocoland suppliers;15% generalVenezuela 5% of net worth — —

Interests 3Paid to banks duringa later periodFeesTax applicable Treaty rate of tax Tax applicableby clause M.F.N. 4 by clause M.F.N.10% banks; — 10% —15% general10% banks; — 10% —15% generalAlso for the insurance — 10% —institutions and comingfrom titles negotiatedin a recognizedstockmarket at 5%;10% paid by banksand suppliers;15% general155Tax Regime4.9% also to insurance — 10%companies and comingfrom negotiatedbonds recognized;10% paid by banksand suppliers;15% general4.9% of the net worth — 10% —of the interests, in thecase of banks orinsurance companies;10% interestspaid by the bankregarding bond interestor credit titles that areagreed in a recognizedstockmarket;15% general

CHAPTER VIIIForeign Trade andCustoms RegulationsThis chapter gives an overview of the basic regulation of foreign trade in Mexico, aswell as a brief outline of the interaction of the different international agreements thathave an impact on Mexican regulation. The regulation of the manufacturing, maquiladora,and export services industries is also examined and the manner in whichnew rules have been substituted for old ones in an effort to construct a modern regulatorymodel.1571. IntroductionIn very general terms and from a strictly legal point of view, foreign trade can be understoodas the group of rules and regulations governing the commercial exchange of goods,merchandise, and services between residents of two or more countries.As a general rule, the legal regulations regarding foreign trade are a reflection of theeconomic policy each country adopts. In the case of Mexico, foreign trade regulationssolidify the economic policy of commercial openness, which was initiated when Mexicojoined the General Agreement on Tariffs and Trade (GATT).The foreign trade regulations that govern our country are found, primarily, in thePolitical Constitution of the United Mexican States (Constitución Política de los EstadosUnidos Mexicanos), in several federal laws, and in multiple international commercialagreements that Mexico has signed.In relation to such agreements, the Supreme Court of Justice of the Nation (SupremaCorte de Justicia de la Nación, SCJN), the highest judicial body in the country, issued a nonbindingdecision stating that lawfully executed treaties are hierarchically superior to federallaws, which indicates the current importance of the commitments Mexico hasassumed through such instruments.

Foreign trade regulations are also found in numerous administrative decrees that areessentially regulatory and therefore they cannot be contrary to or exceed the aboveindicatedlaws.As can be seen, the topics and sources of foreign trade in Mexico are numerous andprofuse. However, taking into account the purpose of this work, we will limit ourselvesto mentioning briefly certain specific topics that, from our perspective, have particularimportance in relation to the establishment of companies and doing business in thecountry.2. Exchange of Goods158C H A P T E R V I I IThe import and export of goods to and from Mexican territory are subject to the paymentof the general import tax and the general export tax, respectively. In fact, theLaw of the General Import and Export Taxes (Ley de los Impuestos Generales de Importacióny de Exportación, LIGIE) attempts to list, under the form of tariff classifications,all of the possible goods that can be imported or exported and assigns to them a particulartariff.Nevertheless, through numerous international commercial instruments, Mexico hasattempted to facilitate the commercial exchange of goods between its residents and residentsof other countries by the reciprocal granting of tariff benefits, either through preferentialtariffs or percentual preferential tariffs.Thanks to such instruments it is possible to import merchandise into the country byapplying a preferential tariff instead of a general tariff or to export merchandise to othercountries who also have established a preferential tariff law.2.1. Tariff PreferencesIn very general terms, tariff preferences are determined based on the duties that arenegotiated for each product in a free trade agreement, with the understanding that generallysuch duties will be eliminated according to an agreed elimination schedule untilthey reach zero duty, which is a necessary prerequisite for establishing a free trade zone.To date, Mexico has executed 11 free trade agreements with different countries, whichgrant the above-mentioned preferential tariffs. These treaties are:TreatiesPartner countriesPublication in DOFEntry into forceNAFTAUnited Statesand CanadaDecember 20, 1993January 1, 1994FTA-G3ColombiaJanuary 9, 1995January 1, 1995

TreatiesPartner countriesPublication in DOFEntry into forceFTA Mexico–Costa RicaCosta RicaJanuary 10, 1995January 1, 1995FTA Mexico–BoliviaBoliviaJanuary 11, 1995January 1, 1995FTA Mexico–NicaraguaNicaraguaJuly 1, 1998July 1, 1998FTA Mexico–ChileChileJuly 28, 1999August 1, 1999FTAUEMEuropean UnionJune 26, 2000July 1, 2000FTA Mexico–IsraelIsraelJune 28, 2000July 1, 2000FTA Mexico–TNFTA Mexico–AELCFTA Mexico–UruguayAAE Mexico–JapanEl Salvador,Guatemala, and HondurasIceland, Norway,Liechtenstein, andSwitzerlandUruguayJapanMarch 14, 2001June 29, 2001July 14, 2004March 31, 2005March 15, 2001with El Salvador andGuatemala, and June 1,2001 with HondurasJuly 1, 2001July 15, 2004April 1, 2005For merchandise to benefit from the preferential tariffs negotiated in a free trade agreement,it must be merchandise “originating” from one of the countries party to the respectiveagreement.Each of the free trade agreements executed by Mexico indicates the applicable rulesfor determining whether or not merchandise complies with the rules for conferring toit the status of an “originating good.” Therefore, it is not sufficient that merchandisebe sent from one country that is party to a treaty to another for it to be considered an“originating good” and thereby eligible for preferential tariffs.With regard to the origin of the merchandise, the commercial treaties executed byMexico require the direct transshipment of the merchandise in order for it to maintainits character of an originating good. Direct transshipment will exist if the merchandiseis transported without passing through the territory of a country that is notparty to the treaty. It may pass through the territory of one or more non-parties, butthe merchandise must remain under customs control and not undergo further operationsother than unloading, reloading, or any other operation necessary to preserveit in good condition.159Foreign Trade and Customs Regulations

In the case of the free trade agreement executed with the United States of Americanand Canada (NAFTA), the importation of the majority of merchandise to and from Mexico,the United States, and Canada is duty free. In the case of other free trade agreements,the tariff elimination schedules are in the process of being created; it is currently necessaryto verify the status applicable to each particular good at this time.Obviously, in all cases there are certain goods that, due to their strategic importance orother reasons, are not included in the scope of the application of the free trade agreementsexecuted by Mexico, such as hydrocarbons, fuels, and certain agricultural products.2.2. Percentual Preferential Tariffs160C H A P T E R V I I IPercentual preferential tariffs are those that the parties to a trade agreement grant reciprocally.They consist of a percentage reduction of the duties applicable to the importationsfrom other countries. This means that the tariffs applicable to the importation of goodsinto each of the parties will be reduced by the percentage agreed upon with each country.This benefit is not applicable to merchandise that has been expressly excluded.A clear example of a percentual preferential tariff is the regional preferential tariff inArticle 5 of the 1980 Montevideo Treaty, which gave rise to the Latin American IntegrationAssociation (Asociación Latinoamericana de Integración, ALADI). Based on the RegionalAgreement Number 4 and the Second and Third Protocols amending it, the regionalpreferential tariffs are the following: Paraguay (48 percent), Ecuador (40 percent), Cuba(28 percent), Argentina and Brazil (20 percent).Within the ALADI framework, the agreements take the form of a partial reach agreementthat has been executed only between member countries. The tariff benefits are onlyapplicable between those members of ALADI that execute them and with respect to themerchandise expressly included in such agreements. The complementary economicagreements that Mexico has executed with Argentina and Brazil, which contemplate percentualtariff reductions between 50 and 100 percent, have been particularly significant.Finally, some member countries of ALADI, such as Venezuela, Colombia, Chile, Uruguay,and Bolivia, have executed free trade agreements with Mexico that incorporate thetariff preferences agreed to in Regional Agreement Number 4.3. Customs RegulationsThe Customs Law (Ley Aduanera, LAA) regulates the different customs regimes underwhich merchandise can be imported and exported to and from Mexican territory. Eachof these regimes entails various obligations for importers regarding, among other things,the payment of tariffs and levies on imports and compliance with non-tariff regulationsand restrictions.

In this section we will limit ourselves to describing certain particularities of the definitiveimport and export customs regulations, the customs regulation of the temporaryimport of merchandise for return abroad after being used in a process of preparation,transformation, and repair, and the customs regulation of the two types of customshousedeposit: general and automotive.3.1. Definitive Import and Export Customs RegulationsThe definitive import customs regulation consists of the entrance into the country of merchandisefrom abroad that will remain in the country for an unlimited time period. Forits part, the definitive export customs regulation consists of the exit of merchandise fromMexican territory that will remain outside of the country for an unlimited time period.The import and export of merchandise under the definitive customs regulation forimports and exports are subject to the payment of, among other things, the generalimport tax and the general export tax respectively, as well as compliance with the nontariffregulations and restrictions that may be applicable to each specific good.The taxable base of the general import tax is the customs value of the merchandise. Inprincipal, the customs value is the transaction value, consisting of the total price paid bythe importer for purposes of an export sale destined for Mexico. Such price must includecertain items charged to the importer and that are not included in the price paid, suchas the costs of the packaging that, for customs purposes, is considered to form a wholewith the respective merchandise. If there is no export sale or if certain other situationsindicated in the LAA exist, the customs value will be determined according to one of thealternative methods established by the law.In order to calculate the general import tax, the duty or tariff due on merchandise isapplied to the taxable base. The duty or tariff to be applied will be the one indicated inthe LIGIE, unless there is a commercial agreement that allows the application of a tariffbenefit pursuant to the discussion in the above section.The taxable base of the general import tax is the commercial value of the merchandise atthe place of sale. However, the LIGIE does not establish any duty or tariff applicable tothe export of the large majority of goods.The non-tariff regulatory measures and restrictions applicable to imports andexports may consist of permits, maximum quotas, country of origin markets, certifications,countervailing duties, etc. In all cases, the existing measures shall be identifiedbased on the tariff classification established in the LIGIE tariff, according to whicheach good is classified. Apart from the above, the imposition or creation of non-tariffregulatory measures and restrictions on the import and export of merchandise is verylimited in view of the numerous international commitments that Mexico has assumedcommercially.161Foreign Trade and Customs Regulations

3.2. “In Bond” Deposit162C H A P T E R V I I IUnder this regime it is possible to import into the country merchandise from abroad forits storage in publicly bonded warehouses, authorized by the customs authorities forthat purpose. In that regard, once customs clearance of the merchandise is obtained, itmust be sent to and deposited in such a warehouse.When merchandise is cleared under this regime, the general import tax and any applicablecountervailing duties will be quantified, but do not need to be actually paid.The goods imported under this customs regime cannot be subject to processes that alteror change their nature, but they can be subject to preservation, exhibition, hanging ofcommercial identification signs, packaging, examination, demonstration, labeling, andsample-taking. Therefore, this regime can be a viable option when the goods that will beimported into the country do not comply with some necessary requirement for theirimportation under some other customs regime until such requirement is complied with.It should be mentioned that residents abroad can request this regime directly througha customs agent, provided that certain requirements are met regarding the filling out ofthe import declaration, without needing to obtain their registration at the importers registry,which is necessary to import merchandise into the country as a definitive import.The merchandise imported under this regime can also be acquired by residents in Mexicoor abroad, in which case presuming conformance with the public bonded warehouse regime,the buyer will subrogate the rights and obligations applicable to this regime. However, itshould be clarified that the alienation of merchandise under this regime can be subject to thepayment of other taxes, such as the value added tax and the special tax on production andservices, it being considered that there is an alienation of goods within Mexican territory.Merchandise originating from abroad that is in “in bond” deposit can be removed fromthe warehouse in order to be definitively brought into the country, in which case the foreigntrade taxes and other taxes related to the importation will be paid. Such goods mayalso be removed from the warehouse in order to import them as temporary imports forproduction, transformation, or repair. As an exception, the Ministry of Treasury andPublic Credit (Secretaría de Hacienda y Crédito Público, SHCP) can authorize companies ofthe terminal automotive industry to establish specific “in bond” deposits, for the merchandiseto be submitted to a vehicle assembly and manufacturing process. Most of thelarge vehicle assemblers of the country operate under this scheme.3.3. Temporary Import for Production, Transformation, and Repairin Programs to Promote ExportsMexican companies that obtain from the Ministry of the Economy (Secretaría de Economía, SE)an authorization to operate a program under the Decree to Promote the Manufacturing,

Maquiladora, and Export Services Industry (Decreto para el Fomento de la Industria Manufacturera,Maquiladora y de Servicios de Exportación). They can import certain merchandisein order to, among other things, use it in a production process and subsequentlyreturn it abroad. Among the goods that can be imported are fuels, lubricants, containers,packaging, labels, machinery, equipment, tools, instruments, molds, and parts.Under this import customs regime, the merchandise can only remain in the countryfor the time periods expressly authorized by the customs law, which varies according tothe type of merchandise. For example, raw materials, parts, components, fuels, andlubricants can remain in the country for a maximum term of 18 months, while machinery,equipment, and tools can remain in the country for as long as the applicable programis in force.From the customs duties perspective, in this section we will limit ourselves to mentioningthat the temporary import of merchandise consisting of machinery and equipmentwill be subject to the payment of the general import tax. However, the importationof other merchandise, such as raw materials or inputs, will be subject to the payment ofthe general import tax when such is established in the free trade agreements executed byMexico, which treatment is discussed in the following section.Finally, it is important to mention again that the merchandise imported into the countryunder this customs regime must be returned abroad or passed over to another customsregime within the above-indicated time periods. Otherwise, the company operatingunder the program could be subject to several sanctions, among which are the determinationof the omitted taxes, the imposition of fines, and the seizure of the merchandise.Similarly, if the merchandise imported temporarily is not returned in a timely fashion, itsimport could be considered a criminal offense.4. Tariff Treatment Applicable to Companies of the Manufacturing,Maquiladora, and Export Services Industry / Other ProgramsUntil December 31, 2000, the temporary import of any type of merchandise under theTemporary Import Customs Regime for Production, Transformation, or Repair throughthe maquila or PITEX programs were exempt from the general import tax. However, suchexemption was changed as of January 1, 2001, on which date Article 303 of NAFTAentered into force. This article prohibits Mexico from reimbursing or exempting fromcustoms tariffs certain goods that are subsequently exported to the territory of the UnitedStates of America or Canada under tariff deferment programs, among which are themaquila and PITEX programs, and which include the programs under the Decree to Promotethe Manufacturing, Maquiladora, and Export Services Industry.Implicit in Article 303 of NAFTA is the idea of avoiding the inputs or materials not originatingfrom the free trade zone from benefiting from the tariff preferences applicable to163Foreign Trade and Customs Regulations

164C H A P T E R V I I Ia final good produced in Mexico, when such a final good is considered as originating fromMexico. The intention is to prevent companies registered in a program from importinginto the country, temporarily and without payment of tariffs, raw materials not originatingfrom the NAFTA free trade zone to produce a final good which is subsequently exportedto the United States of America or Canada with a preferential tariff treatment.In this manner, the internal law provides a formula to ensure payment of the generalimport tax corresponding to the inputs not originating from the NAFTA zone fromwhich a final product qualifying as an originating good is produced and exported to acountry party to NAFTA with a preferential tariff treatment. The general import tax to bepaid in Mexico corresponding to the inputs that are not originating goods may bedecreased with the tariff to be paid for the importation of the final good into the countryof destination (the United States or Canada). If the import into the country of destinationis exempt, the general import tax to be paid in the country may not bedecreaced.It is important to specify that a provision similar to Article 303 of NAFTA has beenincorporated into other free trade agreements executed by Mexico, as is the case ofthose executed with the European Union and with the States of the European FreeTrade Association. Under such similar provisions, the above-mentioned comments areapplicable.The scenario derived from Article 303 of NAFTA and from similar provisions containedin other treaties does not apply when inputs originating from the same commercial zoneas that of the destination of the final product are imported into the country. They are alsonot applicable when, among other situations, the final product manufactured or assembledin Mexico is exported to a country that has not executed a free trade agreement withMexico, or if such treaty does not expressly provide for its application.Similarly, there will be no disadvantage for companies registered in a program if theytemporarily bring into the country inputs covered by a preferential tariff treatment (forexample, from the European Union) to produce a final good that will be exported to acountry belonging to another free trade zone (for example, United States of America).However, in these situations it must be verified that the importation into the country of thenon-originating input of the same free trade zone is exempt from the general import tax.It is important to clarify that there are certain programs to promote exports thatattempt to reduce the impact of Article 303 of NAFTA and other similar provisions on thenational producers of export merchandise, which programs are mentioned below.4.1. Sectorial Promotion Programs (Programas de Promoción Sectorial, PROSEC)PROSEC are instruments created in order to counteract the effects of Article 303 of NAFTA.They are instruments directed at national producers of certain goods grouped by sectors

that allow them to import machinery and inputs under preferential tariff treatments forexclusive use in the production of such goods. In applying the tariff preferences containedin the PROSEC, the origin of the goods to be imported into the country is irrelevant.In order to import machinery and inputs under a PROSEC, an authorization must beobtained from the Ministry of Economy (Secretaría de Economía, SE), for which it is essentialthat the petitioner be a producer of the goods expressly authorized within each ofthe existing sectors. The following are among the currently existing sectors:a) The electric industry;b) The electronics industry;c) The furniture industry;d) The toy, recreational game, and athletic articles industry;e) The shoe industry;f) The mining and metallurgy industry;g) The capital goods industry;h) The photography industry;i) The agricultural machinery industry;j) Other industries;k) The chemical industry;l) The manufacturers of rubber and plastic industry;m) The iron and steel industry;n) The transportation industry, except the automotive industry sector;o) The paper and cardboard industry;p) The wood industry;q) The fur and leather industry;r) The automotive and auto part industry;s) The textile industry;t) The chocolate, candy, and similar products industry;u) The coffee industry.165Foreign Trade and Customs RegulationsThe companies that operate in a particular sector may only import into the countryunder preferential tariff conditions the goods (machinery, inputs, etc.) whose import isexpressly established and authorized for each sector. Furthermore, the companies thatoperate under a PROSEC can import the merchandise into the country under the permanentor the temporary import customs regime, but in this latter case it will be necessaryin addition to have a program under the Decree to Promote the Manufacturing,Maquiladora, and Export Services Industry.Finally, the duration of each of the programs is one year, to be renewed automaticallywhen the producers present the annual report on the operations carried out under theprogram.

4.2. Rule Eight166C H A P T E R V I I IRule Eight was created as a temporary mechanism to create an exemption from the paymentof the general import tax on certain inputs and raw materials that are not listed inany of the PROSEC, but whose importation is considered necessary for the productiveactivity for one of the sectors mentioned in the above section.The special characteristic of Rule Eight is that the inputs will enter the country classifiedunder a pre-established tariff classification (by sector), different from the classificationthat would normally correspond to each particular input whose tariff is normallyless than the specific one of the raw materials.In terms of the above, Mexican producers can even import into the country essentialparts for production originating from countries that do not belong to a specific freetrade region or zone, lessening the effects of Article 303 of NAFTA and the other abovementionedsimilar provisions.In order to apply Rule Eight, it is necessary to obtain permission from the SE andalready have a PROSEC, since it is a complementary mechanism to the latter. Thus, thePROSEC allows the import of inputs with a preferential tariff treatment, but if an indispensableinput is not enumerated among those authorized by the program, the producercan request its importation under Rule Eight. This rule is temporary, since it isdesigned to be applied until the respective goods can be imported under a PROSEC.It is important to mention that the SE issued a decree that contains the rules to be followedfor the granting of permission to import merchandise under Rule Eight. This isintended to provide legal certainty to the importers such that, if the respective rules arecomplied with, the SE must issue the permissions, thereby eliminating any discretion.5. Other Taxes Associated with the Definitive Importationof Goods into the CountryAs we have mentioned, the importation of goods into the country under the definitiveimport regime is taxed with a general import tax, as explained previously.Nevertheless, the act itself of importing goods into the country under the definitiveimport regime can result in the obligation to pay other taxes, some of which will dependon the specific type of good to be imported. The taxes associated with the definiteimport of goods are the following:5.1. Value Added Tax (VAT)The definitive importation of goods into the country generates the obligation to pay VAT.This is a general tax applied to the importation of all types of goods, except those

expressly excluded in the Value Added Tax Law (Ley del Impuesto al Valor Agregado).Among the goods whose importation is exempt are those whose alienation in Mexicanterritory is exempt from payment of VAT, such as patent medicines, food products, fertilizers,gold, jewelry, books, newspapers, and works of art.As a general rule, the VAT imposed by the definitive import of merchandise into thecountry is calculated applying the rate of 15 percent of the value used for customs purposes.However, VAT can also be calculated applying the rate of 10 percent when itinvolves definitive imports into the area referred to as the border zone (franja fronteriza).The VAT paid for import can be a tax credited against the VAT that the importer transfersto and collects from a third party when the imported merchandise is alienated, providedthat the imported good is considered a deductible good for purposes of theIncome Tax Law (Ley del Impuesto Sobre la Renta).Although we are only discussing definitive importation in this section, it must be mentionedthat the import of merchandise under the temporary importation regime referredto in a previous section is exempt from VAT; therefore, one of the principal advantages tothe companies that operate a program under the Decree to Promote the Manufacturing,Maquiladora and Export Services Industry (Decreto para el Fomento y Operación de laIndustria Manufacturera, Maquiladora y de Servicios de Exportación) is the savings of theVAT paid on the definitive importation, even though it can later be credited or evenrefunded.5.2. Special Tax on Production and Services (Impuesto Especialsobre Producción y Servicios, IEPS)The definitive importation of goods can also result in the obligation to pay the IEPS,which applies only to those goods that are expressly indicated in the respective law.The IEPS must be paid at the time of the definitive importation, together with the generalimport tax that may be applicable. The applicable rate varies depending on the typeof good and oscillates between 25 and 160 percent. Among the goods whose importationinto the country is taxed with this tax are alcoholic beverages and beer, processedtobacco, cigarettes, cigars, gasoline, etc.The IEPS paid upon the importation of goods may also be credited against the IEPS thatis caused by the alienation of the same goods in Mexican territory. Therefore, it is anindirect tax that will affect or be paid by the final consumer.167Foreign Trade and Customs Regulations5.3. Tax on New Automobiles (Impuesto Sobre Automóviles Nuevos, ISAN)The ISAN is paid on the importation of automobiles into the country when it involvespersons other than the manufacturer, assembler, authorized distributor, or dealer in the

vehicle business. Thus, if one of such entities makes the importation, it will not be taxed,while the sale in the country of the imported vehicles will be taxed.To calculate the ISAN to be paid for the importation, the value of the sale (invoice value)is taken into account, which amount will be added to the amount of the general importtax actually paid upon the permanent importation into the country.6. Automotive Industry168C H A P T E R V I I IUnder NAFTA, Mexico agreed to eliminate the Decree for the Promotion and Modernizationof the Automotive Industry (Decreto para el Fomento y Modernización de la IndustriaAutomotriz), no later than January 1, 2004, since this decree was in conflict with the provisionsand principles of NAFTA. It should be mentioned that the decree established,among other things, that only companies of the terminal automotive industry couldimport vehicles into Mexico, provided they had a favorable trade balance and the permitsfor the corresponding importation were obtained from the SE.Therefore, under NAFTA, Mexico cannot apply quantitative regulations, taxes, or restrictionsto protect the domestic automotive industry, and it must grant a no less favorable treatmentto imported vehicles as it does to products of national origin in relation to the sale,offer, purchase, transport, distribution, and use of these products in the internal market.As a consequence of the above, on December 31, 2003 the Decree to Support theCompetitiveness of the Terminal Automotive Industry (Decreto para el Apoyo a la Competitividadde la Industria Automotriz Terminal) was published in the Official FederalGazette, whose purpose was not only to comply with the obligations Mexico assumedunder NAFTA, but also to grant certain additional benefits to the automotive sector, withoutseeming to violate the international agreements executed by the country.Thus, this decree grants advantages to companies as a company that produces lightnew automotive vehicles (a producer company) (empresa productora de vehículos automotoresligeros nuevos: empresa productora) that comply with the requirements establishedin this decree. A producer company would be, for example, a company that hasmanufactured at least 50,000 new automobiles in Mexico and invested at least 100 milliondollars in fixed assets. Another type of producer company would be one thatarmor-plates automobiles in Mexico, thereby increasing the final value of the automobilesmore than 50 percent.Among the benefits granted are that the producer company will be considered a manufacturingcompany (empresa fabricante) for purposes of the automotive custom-housedeposit, the sectorial program of automotive promotion, and other provisions of theCustoms Law. Furthermore, they can import new automobiles in an amount that representsat least 20 percent of the units manufactured in the country the prior year, applyinga zero percent tariff regardless of the origin of the automobile.

CHAPTER IXCommercial Regulation1. Forms of Commercial DistributionIn today’s commercial relations the majority of producers do not sell their products orprovide their services directly to the final users. Between them there are intermediariesthat perform a large variety of functions intended to facilitate and expedite such commercialrelations.In this section the most common forms of commercial intermediation, such as the distributionagreement, the agency, and the franchise, will be described. These forms ofcommercial intermediation, given their purpose, have several characteristics in common,including, to a lesser or greater extent, the management of the interests of others. Furthermore,it is important to mention that while these contracts are not specifically regulatedunder Mexican law, the individual nature of each of them presents particularitiesthat distinguish them and that business persons should be aware of in order to fullyaddress their interests and specific needs.1691.1. DistributionThe distribution agreement is an agreement by which a person called a distributor agreesto acquire and resell the products of another, called the producer or principal, under theresale terms and conditions that the latter imposes.The purpose of the distribution agreement is to regulate relations among producers ormanufacturers and the persons who, under certain resale conditions, will market theirproducts.In contrast to the agency agreement, not merely the interests of others are being managedunder the distribution agreement; rather, the distributor purchases and acquires theproducts in order to resell them on his own behalf to the consumer, under the conditionsthat the distributor himself establishes. The principal is generally a business owner whomanufactures the products contemplated in the contract (although not necessarily). The

170C H A P T E R I Xprincipal may be an importer of the products for a specified period or a distributor whoexecutes subdistribution contracts.Given the purpose of this type of contract, generally the products subject to the distributionagreement are those that can be standardized or produced in a series. Commonlythey are products protected by a trademark.Pricing and the price setting are fundamental elements of the distribution agreement.A distinction must be made between the price that the manufacturer designates for resaleor for the final consumer and the purchase price to be paid by the distributor. Normallythe final price serves as a basis for the price between producer and distributor, which isset with a discount or a rebate. In practice the custom is that the price set by the principalcan vary, due to innumerable circumstances that can directly affect its determination;for example, the purchase volume within a particular period. The principal usuallyperiodically informs its distributors of the new prices and provides them with the pricelists to which the operations will be subject for a specific period.In the event that the location of payment and delivery of the merchandise is not stipulatedin advance, since this type of contract is not expressly regulated under Mexicanlaw, the provisions of the Commerce Code (Código de comercio) applicable to purchasesand sales would be applied or, in their absence, those of the Civil Code (Código Civil).Another aspect of special importance in this type of relationship is the clear and preciseestablishment of resale conditions, which can vary greatly, since they depend on thenature of the products and the agreement between manufacturer and distributor. Theobligation of the distributor to respect the resale conditions is probably what characterizesthe distribution agreement most; this is in view of the fact that the primary interestof the principal is in marketing its products through someone over whom it has sometype of control. These resale conditions can, depending on the characteristics of theproducts involved, refer to aspects such as the resale price, the form and place of collection,post-sale service, warranties, advertising, and manner of trademark use, mannerand place of exhibiting products, repair and maintenance, contribution to the advertisingexpenditures, amount of merchandise, etc.It is common for producers that execute these types of contracts to require exclusivity,as a result of which the distributor cannot compete with or acquire products withcharacteristics similar to those contemplated in the distribution agreement. Underthese exclusivity agreements the distributors are understood to be prohibited not onlyfrom acting as distributors, but also as agents, representatives or intermediaries.The establishment of this exclusivity agreement merits special attention, becausesometimes it can be considered as a violation of the Federal Economic Competition Law(Ley Federal de Competencia Económica) regarding relative monopolistic practices. Toprove that the exclusivity agreement or the distribution agreement itself is a relativemonopolistic practice in violation of the law, it must be shown that the party requiring

exclusivity exercises substantial power in the relevant market. It is considered that thispower exists when the economic agent can fix prices unilaterally in the market or hascertain control over the access of its competitors to the market.Thus it is advisable before executing any distribution agreement that contains anexclusivity clause to study carefully the characteristics of the specific case in order notto fall under this presumption.Commonly these types of contracts include a prohibition on subcontracting withoutthe prior express authorization of the principal. In any case, if subcontracting is permitted,it is usually restricted to the exclusive zone of the distributor.With respect to the termination of the distribution agreement, in practice, given thatit is not a statutorily regulated contract, express clauses known as justified causes of terminationare generally included, which address a large variety of factors. The most usualare the insolvency of one of the parties, late payments, the violation of the exclusivityagreement, the use of a trademark other than those authorized, contracting subdistributorswhen this is prohibited, breach of the resale conditions, etc.Furthermore, the end of the specified term and in some cases the death of one of theparties can also terminate the relationship. In any case, if something is not provided forin the contract, it will be interpreted according to the rules of the statutorily regulatedcontract to which it is most similar.1.2. AgencyThrough an agency agreement a person called the agent agrees to undertake an activityintended to find clients for another party, called the principal, and send to the latter theorders for goods or services whose promotion has been entrusted to the agent.The principal, upon accepting the order, makes the contract that links him directlywith the client; the agent is not party to this contract, but rather an independent intermediary,and his compensation generally consists of a percentage of the price of thetransaction.It is important to emphasize that in these types of contracts the agent is independentof the principal, which is to say that neither is subordinate to the other. If either were,this would be considered an employment relationship governed by labor law. A relationshipis considered employment when the agent depends, in a personal, subordinatedrelationship, on the company he/she represents and on whose behalf he/she acts.The activity of the agent consists of the promotion and wherever possible the conclusionof deals and contracts on behalf of the principal. The scope of the activities of agentsis very broad and will depend on the type of products or services involved. Generally,agents promote purchase and sale agreements. However, the agency agreement caninvolve any type of business.171Commercial Regulation

172C H A P T E R I XIt is important to clearly establish in the contract what the activity of the agent will be;nevertheless, it should be understood that the agent must always act in the best interestsof the principal, and therefore the agent does not have to wait to receive specific instructionsfrom the principal. Rather, the agent must do everything within his/her power topromote and conclude all contracts possible on behalf of the principal. This obligationshould be described in the specific contract provisions establishing the procedures forthe promotion and sale of the products or services, as well as the form in which theorders, prices, and quotations to the client will be made.The payment of compensation or commission to the agent is the principal obligationof the principal. This commission generally consists of a percentage of the value of thetransactions that the agent carries out. In practice, it is understood that the agent willonly be entitled to a commission for concluded transactions; however, compensationcan also be agreed upon for the partial execution of a contract, or a right can be establishedto receive a commission for those contracts that are carried out in the exclusivezone of the agent, whether or not he/she has intervened in such transactions.It is advisable to clearly establish in the contract at what point the agent will earn acommission, whether when the principal receives the order, when the principal invoices,or when the principal receives payment by the client. Another aspect that should be consideredis when the commissions owed are to be paid since, although the agent is entitledto them, a time period is usually established for their payment; furthermore, itshould be stipulated what will happen in the case of returns and cancellations, and whatconsequences they will have on the agent’s commission. In practice, commissions lost asa result of returns or cancellations are offset against the payment of future compensation.The agency contract can be representative—governed by the rules applicable to themandate contract (a power of attorney)—or non-representative. In the first case the agentwill pursue and conclude business on behalf and in representation of the principal, whilein the second case the agent will act on behalf of the principal, but the pursuit and conclusionof the business will always be subject to the approval of the principal.The agency contract frequently contains an exclusivity agreement to which one orboth parties are subject. This agreement refers to the zone or zones in which the agentcan and must carry out his/her activities, as well as those in which the principal cannotpursue or conclude business himself or through anyone other than the agent. Ifthe agent violates the exclusivity agreement, the business concluded outside of his/herzone is valid, since the exclusivity agreement does not bind third parties, but only theprincipal and agent; however, the principal can terminate the agency contract forbreach thereof. If it is the principal that does not respect the exclusivity agreement,the agent will be entitled to receive the commission resulting from the transactionscarried out in his/her zone without his/her involvement, provided this is stipulated inthe contract.

The agent may also subcontract with other agents when subcontracting is allowed forin the principal contract and the subcontract is negotiated with the same terms and conditionsas the original.The expiration of the contract and the revocation or resignation of either the principalor the agent are the primary causes for termination of the agency contract. However, itis advisable to establish conditions in the contract for termination in case of revocationor resignation; for example, with advance notice of a certain period so that such terminationis not unanticipated or untimely and does not give rise to liability of the partyconcluding the contract in this manner.The contract can also establish certain justified causes for its termination, such as insolvencyof the agent, violation of the exclusivity agreement, failure to meet expected targets,subcontracting, etc.Finally, the statutory rules applicable to commission agency contracts or the mandatecan be applied in the absence of contractual provisions to this type of contract.1.3. FranchiseArticle 142 of the Industrial Property Law (Ley de la Propiedad Industrial, LPI) establishes:A franchise will exist when, with the licensing of a trademark, technical knowledge istransmitted or technical assistance is provided so that the person to whom the licenseis granted can produce or sell goods or provide services uniformly and with the operative,commercial, and administrative methods established by the trademark holder,thereby maintaining the quality, prestige, and image of the products or services thatthe mark represents [...].173Commercial RegulationGiven that the franchise agreement is regulated by the above-mentioned law, it cannotbe considered an unregulated contract. However, it should also be mentioned that theabove-cited article does not exhaustively regulate such a contract and, therefore, it isadvisable to establish clearly all the terms of the contract in order to avoid ambiguitieswith respect to its interpretation.Basically, the franchise is the means by which the holder of a trademark (the franchisor)or a specific known commercial designation of goods or services reaches thefinal consumer, through a series of commercial establishments (franchisees) that produceand distribute the product or service of the trademark according to the instructionsand requirements of the franchisor.In practice, there are primarily two types of franchising: product trademark franchising,which contemplates a relationship between supplier and distributor, the latter adoptingcertain characteristics of its supplier, and business format franchising, where the relationship

174C H A P T E R I Xbetween franchisor and franchisee includes a product or a service and a trademark, a marketingsystem, operation manuals, procedures, training programs, advertising support, andguidance for the franchisee during the operation and development of the business.With respect to the geographic area within which the franchisee operates, usually theparties agree to either a unitary franchise, where a franchisee is only entitled to open andoperate one establishment, or a master franchise, where the franchisee has the exclusiveright to open a certain specified or unspecified number of establishments within a specificterritory.The trademark that distinguishes the product or service of the franchise is an essentialelement of the contract. Granting the license to use the trademark is one of the principalobligations of the franchisor, and such a license must be registered with the Mexican IndustrialProperty Institute (Instituto Mexicano de la Propiedad Industrial, IMPI) in order to be validbefore third parties. This is a formal requirement for all franchise agreements in Mexico.This obligation of the franchisor is reciprocal to the obligation of the franchisee to usethe trademark pursuant to the terms and conditions of the license, since otherwise thetrademark can lapse for lack of use.Another essential element of this contract is the transfer of knowledge or technology(know-how) contained in the manuals, procedural guidelines, personnel training, inspections,and in general everything that allows the franchisee to produce the products orprovide the services uniformly, thereby maintaining the quality, prestige, and image of theproducts or services to which the licensed trademark applies. In this type of contract itis very important to achieve homogeneity in the product or service, establishing qualitystandards so that the franchisor can control the quality of the product or service and thusmaintain the prestige of the trademark with its clients.The consideration paid by the franchisor to the franchisee is another aspect that mustbe given specific treatment in the contract. Generally two types of payment are agreedto: an initial payment or fee giving the right to the franchise (franchise fee) and royalties(regalías)—periodic payments that will be determined, primarily, by the type of productthat is sold or the services provided.One of the principal obligations of the franchisee, in addition to using the licensedtrademark, is to comply with the specifications and methods provided by the franchisor.Failure to do so can be a cause for early termination of the contract. Furthermore, thecollaboration of the franchisee with the franchisor regarding the advertising of the productsor services is often agreed upon, since it is understood that such advertising willbenefit both.By nature the franchise agreement is usually long term and the principal cause of itstermination is the expiration of the agreement. However, the contracts often stipulateother forms of termination, such as by an advance notice from one party to the other ofthe termination of the relationship.

In addition, the contract can be terminated early for serious breaches or violations thatshould be clearly stipulated in the contract. These causes may involve the principal obligationsof each party, such as the failure to make periodic payments or the opening ofnew establishments without the franchisor’s consent.These are the most important advantages and disadvantages of the most common commercializationschemes in our country. However, given the great flexibility and dynamicsof this area, it should be emphasized that there are many other forms that could be adaptedto more concrete needs of a business. Thus it is recommended to be open to implementingdifferent forms of doing business that allow the company, in a given instance, tobetter satisfy its interests.175Commercial Regulation

CHAPTER XSpecial Regulationsfor the Sale of Products1. IntroductionThe sale of products is perhaps the most relevant aspect of business. Entrance into themarket and successful product sale is the reason for the existence and growth of business.The ability to enter the market and appeal to the consumer depends largely on theobservance of the rules that are important for and of interest to the consumer.In Mexico, in order to protect its population from uncontrolled trade and consumptionof certain products, numerous requirements have been established in order to safeguardthe well-being of consumers. In this regard, the authorities regulate the activitiesand sale of products in relation to health, the environment, safety to the user or consumer,commercial information, and commercial, industrial, and labor practices.These activities are regulated under the General Health Law (Ley General de Salud,LGS) and its regulations, as well as under the Federal Consumer Protection Law (LeyFederal de Protección al Consumidor), among other laws, and through detailed requirementsthat establish the terminology, classification, instructions, specifications, attributes,characteristics, testing methods, or restrictions applicable to a product, process,or service. This process is carried out through the drafting, issuance, and disseminationof rules that can be of three types: a) official Mexican standards (normas oficialesmexicanas, NOMs), b) Mexican standards, and c) reference standards. Of these threetypes of standards, the most important are the official Mexican standards, because theyare mandatory.The NOMs are mandatory technical regulations issued by the competent standardizationagencies; they establish rules, specifications, attributes, instructions, characteristics,or restrictions applicable to a product, process, installation, system, activity, service, ormethod of production or operation, as well as those regarding terminology, symbols,packaging, branding, or labeling, and those regarding their observance or application.All products, processes, methods, installations, services, or activities must comply with177

the NOMs and products or services to be imported must also comply with the specificationsestablished in such standards.Having explained the above, in the second part of this chapter we will discuss thelabeling and advertising requirements of products to be sold in Mexico. In the third partwe will examine the procedures for opening establishments, processes for productionand importation of products or raw materials, and the sale of the products that are subjectto sanitary regulations.2. Labeling Requirements178C H A P T E R XLabeling requirements vary according to the product. For each category of products thereare labeling NOMs. Thus, food, alcoholic beverages, non-alcoholic beverages, toys, tobacco,textiles, electric devices, beauty products, to only mention a few categories, each have aspecific NOM that applies to them with regard to labeling. 1 Therefore, it would be impossiblein this chapter to cover the labeling requirements for each category of products. 2However, there are other NOMs that contain the general guidelines and minimumrequirements relating to commercial information on products such as those cited below.2.1. NOM-050-SCFI-1994The purpose of NOM-050-SCFI-1994, Información comercial, disposiciones generales para productos(Commercial Information, General Provisions for Products) is to establish the commercialinformation that products manufactured nationally or abroad that are to be sold toconsumers in Mexico must contain and to establish the characteristics of such information.__________1It is easy to find out the labeling requirements and other NOMs that apply to each category of products.The Ministry of Economy has published a NOM catalog with an easy method of consultation.See www.economia-noms.gob.mx.2To illustrate the degree of specificity of the NOMs regarding the labeling of products, we mention the threefollowing examples:• NOM-015/1-SCFI/SSA-1994: safety and commercial information on toys, safety of toys and school articles,limits on bioavailability of metals in items covered with paints and inks, chemical specifications, and testingmethods (seguridad e información comercial en juguetes, seguridad de juguetes y artículos escolares, límitesde biodisponibilidad de metales en artículos recubiertos con pinturas y tintas, especificaciones químicas y métodosde prueba);• NOM-020-SCFI-1997: commercial labeling information for leather and naturally tanned skins and syntheticor artificial materials with that appearance, shoes, Moroccan goods, as well as products made withsuch materials (información comercial-etiquetado de cueros y pieles curtidas naturales y materiales sintéticos oartificiales con esa apariencia, calzado, marroquinería, así como los productos elaborados con dichos materiales);• NOM-139-SCFI-1999: commercial labeling information for natural vanilla extract (vanilla spp), derivatives,and substitutes (información comercial-etiquetado de extracto natural de vainilla (vanilla spp), derivadosy sustitutos).

According to this NOM, the information about the products must be true and describedand presented in such a manner as not to mislead the consumer with respect to thenature and characteristics of the products. The labels must contain at least the followinginformation in Spanish:a) Name and generic name of the product;b) Indication of quantity;c) Name and tax domicile of the manufacturer of the product;d) Country of origin of the product;e) Warnings about hazards in the case of hazardous products;f) Instructions and warranty, if the product so requires;g) When applicable, the date of expiration or preferred use.2.2. NOM-030-SCFI-1993For its part, NOM-030-SCFI-1993, Información comercial, declaración de cantidad en la etiqueta,especificaciones (Commercial Information, Declaration of Quantity on the Label,Specifications), establishes the location and dimensions of the declaration of quantity, aswell as the units of measurement that must be used according to the general system ofunits of measurements and the legends: contents, net contents, and drained mass, asrequired on prepackaged products sold in Mexico.In general terms NOM-030-SCFI-1993 establishes the following:a) Declaration of quantity. The legends contenido (contents) and contenido neto (netcontents) or their abbreviations, cont. and cont. net., should be followed by thequantitative information and the unit corresponding to the magnitude that bestcharacterizes the product, avoiding confusing the consumer;b) Location and dimensions of the information. The legends contenido (contents) andcontenido neto (net contents) or their abbreviations, cont. and cont. net., thequantitative data and unit corresponding to the magnitude that best characterizesthe product involved must be located on the principal exhibition surfaceand must appear free of any other information that minimizes itsimportance, except in the case of drained mass, which must be next to thestatement of net content. The area around the statement of amount must befree of printed information.179Special Regulations for the Sale of Products2.3. NOM-008-SCFI-2002In addition, NOM-008-SCFI-2002, Sistema general de unidades de medida (General Systemof Units of Measure), establishes the definitions, symbols, and writing rules of the unitsof the International System of Units (SI) and other units outside of this system that,

180C H A P T E R Xtogether, constitute the general system of units of measurement used in the differentareas of science, technology, industry, education, and trade. The purpose of this NOM isto establish a unifying language accessible to all sectors of the country.The SI is the first compatible unit measurement system, essentially complete and internationallyharmonized, which facilitates the structuring of the metrological systems ofthe nations that adopt it with the highest level of accuracy.In general terms, NOM-008-SCFI-2002 establishes seven base units of the SI, correspondingto the following magnitudes: longitude, mass, time, intensity of electric current,thermodynamic temperature, candle power, and substance quantity. The unit names are:meter, kilogram, second, ampere, kelvin, candela, and mole, respectively. There is also alarge quantity of derived units that are used in the scientific arena. This NOM establishesmagnitudes, units, symbols, and definitions.The cited NOMs are only an example of the degree of specificity that the officialMexican standards impose on commercial practices of all types engaged in within thecountry, and which must be taken into consideration and complied with in doingbusiness in Mexico.3. Product Advertising RequirementsAmong the legal requirements that apply to the marketing of different products or servicesare requirements related to information about or advertising of such products orservices. These requirements are established in NOMs, in the Federal Consumer ProtectionLaw (Ley Federal de Protección al Consumidor), as well as in the General Health Lawand in its Regulation Regarding Advertising (Reglamento en Materia de Publicidad). Below,the provisions of each of these are described generally.3.1. NOM Product Advertising RequirementsThe fundamental purpose of the NOMs in advertising is to establish rules that requireaccuracy in the information directed to the public in order to prevent practices that harmthe interests of consumers.3.2. Product Advertising Requirements in the FederalConsumer Protection LawFor its part, the Federal Consumer Protection Law establishes that the information oradvertising related to goods or services that are disseminated by any medium must beaccurate, verifiable, and free of texts, dialog, sounds, images, and other descriptions thatmislead or could mislead the consumer as a result of inaccuracy.

In general terms, the Federal Consumer Protection Law also establishes that importedproducts must state their place of origin and any places where they may be repaired, ifapplicable, as well as instructions for their use and corresponding warranties.Information on both domestic and foreign products (on their labels, containers, andpackaging) and advertising for them both must be in Spanish, although it can be in otherlanguages as well. Prices must be given in Mexican pesos.3.3. The General Health Law and Its Regulation Regarding Advertising(Reglamento en Materia de Publicidad)The General Health Law (Ley General de Salud, LGS) regulates and authorizes advertisingreferring to the products and services that fall under its application, such as food, alcoholicand non-alcoholic beverages, tobacco, and everything related to medicines andmedical supplies. 3According to this law, advertising the existence, quality, and characteristics of medicalsupplies, alcoholic beverages, and tobacco, and promoting their use, sale, or consumptiondirectly or indirectly, as well as the products and services specified in theregulation of this law regarding advertising, shall require an authorization of the Ministryof Health (Secretaría de Salud, SSA).The advertising of alcoholic beverages, tobacco, and medicines must comply with severalrequisites and requires the permission of the SSA prior to its publication in the media.The cited provisions reflect, in general terms, the requirements regarding informationabout or advertising of products or services in Mexico.Just as advertising is one of the aspects that must be considered for selling productsor services, the SSA, through the LGS, establishes the sanitary rules for the sale of products,which we will discuss below.4. Sanitary RegulationThe sanitary control of imported and exported products and raw materials is the responsibilityof the SSA. The LGS defines sanitary control as the group of actions of guidance,education, sampling, verification, and, if necessary, application of security measures andsanctions that SSA exercises with the participation of the producers, marketers, and consumers,based on the provisions of the NOMs and other applicable rules.181Special Regulations for the Sale of Products__________3For purposes of the LGS, health products are considered as medicines, psychotropic substances, narcotics, andraw materials and additives that are involved in their preparation, as well as the medical equipment, prosthesis,orthesis, functional aids, diagnostic agents, products for odontological use, surgical material, forhealing and hygienic products.

4.1. General ProvisionsThe exercise of sanitary control established in the LGS is applied to the following areas:a) Processing, 4 importation, and exportation of food, non-alcoholic beverages, alcoholicbeverages, perfumery, beauty and bath products, tobacco, as well as rawmaterials, and, if applicable, additives used in their preparation;b) Processing, use, maintenance, importation, exportation, and final disposal of medicalequipment, prostheses, orthotics, functional aids, diagnostic agents, odontologicuse materials, surgical and healing materials, and hygienic products;c) Processing, use, importation, exportation, application, and final disposal of pesticides,plant nutrients, and substances toxic or hazardous to health, as well as theraw materials used in their preparation.182C H A P T E R XIn particular, four main processes are covered:a) The preparation of products subject to sanitary regulation;b) The authorization for establishments that require a sanitary authorization;c) The authorization for the importation of certain products;d) The authorization for the sale or supply of products.4.2. Product Preparation ProcessThe LGS establishes that the product preparation process must be carried out underhygienic conditions, without adulteration, 5 contamination, 6 or alteration 7 and in accordancewith the provisions of the LGS.__________4For purposes of the LGS, process is understood as the group of activities related to the obtaining, elaboration,manufacture, preparation, conservation, mixing, conditioning, packaging, manipulation, transportation,distribution, storage, and sale or supply to the public of the products referred to by the LGS.5A product is considered adulterated when:a) Its nature or composition do not correspond to what is written on its label, in its advertising, stated whenit is sold or supplied, or when its nature or composition do not correspond to the specifications of itsauthorization;b) It has suffered treatment that conceals its alteration or defects in its processing or in the sanitary qualityof the raw materials used are covered up.6The product or raw material is considered contaminated when it contains microorganisms, hormones, staticbacteria, pesticides, radioactive particles, or foreign matter, as well as any other substance in quantities thatsurpass the permissible limits established by the SSA.7A product or raw material is considered altered when, from the action of any cause, it has suffered modificationsin its intrinsic composition that:a) Reduce it nutritive or therapeutic power;b) Make it unhealthy;c) Modify its characteristics, if they have repercussions on their sanitary quality.

In this respect it should be mentioned that the owner of a product can allow it to beprepared in whole or in part by any manufacturer, provided that the requirements laidout in the LGS and other applicable provisions are complied with.4.3. Sanitary Authorization for EstablishmentsAccording to the LGS, only establishments engaged in the following activities require asanitary authorization:a) The processing of medicines containing narcotics and psychotropic substances;vaccines; toxoids; serums and antitoxins of animal origin and hemo-derivatives;b) The production, manufacture, or preparation of medicines, pesticides, plant nutrients,or toxic or hazardous substances;c) The application of pesticides;d) The use of sources of radiation for medical or diagnostic purposes;e) Establishments that engage in surgical or obstetric activities.Other establishments that do not require a sanitary authorization must only give anoperating notice to the SSA, 8 which is to say that they only need to advise the Ministrythat they have commenced operations and do not need a permit prior to operating.4.4. Importation AuthorizationThe SSA establishes what products or raw materials require an authorization prior toimportation. The products that may require an importation authorization are food, nonalcoholicbeverages, alcoholic beverages, perfumery, beauty and bath products, tobacco,and the materials used in their preparation. The above is determined based on the healthrisks such products may produce.Furthermore, a sanitary authorization issued by the SSA is required for the importationof medicines and their raw materials, medical equipment, prosthesis, orthotics, functionalaids, diagnostic agents, odontologic use materials, surgical, and healing materials andhygienic products specified by the Ministry of Health. Finally, a sanitary authorization of__________8These notices must be filed in writing before the SSA or the governments of the states within 10 days followingthe initiation of operations. They should contain the following information:a) Name and domicile of the individual or entity that owns the establishment;b) Domicile of the establishment where the process is carried out and the date of initiation of operations;c) Processes used and product line or lines;d) Declaration under oath that the requirements and provisions applicable to the establishment have beencomplied with;e) Code of activities of the establishment;f) Professional license number of the person responsible for sanitary matters, if applicable.183Special Regulations for the Sale of Products

the SSA is required for the importation of pesticides, plant nutrients, and toxic or hazardoussubstances that are a health risk.4.5. Authorization for Sale or SupplyMedicines and other health materials, narcotics, psychotropic substances and productsthat contain them, as well as pesticides, fertilizers, and toxic or hazardous substances,must have a sanitary authorization for their sale or supply.The importation of persistent and biocumulative pesticides of any chemical compositionwill only be authorized when they are not a hazard to human health and there is noadequate substitution for them. However, the SSA, by a ruling that will be published inthe Official Federal Gazette, can determine that pesticides and plant nutrients will notrequire a sanitary authorization for their importation.184C H A P T E R X4.6. Other Rules Applicable to Specific ProductsBased on what is established in the LGS in relation to the sanitary regulation of products,the regulation of the following products should be mentioned: health medicines andproducts, alcoholic beverages and tobacco, food and non-alcoholic beverages, and otherproducts also regulated by the LGS.4.6.1. Medicines and health products 9For purposes of the LGS, the following concepts are defined as indicated:a) Medicines. 10 Any substance or mixture of substances of natural or synthetic originthat has a therapeutic, preventive, or rehabilitative effect, that is presented in a pharmaceuticalform, and is identified as such by its pharmacological activity and physical,chemical, and biological properties. When a product contains nutriments,it will be considered as a medicine, provided it is a prepared product containing__________9See the definition of health products in Note 3 of this chapter.10Medicines are classified:By their form of preparation in:a) Magistral. When they are prepared according to the formula prescribed by a doctor;b) Oficinal. When they are prepared according to the rules of the pharmacopoeia of the United MexicanStates;c) Pharmaceutical specialties. When they are prepared with formulae authorized by the SSA in establishmentsof the chemical-pharmaceutical industry.By their nature:a) Allopathic. Any substance or mixture of substances of natural or synthetic origin that has a therapeutic,preventive, or rehabilitative effect that is sold? in pharmaceutical form and is identified as such by itspharmacological activity, physical, chemical, and biological characteristics, and is registered in the pharmacopoeiaof the United Mexican States for allopathic medicines;

individually or in association vitamins, minerals, electrolytes, amino acids, or fattyacids, in concentrations greater than those of natural foods and they are also presentedin a defined pharmaceutical form and the indication of use contemplatestherapeutic, preventive, or rehabilitative effects;b) Farmaco. Any natural, synthetic, or biotechnical substance that has any pharmacologicalactivity and that is identified by its physical, chemical, or biologicalaction properties, that is not presented in a pharmaceutical form, and that meetsconditions to be used as a medicine or ingredient of a medicine;c) Raw material. Substance of any origin that is used for the preparation of natural orsynthetic medicines or farmacos;d) Additive. Any substance that is included in the formulation of a medicine that actsas a vehicle, preservative, or modifier of any of its characteristics to improve its efficacy,safety, stability, appearance, or acceptability;e) Materials. The products necessary for the containing and packaging of medicine.The SSA will only grant authorization for medicines when it is shown that the substancesthey contain meet the safety characteristics required by the LGS.In addition, the LGS establishes that laboratories, as well as deposit and distributionwarehouses, for medical products may only distribute them to establishments that havea sanitary license that certifies them as drug stores or pharmacies authorized to supplyto the public drugs that contain narcotics or psychotropic substances. For the sale ortrade of narcotics in the interior of Mexico, the SSA will set requirements that must besatisfied and issue special acquisition or transfer permits.The LGS classifies establishments that engage in the processing of medical products,including their importation and exportation, in the following manner:a) Factory or laboratory of raw materials engaged in the preparation of medicines orbiological products for human use;b) Factory or laboratory preparing medicine or biological products for human use;c) Factory or laboratory working with herbal remedies;d) Laboratory engaged in chemical, biological, pharmaceutical, or toxicological controlfor the study or testing of medicines and raw materials, or else involved in sanitaryregulation;__________b) Homeopathic. Any substance or mixture of substances of natural or synthetic origin that has a therapeutic,preventive, or rehabilitative effect and that is prepared according to the manufacturing proceduresdescribed in the homeopathic pharmacopoeia of the United Mexican States, in those of other countries,or in other sources of national and international scientific information;c) Herbal. The products prepared with plant material or some derivative thereof, whose principal ingredientis the above-ground or subterranean part of a plant or extracts, as well as juices, resins, oils, andessences, presented in a pharmaceutical form, whose therapeutic efficacy and safety have been confirmedscientifically in the national or international bibliography.185Special Regulations for the Sale of Products

e) Warehouse for conditioning of medicines or biological products and herbal remedies;f) Warehouse for deposit and distribution of medicines or biological products forhuman use, as well as for herbal remedies;g) Warehouse for the deposit and distribution of raw materials for the preparation ofmedicines for human use;h) Drug store: establishment that engages in the preparation and sale of medicinesand the sale of pharmaceutical specialties, including those containing narcoticsand psychotropic substances, and other health products;i) Pharmacy: establishment that engages in the sale of pharmaceutical specialties,including those that contain narcotics and psychotropic substances, health productsin general, and perfumery, beauty, and cleaning products;j) Establishments engaging in the processing of drugs for veterinary use.186C H A P T E R XAccording to the LGS, the persons responsible for sanitary matters at these establishmentsmust be professionals with their academic credentials registered by the competenteducational authorities; they must meet the requirements established in the applicableprovisions; and they will be appointed by the license holders or owners of the establishments,who will give the corresponding notice to the SSA.In cases when the identity, purity, preservation, preparation, dose, or manufacturingof products are affected, by action or omission, the person responsible for sanitary mattersfor the establishment and the owner will be jointly liable for the correspondingpenalties as established in the LGS and the other applicable legal provisions.For health products, the LGS establishes the following definitions:a) Medical equipment. 11 The devices, accessories, and instruments with specific functions:intended for providing medical or surgical attention or for exploratory, diagnostic,treatment, or rehabilitation procedures for patients, as well as those forcarrying out biomedical research activities; 12b) Prosthesis, orthotics, and functional aides. Devices that substitute or complementa function, an organ, or a tissue of the human body;__________11In the case of medical equipment, prosthesis, orthesis, and functional aids, the handling and preservationspecifications shall be stated on the label or in the corresponding manual, with the characteristics indicatedby the SSA.12The processing, use, and maintenance of medical equipment and diagnostic agents involving sources ofradiation must comply with the NOMs issued by the SSA, including in the elimination of the wastes of suchmaterials, without prejudice of the involvement corresponding to other competent authorities. The labelsand counter labels of the equipment and diagnostic agents must also display the legend, “Danger,radioactive material exclusively for medical use,” the indication of the isotopes that contain activity, theirhalf-life and type of radiation they emit, as well as the internationally recognized logo to indicate radioactivematerials.

c) Diagnostic agents. 13 All products, including antigens, antibodies, calibrators, verifiers,reagents, reagent equipment, culture and contrast mediums, and any other similarproducts that can be used as aids for other clinical or paraclinical procedures;d) Odontological Products. All substances or materials used for attention to dental health;e) Surgical and healing materials. The devices or materials that, with or without antisepticsor germicides, are used in surgical practice or in the treatment of continuitysolutions, skin wounds, or related problems;f) Hygiene products. The materials and substances that are applied on the surface ofthe skin or body cavities and that have pharmacological or preventive action.4.6.2. Alcoholic beverages and tobaccoFor purpose of the LGS, alcoholic beverages are considered those that contain ethylic alcoholin a proportion of 2 percent up to 55 percent in volume. Any other substance containinga greater proportion of alcohol cannot be sold as a beverage.The LGS requires that alcoholic beverages show, on their containers, the legend: “Theabusive consumption of this product is harmful to health,” in compliance with therequirements of the LGS and the corresponding NOMs.In the case of tobacco, the LGS provides that the name tobacco refers to the plant NicotinaTabacum and its substitutes, in their natural state or modified, in different forms usedto smoke, chew, or inhale.In addition to what is established in the Mexican official standards, on the labels of thepackages and containers in which tobacco is distributed or supplied, warning labelsmust be displayed clearly and visibly, written in easily readable print with contrastingcolors, stating alternately the following:a) Quitting smoking reduces important health risks;b) Smoking is a cause of cancer, including lung cancer;c) Smoking during pregnancy increases the risk of premature birth and low birthweight in newborns.It is important to include on the label the information that in no case and in no formmay tobacco be supplied to minors.187Special Regulations for the Sale of Products4.6.3. Food and non-alcoholic beveragesa) For purposes of the LGS, food is understood as any substance or product, solid or semisolid,natural or transformed, that provides the body with elements for its nutrition;__________13The labels and counter labels of the diagnostic agents that are used on medical devices or equipment shallcontain the legend: “For exclusive use in clinical laboratories or doctors’ officies.” The indications on theuse in the laboratory or gabinete, the techniques for its use, its form of application, if any, and the warningsfor its use will be detailed in the instructions attached to the product.

) A non-alcoholic beverage is understood as any liquid, natural or transformed, thatprovides to the body elements for its nutrition;c) Raw material. Substance or product of any origin that is used in the preparation offood and non-alcoholic or alcoholic beverages;d) Additive. Any permitted substance that, without having nutritive properties, isincluded in the formulation of food products and that acts as a stabilizer, preservative,or modifier of its organoleptic properties and contributes to its stability,preservation, appearance, or acceptability;e) Food supplements. Products based on herbs, plant extracts, traditional foods, dehydratedor concentrated fruits, with or without added vitamins or minerals, that canbe supplied in pharmaceutical form for the purpose of increasing total diet intake,to complement it, or supplement one of its components. 14188C H A P T E R X4.6.4. Other productsThe LGS also addresses the granting of authorizations for the sale of the following productsand other sanitary regulations applicable thereto: perfumery and beauty, cleaningproducts, pesticides, plant nutrients, and toxic or hazardous substances and biotechnologyproducts.4.6.4.1. Perfumery and beauty productsFor purposes of the LGS, perfumery and beauty products 15 are considered the following:a) Products of any origin, regardless of their physical state, used to change the naturalodor of the human body;b) Products or preparations for external use intended to preserve or improve personalappearance;c) Products or preparations used for personal hygiene;d) Repellants applied directly to the skin.Products to decrease or increase the physical size of parts of the body or to change thebody’s proportions that contain hormones, vitamins, or substances with therapeuticaction in general to which this action is attributed will not be considered beauty productsbut rather medicines and shall be subject to the rules of the LGS applicable to medicines.__________14The SSA will determine which products, including those that are used in special food regimens, can be attributedwith particular nutritive properties, based on their composition. When the Ministry of Health recognizestherapeutic properties in them, they will be considered medicines.Foods or beverages to be sold to the public in circumstances that suggest to the consumer that theproduct has therapeutic properties must include on their labels the legend: “This product has no medicinalproperties.”15No therapeutic action can be attributed to perfumery and beauty products, either in the name, indications,instructions for use, or advertising.

4.6.4.2. Cleaning productsThe LGS considers cleaning products to be soaps, detergents, cleaners, bleach, starchesfor external use, spot removers, disinfectants, deodorants, and air fresheners and othersimilar products specified by the SSA.The labels of the containers and packaging in which the cleaning products are presentedmust comply with the legal labeling requirements established in the applicable NOMs.4.6.4.3. Pesticides, plant nutrients, and toxic or hazardous substancesFor these products the LGS establishes the following definitions:a) Pesticide. Any substance or mixture of substances that is used to control any pest,including the vectors that transmit human and animal diseases, undesirablespecies that cause harm or that interfere with agricultural, livestock, and forestryproduction, as well as defoliant and drying substances;b) Plant nutrient. Any substance or mixture of substances that contain elements usefulfor the nutrition and development of plants, growth regulators, soil enhancers,inoculants, and moisturizers;c) Hazardous substance. Element or composite, or the chemical mixture of both, thathas corrosive, reactive, inflammable, explosive, toxic, bio-infectious, carcinogenic,teratogenic, or mutagenic characteristics;d) Toxic substance. Element or composite, or the chemical mixture of both that, whenby any means of ingestion, whether inhalation, oral ingestion or contact with theskin or mucus, causes adverse effects to the organism, immediately or in the longterm, temporarily or permanently, as functional lesions or genetic, teratogenic,mutagenic, or carcinogenic alterations, or death.The sanitary regulation of these products consists of the authority of the SSA to classifythe products according to the risk they represent to human health; to authorize the saleof the products and establish, in coordination with the competent agencies, the officialMexican standards specifying the conditions that must be complied with to manufacture,formulate, containerize, label, package, store, transport, sell, and apply pesticides, plantnutrients, and toxic or hazardous substances in any phase of their life cycle.The applicable NOMs are those that establish the rules and methods of protection forthe processing, use, and application of pesticides, plant nutrients, and toxic or hazardoussubstances.Labels of the containers of the pesticides, plant nutrients, and toxic or hazardous substancesmust show, clearly and in Spanish, the legend containing the hazards of handlingthe product, its form of use, its antidotes in case of poisoning, the handling of the containerscontaining them or that have contained them, in accordance with the applicablelegal provisions and the rules issued by the SSA.189Special Regulations for the Sale of Products

4.6.4.4. Biotechnological productsThe LGS defines biotechnological products as the food, ingredients, additives, raw materials,health products, pesticides, toxic or hazardous substances, and their wastes, inwhose processing live organisms or parts thereof, modified by traditional technology orgenetic engineering, are involved.Persons who sell these types of products must notify the SSA of all biotechnologicalproducts or their derivatives that are destined for human use or consumption, since thissituation requires special authorization.The above is a general description of the existing sanitary regulations in Mexico. Obviously,depending on the specific activity and products, corresponding specific regulationswould have to be addressed. Therefore, before establishing a business of this nature,we suggest checking all the existing permits, authorizations, and restrictions.190C H A P T E R X

CHAPTER XIFinancing Guarantees1. IntroductionIn Mexico, as in many other parts of the world, various legal instruments are available for thepurpose of securing financing and offering guarantees. The Mexican Civil Code (Código CivilMexicano) basically provides for the surety bond (fianza), the pledge (prenda), and the mortgage(hipoteca) as guarantee contracts. However, another more commonly used instrument isthe trust (fideicomiso), whose flexibility allows it to adapt to multiple commercial situations.In what follows, the essential aspects of each of the above-mentioned legal conceptsare explained.1912. Surety Bond (Fianza)2.1. CharacteristicsThrough the formation of a surety bond contract, a surety institution, which must complywith various requirements and authorizations from the Ministry of Finance andPublic Credit (Secretaría de Hacienda y Crédito Público, SHCP), agrees with a third partyto pay a debtor’s debts in the event the debtor does not do so, in exchange for a feecalled a premium (prima).With the surety bond, the lender of the secured obligation acquires the right to be paidby the surety institution in the event the borrower does not pay its debt. Therefore, thecreditor has the right to demand and receive the payment of the secured obligation directlyfrom the surety institution or from the borrower, or from both, because the suretybond is not extinguished even if the beneficiary refrains from taking legal action againstthe debtor for payment of the principal debt.This type of guarantee is frequently used in legal or administrative matters and, withrespect to the surety bond used to secure financing, the SHCP has issued special rules

192C H A P T E R X Ifor the granting of surety bonds that secure credit operations, some of which are mentionedbelow:a) Surety institutions may only post surety bonds that secure credit operations inthe case of payments derived from transactions involving the purchase and saleof goods and services commercially distributed; payments derived from creditsdocumented in negotiable instruments recorded in the National Registry ofSecurities (Registro Nacional de Valores, RNV); payments derived from financiallease contracts; payments derived from negotiable instrument discounts or factoringcontracts, etc.;b) These surety bonds will be posted only after analysis and approval by the headquarters,branches, or service offices of the surety institution;c) They may only be furnished to legal entities;d) The surety institutions can agree on deductibles with the beneficiary in relation tothe amount secured;e) An insurance policy for damages must first be contracted in favor of the suretyinstitution for the entire period during which the surety bond is in effect, coveringthe goods underlying the security bond, and a life insurance policy covering thedebtor when this party is an individual under the age of 65;f) The duration of the surety bonds must be specified. Their renewal or extensioncannot be automatic and the bonds will be automatically cancelled at the end oftheir agreed-upon term;g) In the case of default on the secured obligation, the beneficiary must suspend theoperations that underlie the surety bond and, if this is not done, new operationswill not be secured unless the surety institution grants its consent in writing.2.2. Requirements for the Formation of a Surety Bond ContractThe surety bond contract must be in writing and must incorporate the correspondingsurety bond policy in the contract itself, which must also meet the requirements indicatedin the Federal Law of Surety Institutions (Ley Federal de Instituciones de Fianzas),such as:a) The names of the beneficiary, debtor, applicant, and surety institution;b) The secured obligation;c) The amount the surety institution will guarantee;d) The term of the surety bond;e) The rights and obligations of the surety institution and the beneficiary.In the event of default, claims must be filed in writing either with the headquarters,branches, or service offices of the surety institution, accompanied by the original

documents that evidence the existence and enforceability of the secured credit, as wellas a report regarding the beneficiary’s efforts to collect payment to that date.3. Pledge3.1. Common Pledge (Prenda ordinaria)3.1.1. CharacteristicsThrough the formation of a pledge contract, the lender is permitted to secure the loanwith one or more goods, regarding which it has a right of preference superior to otherlenders of the same debtor. The pledge is an interest in specific property (right in rem)over a moveable and alienable good used to secure compliance with an obligation andpreference in the payment thereof.The pledge is, therefore, an ancillary contract whose only purpose is to secure for thelender the performance of an obligation owed to the lender and preference in the paymentthereof. Traditionally, through the pledge, the debtor or third-party guarantor forfeitspossession of the goods given in guarantee; however (as the next section willshow), it is possible to avoid this in the case of a non-possessory pledge (prenda sintransmisión de posesión), in which the debtor remains in possession of the goods and hasthem at his disposal.3.1.2. Material object of the commercial pledgeAny alienable moveable good can be the material object of a pledge, including machinery,equipment, negotiable instruments, stocks, bonds, securities, title to merchandise,etc., all of which can be the property of the debtor or a third party, who must have titleto or adequate authority to dispose of such goods.193Financing Guarantees3.1.3. Requirements for the formation of a commercial pledgeThe manner of perfecting the pledge varies depending on the goods that are to serve ascollateral. For example:a) Goods or negotiable instruments payable to bearer:i) By tendering these goods or instruments;ii) By depositing them with a third party designated by both parties and placingthem at the disposal of the lender;iii) By depositing them at the disposal of the lender in locations to which the latterhas the key, even if the facility may be the property of the debtor;b) Negotiable instruments payable to the order of a specified person, with endorsementto the lender and, if applicable, the endorsement and the correspondingnotation in the issuer’s records;

194C H A P T E R X Ic) Non-negotiable loan, by tendering the instrument or document recording the loan;d) Instruments representing merchandise, by tendering and endorsing said instruments;e) Pledge bond (a special type of negotiable instrument), by issuing or endorsing thepledge bond;f) Machinery, equipment, and corporate assets, in the case of fixed-asset loans or workingcapital loans, by registering the instrument in the Commercial Registry (Registrode Comercio), with the debtor remaining in possession of the pledged goods;g) A loan for the acquisition of durable goods, by tendering the bill for the goods tothe lender (a credit institution) who acknowledges the ownership of the acquiredproperty, with the respective annotation. In this case, the property remains in thepossession of the debtor as a depositary;h) Accounts receivable, by making an annotation in the corresponding contract thatthe loans pledged have been specified in the notes or respective records and that thelatter have been transcribed by the credit institution into a special book.In any case, the pledge is a formal contract that must be in writing. Where the writingis not notarized, it should be memorialized in two identical documents. The pledgewill not be enforceable against third parties until the date of its formation is made officialby recording, by public instrument (notarization), or by some other reliable means.In addition, the Securities Market Law (Ley del Mercado de Valores) provides for a securitiespledge to secure the performance of transactions by brokerage firms with or onbehalf of their clients by entering into a Securities Pledge Agreement (Contrato de PrendaBursátil) without requiring for its formation the endorsement and material delivery ofthe securities nor an annotation in the securities issuer’s records. The parties can agreein the Securities Pledge Agreements to the sale of the securities given as collateral, providedthat the relevant provisions of the Securities Market Law are complied with.Also, with respect to the formation of some special types of pledges, the documentsrecording them must be registered in the public registries in order to be enforceableagainst third parties. For example: pledges based on fixed asset loans or working capitalloans must be registered in the Public Registry of Commerce; and pledges on maritimeor aeronautical assets must be registered in the National Public Maritime Registry (RegistroPúblico Marítimo Nacional) or the Mexican Aeronautical Registry (Registro AeronáuticoMexicano) respectively.3.1.4. Foreclosure of a pledgeIf the debtor defaults on the secured obligation, the lender cannot take title to thepledged goods or instruments without the express consent of the debtor, manifested inwriting subsequent to the formation of the pledge.

Consequently, when the secured obligation becomes payable, the lender may requestthat a judge authorize the sale of the pledged goods or instruments and the proceeds of thesale must be preserved as a security interest by the lender, in lieu of the goods or instrumentssold.Also, the lender may sell the pledged goods when their value declines to the point thatthey will be insufficient to cover the debt plus an additional 20 percent thereof, or whenthe debtor fails to provide in a timely manner the necessary funds to cover the installmentpayments that must be made on the pledged instruments.This, because the pledgee, in addition to being obligated to protect and conserve thepledged goods or instruments, must exercise all the rights intrinsic to them. The debtoris responsible for the relevant expenses, and therefore if the debtor fails to cover saidexpenses in a timely manner, the goods or instruments can be sold.3.2. Non-possessory Pledge or Registered Pledge3.2.1. CharacteristicsThis pledge is based on fixed-asset loans, working capital loans, or on accounts receivablethat are not conveyed to the pledgee, but rather remain in the power of the party grantingthe guarantee, who is considered a legal depository of the assets or instruments offered as aguarantee, as well as all other cases provided in the General Law of Negotiable Instrumentsand Credit Operations (Ley General de Títulos y Operaciones de Crédito, LGTYOC) in whichparties seek to secure an obligation and preference in payment relative to other lenders,where the debtor remains in material possession of the pledged goods. In exceptionalcases, the parties can agree that the lender or a third party take possession of such goods.This type of special pledge can be used to secure any obligation regardless of thedebtor’s principal activity, including future obligations. However, in this case the guaranteecan only be foreclosed when the underlying obligation is due and payable.It is worth mentioning that the amount of the guarantee can be an amount determinedat the time the guarantee is granted or at the time of its foreclosure. The guarantee mustbe recorded in the registry, even when the maximum amount guaranteed has not beendetermined.Along with the above, the guarantee includes, unless otherwise agreed, the ordinaryand past due interest and penalties stipulated in the respective contract and the costsincurred in the process of foreclosing on the pledge.195Financing Guarantees3.2.2. Material object of the non-possessory pledgeAll types of rights and moveable goods can be the material object of the non-possessory pledge.These rights or goods must be identified, unless all of the debtor’s goods used in carryingout its primary activity are being pledged, in which case a generic description will suffice.

Therefore, the following may be pledged through a non-possessory pledge: thedebtor’s goods and rights as they exist at the time of granting the pledge, includingindustrial property rights; the rights and goods the debtor may acquire after the pledge’sformation; the fruits or products pending or already obtained; the goods and rights thatthe debtor receives or has the right to receive as payment for the alienation to third partiesof the pledged property or as payment of an indemnity in the case of damage ordestruction of said property.One unique characteristic of this type of guarantee is that the debtor, unless otherwiseagreed, has the right to use the pledged goods, as well as combine them with other goodsand use them in the manufacture of other goods, as long as the value of the guarantee isnot reduced and the product thereof becomes part of the pledged property, and toreceive and use the fruits and products of the pledged goods.196C H A P T E R X I3.2.3. Requirements for the formation of the non-possessory pledgeThe non-possessory pledge must be in writing, and if the value of the pledged goods isequal to or more than 250,000 investment units (a financial measurement unit), the partiesmust ratify their signatures before a certifying public official.When executing the non-possessory pledge contract, the parties must also agree onthe place or places where the pledged goods are to be located; the minimum considerationthat the debtor should receive from purchaser from the sale or transfer of the goods;the characteristics or categories that allow for the identification of the person or personsto whom the debtor can sell or transfer the goods, as well as the destination of themoney, goods, or rights obtained from the sale; and the information that the debtor mustdisclose to the lender with respect to the transformation, sale, or transfer of the goods.The debtor’s noncompliance with these stipulations will trigger the acceleration of theloan’s maturity date.The pledge, its extinguishment, modification, transfer, and preference take effectagainst third parties as of its registration in the registry. The registered non-possessorypledge has priority over unsecured loans, credit supported by an unrecorded guaranteein real property, and unrecorded pre-existing judicial liens and grants the lender theright to receive the principal and interest of its loan from the product of the pledgedgoods, with the absolute exclusion of the debtor’s other lenders, except for preferencesgranted by other laws, such as the Federal Labor Law.3.2.4. Foreclosing on the non-possessory pledgeThe Commerce Code provides for two types of foreclosure procedures for goods pledgedthrough the non-possessory pledge: the extra-judicial procedure and the judicial procedure.a) The purpose of the extra-judicial procedure (ex judiciae) is both to secure the paymentof past due credit and to obtain possession of the pledged goods. The

equirements for this process are the following: that there is no dispute and thatthere is an agreement between the parties, which is to say that the debtor mustagree to tender the pledged goods to satisfy its debt.This process begins with the lender’s formal petition for the debtor’s forfeiture ofpossession of the pledged goods made before a certifying public official. Once possessionis transferred to the lender, the lender becomes the legal depository of thegoods for the entire time that transpires from the deposit of the goods until their sale;b) The purpose of the judicial procedure (judiciae) is to secure the payment of a specific,liquid, and payable credit and to obtain the material possession of the goodsthat secure the credit through a non-possessory pledge on the condition that thecredit must be memorialized in a public (notarized) or private document and thatthe credit is payable under the agreed terms or in accordance with the provisionsof the General Law of Negotiable Instruments and Credit Operations and otherapplicable laws.When the lender sues to foreclose judicially, the suit documents should includethe relevant contract and a declaration of the debt balance and, if the lender is acredit institution, a certification of the debt balance.4. Working Capital LoansThis type of credit is distinguished from other types by virtue of the specific purpose forwhich the debtor is obligated to use the loan proceeds, since the debtor is obligated toinvest the loan in the acquisition of raw materials and the payment of direct labor services,as well as in the purchase of goods and services that are immediately related to theproduction process.Although this type of credit is not exclusive to credit institutions, these are the institutionswho generally offer these loans and who must make sure that the loan proceeds areused for the purposes outlined in the contract, because if it is shown that the loan wasnot used for such purposes due to the bank’s negligence, the latter will lose the privilegesof automatic and privileged guarantee that the lender enjoys in these contracts. Therefore,working capital loans, duly registered, will be paid preferentially relative to fixed assetloans, and both of these preferentially relative to subsequently recorded mortgages.197Financing Guarantees4.1. GuaranteesAs a general rule, the guarantees of the loans at issue are based on the goods acquiredwith the borrowed money; therefore, the working capital loan will be guaranteed withthe raw materials and materials acquired and with the products or benefits generatedfrom the loan, even when these may be future or pending.

Notwithstanding, guarantees can be outlined in the contract, in addition to thoseexisting by mere effect of the contract, such as a pledge, a mortgage, or a guaranty trust.In this regard, it is very important to establish clearly in the contract the goods uponwhich the security interest will be created. The pledge can be made by the person whomanages the business whose development is the object of the credit, even if the person isnot the owner, unless the contract is recorded in the corresponding property, agriculturalcredit, mining, or commerce registries, and the company has reserved the right to permitthe formation of the pledge in the given registry. In addition, the pledged goods can remainin the possession of the debtor, who, for the purposes of civil and criminal liability, will beconsidered as a legal depository of the goods over which the pledge was formed.Furthermore, this type of credit allows the borrower to issue a promissory note eachtime that the borrower uses part or all of the money loaned by the bank, as long as thenotes are issued with maturity dates prior to that of the loan contract.198C H A P T E R X I4.2. Formation RequirementsWorking capital loan contracts must be formed through a policy executed before a commercialnotary public (corredor público), in a notarized public instrument or in a privatecontract signed in triplicate and with a ratification of signatures before a certifying publicofficial, thereby acquiring title effects.In order to be enforceable against third parties, these loans must be recorded in thePublic Registry of Property or in the Public Registry of Commerce when the security interestis not over real estate. Moreover, the contract should clearly state the purpose forwhich the credit will be used, the goods over which the security interest will be placed,the duration of the credit, and the form in which the debtor will be able to make use ofthe loan amount. Finally, it must be remembered that once the requirements related to itsgranting are met, the fixed-asset loan or working capital loan contract will be an executoryinstrument, enforcement of which will be via summary proceedings. However, bankscan pursue payment via this method or they can elect to foreclose on the property placedin guarantee in accordance with the terms provided in the General Law of NegotiableInstruments and Credit Operations for the foreclosure of a commercial pledge.5. Mortgage5.1. Real Property MortgageThrough the formation of a mortgage contract, the mortgagor, who can be the debtor ora third party, creates a right in rem over one or more specific properties in favor of alender, without surrendering these properties, so that the lender may satisfy the payment

of its loan through these properties in the event that the debtor fails to pay his debt arisingfrom a prior principal obligation.The principal virtue of the mortgage contract is that it gives the debtor the possibilityof acquiring financing and guaranteeing payment with property (generally real estate)that is not transferred to the lender, and therefore the mortgagor will be able to use andenjoy the property in the development of its commercial or industrial activities.The above is possible because the mortgage applies to certain types of property, suchas real estate, maritime vessels, or industrial plants that cannot be hidden, as can occurwith moveable property, which is why the mortgage constitutes a reliable guarantee,in spite of the fact that the property remains in the hands of the debtor, and eventhough the debtor may use, enjoy, or even alienate the mortgaged goods because, aspreviously mentioned, the mortgage is a right in rem over the mortgaged property bywhich the mortgagee can enforce the credit regardless of whose hands the property isfound in.5.1.1. General characteristicsa) Only someone with the right to alienate property can mortgage that property,whether that person is the property’s owner or someone that has been grantedpowers of an owner or has judicial authorization to do so, this being an act of ownershipand not of administration;b) Equally, only alienable property can be mortgaged, and it must also be specificallyidentified;c) Although a mortgage is an accessory contract that is extinguished with the terminationof the principal contract, if the guaranteed obligation is only reduced, theoriginal mortgage will still remain in full force;d) A mortgage can be validly formed over two or more pieces of real property, but inthis case it is obligatory to establish in the contract what portion of the credit willcorrespond to each of the properties. Moreover, the same property can be mortgagedtwice, which would invalidate any pact not to make any subsequent mortgages;e) There are certain types of property that cannot be mortgaged and others that areunderstood to be included in the mortgage, although such inclusion is not express,and other types that are understood to be excluded unless otherwise agreed. Propertythat cannot be mortgaged includes the rents and profits yet to be obtained,moveable objects permanently located in buildings, property subject to a lawsuit, etc.Property that is understood as included is the natural accretions to the mortgagedproperty, improvements made by the owner on the property, new buildings constructedon the mortgaged property, etc. Unless otherwise agreed, industrial profitsstemming from the mortgaged property and any outstanding rents at the time ofenforcement of the secured obligation will not be considered part of the mortgage.199Financing Guarantees

5.1.2. Formalities and registration of the mortgageThe formalities of the mortgage contract follow the same rules as those for a purchaseand sale contract. Therefore, it must be granted in a public (notarized) instrument if thereal property is valued at more than the equivalent of 365 days worth of the general minimumwage. Moreover, in order for the mortgage to be enforceable against third parties,it must be recorded in the Public Registry of Property with jurisdiction in the location ofthe mortgaged property.Furthermore, as we will see in the following sections, there are some types of specialmortgages that will require the observance of different formalities or recordation in otherregistries, depending on the persons entering into the contracts or on the property beingmortgaged.200C H A P T E R X I5.1.3. ForeclosureAs was previously mentioned, in the event of default on the obligation secured by themortgage, the lender will have the right to be paid with the value of the mortgaged propertyin accordance with the priority in payment established by law. Therefore, saidlender will have the right to sell the mortgaged item and apply the necessary part of thesale price obtained to the payment of the debt.The mortgage foreclosure can be carried out judicially or extra-judicially. Likewise, theparties can contractually agree in the contract that the mortgaged property will be forfeitedto the lender at the price that will be determined at the time the lender demandspayment of the debt, as opposed to when the mortgage is taken out, with the understandingthat such agreement cannot adversely affect the rights of third parties.It is important to emphasize that in the event of default, the lender does not itself havethe right to foreclose nor does the lender acquire the mortgaged property upon suchdefault; rather the lender must pursue the civil or mercantile legal actions appropriatefor foreclosing on the debtor’s property.5.1.4. Priority in payment of mortgagesAlthough mortgagees, just as pledgees, have a preferential right to be paid with the proceedsfrom the sale of the encumbered property, it is worth mentioning that under applicableMexican law, some loans must be paid before others. Thus, for example, employeesdo not need to join a bankruptcy proceeding to make a claim for salaries or wagesaccrued from the previous year or for severance indemnifications. Also, fiscal debts arisingfrom taxes will be paid preferentially with the proceeds of the property from whichthe debt derives.Special mortgages also have different priorities in payment, which will be discussed inthe following sections.

5.2. Special Mortgages5.2.1. IndustrialThese mortgages are created over an entire unit of an industrial, agricultural, ranching,mining, forestry, commercial, or service enterprise in favor of a credit institution. Sucha guarantee includes and encompasses any applicable authorization or concession, aswell as all of the real or personal property used in the mortgaged property’s exploitation,considered as a single unit.This type of mortgage is generally formed in order to guarantee fixed-asset loans,which the borrower is obligated to invest in the purchase or installation of machinery,or in the construction of projects or works that are necessary for the development of theborrower’s business, or for the purchase of real or personal property. These loans areguaranteed either as a group or individually with the assets of the company to whosedevelopment the loan funds are destined.One fundamental characteristic of this type of guarantee is that, with the exception ofcreditors having title over property in possession of a borrower undergoing bankruptcyproceedings and previously recorded mortgages, the lender will have a priority in thepayment of its debt with the product of the encumbered property superior to any rightsother lenders may have.An industrial mortgage should be identified as such in the fixed-asset loan contract,which shall be granted in a private (unnotarized) document signed in triplicate, beforetwo witnesses, ratified before an authority of the Public Registry and recorded in thePublic Registry of Property of the jurisdiction in which the property is located, at whichpoint the contract will be enforceable against third parties. When the fixed-asset loanis granted by a credit institution, the parties will be entitled to enter into this contractin a sealed writing executed before a commercial notary public, in a public instrument,or a private document, in the latter case signed in triplicate and ratified before a certifyingpublic official.201Financing Guarantees5.2.2. Ships and aircraftThe maritime mortgage is a contract through which the owner of a vessel or naval structureconstructed or in the process of construction constitutes an in rem right in favor ofthe lender in order to guarantee payment of an obligation with the proceeds from thesale of said property, with a priority in payment superior to all other lenders, accept forcertain preferences specific to maritime law.Maritime vessels are the collateral of this security interest in property, which is to sayall constructions used to navigate, regardless of their type and dimensions, as well asnaval structures, which include floating or fixed constructions that do not navigate butcarry out in the water functions complementary or auxiliary to maritime, river-bound,

202C H A P T E R X Ior lake-bound activities or exploratory or natural resource exploration activities,including fixed platforms, except for port facilities.It is worth mentioning that, in the event of loss or serious deterioration of the vessel ornaval structure, the mortgagee can foreclose on the derelict property, that is, on the vesselsor naval structures that are unnavigable, the provisions and cargo, machinery, anchors, andthe remains of the vessels, as well as the merchandise thrown or fallen into the sea.The mortgage must be recorded in a document authorized before a certifying public officialeither in Mexico or abroad, which should be noted in the vessel’s registry and registeredin the National Public Maritime Registry in order to be enforceable against third parties.One important difference between a mortgage on maritime vessels and a civil mortgage isin the order of priority, since the lender of the maritime mortgage is subordinated to thecredits considered as maritime privileges, such as wages owed to the crew, repatriation costs,and contributions to the crew’s social security payments, debts payable by the vessel, etc.It is also important to point out that the statute of limitations to foreclose on a maritimemortgage terminates three years after the expiration of the secured loan.It is also possible to enter into mortgage agreements over aircrafts, which must containa description of the aircraft and equipment being mortgaged and indicate the nationalityand identification number, the name of the manufacturer, and the serial number. In theevent that a person who has a concession or right to provide air transportation servicesseeks to mortgage an aircraft, such person must request an authorization from the Ministryof Transportation and Communications (Secretaría de Comunicaciones y Transportes).All aircraft mortgages must be recorded in the craft’s registry and in the Mexican AeronauticalRegistry, which will be effective with respect to third parties beginning on thedate of such recordation. A copy of each recordation shall be sent to the Public Registryof Property.Tax obligations, debts derived from the salvaging of an aircraft, and debts stemmingfrom extraordinary expenses indispensable for the aircraft’s upkeep, have priority overmortgages.6. Trusts6.1. CharacteristicsThrough the trust agreement, the trustor transfers ownership or title over one or moregoods or rights to a fiduciary institution for the purpose of guaranteeing to the beneficiarycompliance with an obligation and priority in the payment thereof.The trust is a contract that involves three principal parties: a trustor, who generallyis also the debtor, who transfers the ownership of goods to a fiduciary institution, abank, or another authorized institution, so that if the trustor debtor or a third party fails

to perform its contractual duties, the institution proceeds to effect the sale of the goodsto satisfy the agreed compensation owed to the beneficiary.The guaranty trust is generally used to guaranty payment of loans; however, it is alsouseful in guaranteeing other obligations such as the timely delivery of merchandise, thecompletion of a public work without defects, the return of securities subject to repurchaseagreements, etc. Also, it is frequently used as a guaranty in the construction oflarge infrastructure projects such as industrial plants, highways, and stadiums, as well asin loans granted by foreign credit institutions.One of the principal characteristics of this type of guaranty is the fact that in theevent that the debtor fails to comply with its obligation according to the stipulatedconditions and time period, the trustee will be able to foreclose on the trust uponproving noncompliance and without the need to involve any judicial authorities to suefor foreclosure.6.2. The Trust Res or Trust PropertyThe property conveyed in trust can be real or personal and, if personal, the parties canagree that said property held in trust can be utilized or employed in the production ofother goods, as long as its value is not reduced and such produced goods become partof the trust in question.The parties can agree that the trustor or a third party will remain in possession of theproperty held in trust, who will act as depository, and therefore will be responsible forany loss, damage, or deterioration the property may suffer.203Financing Guarantees6.3. Requirements for FormationThe trust’s formation must always be recorded in writing, and when the property is realestate, the trust must be registered in the Public Registry of Property in the jurisdictionin which the property is found. At the date the trust is recorded, it will become enforceableagainst third parties. When the guaranty trust involves personal property and itsvalue is equal to or greater than 250,000 investment units valued in Mexican pesos, thecontract signatures must be ratified before a certifying public official.6.4. ForeclosureAs was mentioned in previous sections, the guaranty trust allows the parties to determinethe manner in which the fiduciary institution may proceed extra-judicially to sellthe trust property in the event that the debtor fails to comply with its obligations, as longas the following is agreed to:

a) That the trustee can only begin the extra-judicial foreclosure process when itreceives a written petition from the beneficiary requesting such action, and thenature of the debtor’s noncompliance is specifically stated;b) That the trustee must notify the trustors of the petition, and the latter may onlychallenge the foreclosure if they tender payment of the debt, prove their compliancewith the obligation, or provide documentation that proves an extension of thepayment period.204C H A P T E R X IThe document containing the extra-judicial foreclosure agreement must be includedin a special section of the guaranty trust, which must have the signature of the trustor inaddition to the his signature on the trust agreement. If the extra-judicial foreclosure isnot expressly agreed, the procedures dictated by the Commerce Code must be followed.Although the protection provided by guaranteeing obligations through a trust agreementoffers various advantages in relation to other types of guaranties given that in thetrust the goods are no longer owned and possessed by the debtor, thereby allowing fora much larger and more ideal range of legal action in an innumerable amount of transactions,it must be kept in mind that the formation of this type of guaranty involves significantoutlays in notary fees and administrative costs, which may render the trust apoor option in some cases.

CHAPTER XIIIndustrial Property1. IntroductionWithout doubt some of the most important assets of companies today are their patents, 205trademarks, slogans, and, in general, the intangible goods that serve to differentiate andsell their products under highly competitive market conditions. In Mexico, together withthe commercial opening of the country and the liberalization of the economy, there hasbeen a significant legal evolution to protect these intangibles, in order that companiesmay invest in our country without fear of being deprived of such goods by third partiesthat attempt to take advantage of their prestige and technological developments. Below,the current regulation of this area is explained.2. Creations with Industrial Application2.1. Invention PatentsAn invention is any human creation that permits the transformation of matter or energythat exists in nature for its use by humans and for the satisfaction of their concrete needs(specifically, inventions are industrial products, processes conceived for their productionor use, and apparatuses regarding their application).The patent, for its part, is the document issued by the State to record the exclusive 1and temporary right that a natural person or legal entity has to exploit in the industrialarena an invention that meets the legal requirements. 2__________1Such exclusivity rights consist of preventing other persons from manufacturing, using, selling, offering forsale, or importing the patented product without the patent holder’s consent, and the right to prevent otherpersons from using the patented process and from using, selling, offering for sale, or importing a productobtained directly from a patented process without the patent holder’s consent.2Patents are granted for inventions that have a technical or essentially technical nature.

In this respect, the Industrial Property Law (Ley de Propiedad Industrial, LPI) establishesfour fundamental requirements that must be met in order for an invention to be patentable:a) The presence of an invention according to its legal definition (products, processes,apparatuses, etc.);b) That the invention has been obtained through an inventive step whose results cannotobviously be deduced by a person skilled in the art;c) That the invention is new (this being understood as not being found in the state ofthe art, which is to say that the knowledge related to it has not been made publicin Mexico or abroad);d) That the invention has an industrial application.206C H A P T E R X I IThe LPI also establishes what cannot be patented (including what is not considered aninvention and therefore not patentable):a) Essentially biological processes for the production, reproduction, and propagationof plants and animals;b) Biological and genetic material as found in nature;c) Animal breeds and the human body and the living matter that forms them;d) Plant varieties;e) Theoretic or scientific principles and discoveries consisting of making known orrevealing something that already existed in nature, even though previouslyunknown to humans;f) Schemes, plans, rules, and methods for carrying out mental processes, playinggames, or doing business, and mathematical methods;g) Computer programs;h) Methods of presenting information; æsthetic creations and artistic or literaryworks; surgical, therapeutic, or diagnostic methods of treatment applicable to thehuman body and to animals;i) Juxtaposition of known inventions or mixtures of known products, or variationsin their use, form, dimensions, or materials. 3A patent is processed before the Mexican Industrial Property Institute (Instituto Mexicanode la Propiedad Industrial, IMPI). The procedure is initiated by the filing of an application(which includes the patent request, the description, claim, and abstract 4 of theinvention, and the payment of the corresponding fees; furthermore and if applicable, it__________3Unless in reality such juxtaposition or variation involves their combination or fusion, such that they cannotfunction separately or that their characteristic qualities or functions have been so modified as to produce anindustrial result or a use not obvious to a person skilled in the art.4The Regulation of the LPI establishes that the translation into Spanish of the description of the invention andclaims may be filed within two months from the date of filing the application.

should include the power of attorney, the document assigning rights by the inventor, andthe priority document). 5 After the application is filed, IMPI will do a formal examination,that takes from 18 to 24 months and concludes with the publication of the applicationin the Industrial Property Gazette, and a substantive examination, the purpose of whichis to verify compliance with the patentability requirements and which takes approximately24 months, concluding with the granting or denying of the patent.With respect to the above-mentioned examinations, IMPI may issue one or morerequirements to the applicant, to which the latter must respond to within a term of twomonths (having, in turn, a second two-month extension).Patents have a non-extendible term of 20 years from the date of filing of the application,conditioned on the timely payment 6 of the annual fees for retaining the patent registration.In the case of applications filed under the Patent Cooperation Treaty (PCT),there is also a 20-year non-extendible term, but counting from the date of filing of theinternational PCT patent application.Finally, it should be mentioned that upon the expiration of a patent or its lapse for failureto make the annual payments, the patent passes into the public domain.2.2. Utility ModelsUtility models are considered the objects, implements, appliances, or tools that as aresult of a change in their disposition, configuration, structure, or form present a differentfunction with respect to the component parts or advantages with respect to their utility.Their registration grants the right of exclusive use, but it is conditioned on thefollowing fundamental requirements:a) The presence of a utility model according to its legal definition (object, implement,appliance, tool, etc.);b) The model is new;c) The model can have an industrial application.207Industrial PropertyUtility models are also processed before the IMPI and are governed by the same rules thatare applicable to patents. Nevertheless, in the registration process for utility models, theapplication is not published, which shortens the time period to an average of three years.__________5The priority document can be presented within a term of three months from the filing date. This documentconsists of a certified copy of the first deposit made before the national patent office of a country that is amember of the Paris Convention. In this respect, Mexico is a contracting party of the Paris Convention andof the Patent Cooperation Treaty (PCT), and therefore there is a recognition of the priority date and the internationalPCT deposit date when it designates Mexico.6With respect to the payment of the annual fees, the LPI establishes a grace period of six months, after whichif they are not paid the patent will lapse.

208C H A P T E R X I IRegistrations of utility models are granted for 10 non-extendible years from the dateof filing the application and conditioned on the payment of annual fees. Like patents,the utility model applications can lapse for failure to make such payments in a timelyfashion, and upon their lapse or expiration they enter the public domain.It should be mentioned that the LPI establishes certain limitations concerning theexclusivity that is granted by a patent or the registration of a utility model, which can besummarized as establishing that the right of exclusivity granted will not be enforceableagainst a third party when:a) The third party performs non-commercial research for experimental, testing, orteaching purposes;b) The product or patented process or utility model is used or marketed by the thirdparty after having been legally introduced into the market;c) The product or patented process or utility model was used by the third party priorto the date of filing of the invention;d) In the case of patents related to products that are live matter, the third party usesthe product as an initial source of variation or propagation to obtain other productsor utilizes, puts in circulation, or markets the patented products for purposesthat are not multiplication or propagation after they have been legally introducedinto the market.2.3. Industrial DesignsAn industrial design consists of the visual, ornamental characteristics applicable to an articleof manufacturing. Industrial designs can be divided into industrial drawings, constitutedby any combination of figures, lines, or colors that are incorporated into anindustrial product as ornaments and that give it a special and unique aspect, and industrialmodels, which are any three-dimensional forms that serve as models or patterns forthe manufacture of industrial products and gives them a special appearance.The registration of industrial designs with the IMPI also establishes an exclusive rightof use and, as with the figures studied above, the following requirements must be metin order to register them:a) The presence of an industrial design according to its legal definition (design ormodel);b) The industrial design is new or original;c) The industrial design can have an industrial application.This registration is also processed by the IMPI and is governed by the same rules as areapplicable to patents (with the exception of the publication of the application in theIndustrial Property Gazette).

The industrial design registrations are granted for 15 non-extendible years, conditionedon the payment of annual fees.2.4. Integrated Circuit Designs (Electronic Boards)Registrations of integrated circuit designs are granted to topographies, which consist ofthe three-dimensional disposition of the elements of the integrated circuit, of which atleast one must be active, and of some or all of the interconnections of the integratedcircuit. 7Their registration is processed before the IMPI according to the same rules as those forobtaining a patent and the title granting the exclusivity of an integrated circuit designhas a term of 10 non-extendible years (counted from the application filing date), conditionedon the payment of annual fees.The exclusivity rights in relation to an integrated circuit design will not produce effectsthat prejudice third parties when:a) The use is by a third party for private purposes of evaluation, investigation, analysis,or teaching;b) A third party had used it independently and prior to the filing of the holder ofthe right;c) A third party sells or distributes the product that contains the integrated circuitdesign if it was acquired legally from the holder of the right or its licensees or distributors;d) A third party sells or distributes a product that contains an illegal reproduction ofthe integrated circuit design if the third party acquired it in good faith and showsthat it had no reason to know, and did not know, that it was an illegal reproduction.209Industrial PropertyFinally, it is important to mention that industrial rights derived from patents, utilitymodels, industrial designs, and integrated circuit designs (as well as rights derived froman application in process) can be encumbered or transferred in whole or in part.To that effect, only the formalities established in the Civil Code need to be compliedwith and, subsequently, in order for the transfers to have effect against third parties, theymust be registered with the IMPI.__________7In this respect, the LPI defines these concepts as: (i) topography: The three-dimensional disposition,expressed in any form, of the elements, of which at least one must be active, and of some or all the interconnectionsof the integrated circuit, or the three-dimensional disposition prepared for an integrated circuitto be fabricated; and (ii) integrated circuit: a product, in its final or intermediate stage, in which the elements—at least one of which is an active element— and one or all of the interconnections, form an integral partof the body or of the surface of a piece of semiconductive material, and which is designated to carry out anelectronic function.

Furthermore, the holder of a patent or a registration of a utility model, industrialdesign, or integrated circuit design can grant, by means of a contract, a license for itsexploitation. In this case, the license must be registered before the IMPI in order to produceeffects against third parties. In this regard, it is important to emphasize that in relationto inventions, the LPI has established that any person can request from the IMPI theassignment of a mandatory license 8 to exploit an invention (i) when after three yearsfrom the date of the granting of the patent, or four years from the filing of the application,it has not been exploited, or (ii) for purposes of public interest.3. Distinctive Signs3.1. Trademarks210C H A P T E R X I IA trademark is any visible sign that distinguishes products or services from others of thesame kind or type in the market, and its principal function is to distinguish and individualizeproducts or services and their manufacturers or providers. It should be emphasizedthat from the moment that a product or service is distinguished by means of a sign,whether words, designs, or a combination of both, 9 it is considered that a trademarkexists. However, it is necessary to obtain its registration before the IMPI for it to have officialrecognition, which results in a right to its exclusive use.Like other industrial property rights, their registration begins with the filing of anapplication before the IMPI (and the payment of the respective fees). The registrationprocess can take from three to twelve months or more, depending on if during the examinationsof form and substance done by the Institute any legal requirement or impedimentis found. 10__________8In case of the granting of a mandatory license to a third party, the latter must exploit the invention withina maximum term of two years or otherwise the authority may revoke the granting of the license.9Based on their characteristics and the elements that compose them, trademarks can be (i) nominative, whichare those that permit the identification of a product or service through a word or group of words; (ii) nonnominative(or design), which consists of symbols, designs, logos or any figurative element that is distinctive;(iii) mixed, which are those resulting from the combination of words with figurative elements thatshow the trademark as a single distinctive element or combination, and (iv) three-dimensional forms,among which are recognized packaging, containers, or the form or the presentation of the products.10The LPI expressly states what cannot be registered as a trademark: (i) animated or changing words, figures,or three-dimensional forms expressed dynamically; (ii) technical names or names of common usageof the products or services the trademark intends to cover, as well as words that, in the common languageor commercial practice, have become the usual or generic designation of the same; (iii) three-dimensionalforms that are in the public domain or have become of common usage or those lacking the originality tofacilitate distinction, as well as the usual and common form of the product or the form imposed by theirnature or industrial function; (iv) words, figures, or three-dimensional forms that are descriptive; (v) isolatedletters, numbers, or colors, unless combined or accompanied by elements that give them a distinctive

In this regard and just as with the registration of creations of industrial application, inthe event that the IMPI concludes from the examinations of form and substance that thereis a prior registration, 11 a legal impediment or a requirement, it will notify the applicantof its ruling, granting the latter a term to respond (complying with the requirementsmade or arguing against the prior registrations or the legal impediments).The registration of a trademark has a duration of 10 years from the filing of the applicationand may be renewed 12 for equal periods if the renewal request is filed by the titleholder within six months prior to its expiration.__________character; (vi) translations into other languages, capricious orthographic variations, or artificial constructionof non-registerable words; (vii) unauthorized reproduction or imitations of seals, flags, oremblems of any country, state, municipality, or equivalent political division, as well as names, abbreviations,symbols, or emblems of international organizations, governmental, non-governmental, or of anyother officially recognized organizations, as well as the verbal designations of the same; (viii) reproductionsor imitations of official signs or seals of control and guarantee without authorization from the competentauthority, or coins, bank notes, commemorative coins, or any official mode of payment, nationalor foreign; (ix) reproduction or imitation of names or graphic representation of badges, medals, or otherawards obtained in officially recognized exhibitions, fairs, conferences, or cultural or sporting events; (x)proper geographic names and maps, as well as the regional references, names, and adjectives, when theyindicate the origin of products or services and may cause confusion or error as to such origin; (xi) thenames of towns or places known for the manufacture of certain products (except the names of places in privateownership when they are special and not liable to be confused, and when the consent of the ownerhas been obtained); (xii) the names, pseudonyms, signatures, and portraits of persons, without the consentof the persons concerned; (xiii) the titles of intellectual or artistic works and the titles of periodicalsand other distributed publications, the names of fictional or symbolic characters or real personages portrayed,stage names, and the names of performing groups (except where the owner of the correspondingrights has expressly authorized such registration); (xiv) words, figures, or three-dimensional forms liableto deceive or mislead the public, understood as being those that constitute false indications as to thenature, components, or qualities of the products or services that they claim to protect; (xv) words, figures,or three-dimensional forms identical or similar to a mark that the Institute considers well knownin Mexico, to be applied to any product or service; (xvi) a mark that is identical or confusingly similar toanother in respect of which an application has been filed earlier and is awaiting registration or to anotherthat is already registered and in force, and is applied to the same or similar products or services, providedthat a mark identical to one previously registered may be registered if the application is made bythe same owner for use in connection with similar products or services; and (xvii) a mark that is identicalor confusingly similar to a trade name applied to a firm or industrial, commercial, or service establishmentwhose principal business is the manufacture or sale of the products or the provision of theservices that the mark is intended to protect, provided that the trade name has been used prior to the filingdate of the application for registration of the mark or the date of the declared use thereof; the foregoingshall not be applicable when the application for a mark is filed by the owner of the trade name, ifno identical trade name exists that has been published.11In trademark matters the existence of a prior registration or application that is identical or confusingly similarand is applied to the same or similar products is called a prior registration cite.12A registration (of a trademark or slogan) must be renewed six months prior to its expiration, paying the feeestablished by the IMPI. Nevertheless, the Institute may process renewal requests filed within the six monthsfollowing the expiration of the registration. Once this last mentioned period passes, if the registration hasnot been renewed it will lapse.211Industrial Property

3.2. Slogans212C H A P T E R X I IA slogan consists of a phrase or sentence intended to capture the public’s attentionregarding a commercial, industrial, or service establishment or business, and/or a productor service, and to distinguish it from others of the same type.The right to exclusive use of slogans is also granted for 10 years, which can berenewed for equal periods, and is acquired through the registration granted by the IMPI,as the result of a process governed in general by the rules established for trademarks,provided there are no special rules applicable.In order to ensure a registration does not lapse for lack of use, the trademark or sloganshould not be left unused for three consecutive years with respect to the productsor services for which it was registered. In this regard it is general practice in Mexico tofile a notice of use with respect to the registration every three years. While such a noticeis not mandatory, 13 it is considered a presumption of use since it is filed under oath.3.3. Trade NamesThe trade name is a distinctive sign that is used to identify an industrial, commercial, orservice company or establishment and distinguish it from the others that engage in thesame or a similar activity. 14The difference between a trademark registration and trade name is that the purpose ofthe first is to distinguish products and services, while the purpose of the second is to differentiateestablishments, businesses, and companies. In this respect, the right to exclusiveuse of a trade name will be protected without the need for registration; its use issufficient. However, its publication in the Industrial Property Gazette will produce theeffect of establishing a presumption of good faith in the adoption and use of the name.In terms of the LPI, the effects of the publication of a commercial name will last for 10years from the date of the filing of the petition and may be renewed for periods of thesame length.The procedure for such publication by the IMPI is initiated with a petition that can befiled by the person who is using the trade name (evidencing the actual use in relation toa particular line of business). Subsequently, once the legal requirements are met, a substantiveexamination will be done to determine if there is any identical or confusinglysimilar trade name applied in the same line of business, either applied for or published__________13Under the prior LPI, the filing of such a notice of use was mandatory; however, with the reforms of the lawit was removed as an obligation and left to the discretion of the client.14The protection of a trade name covers the geographic zone of the actual clientele of the company to whichthe trade name applies, which will be extended to the entire Mexican Republic if there is a massive and constantdissemination of the name in the country.

prior to this petition, or a trademark application or registration that is the same as orconfusingly similar. If no such prior application or registration is found, the publicationwill be made. Finally, the trade name will be governed to the extent applicable and whenthere are no special rules applicable, by the rules established in the LPI for trademarks.According to the LPI, a distinctive sign will not produce effects against a third party when:a) The same or a confusingly similar distinctive sign is exploited in good faith in thecountry for the same or similar products or services, provided such use beganbefore the date of filing of the application or the first use declared in such filingand it has been used continuously without interruption; 15b) The product to which the registered trademark is applied is sold, distributed,acquired, or used after such product had been legally introduced in the market bythe holder of the registered trademark or the licensee;c) The third party (whether an individual or an entity) applies its name or denominationto the products it produces or distributes, the services it provides, or itsestablishments, or uses it as part of its trade name, provided the third party appliedit in the form in which it is accustomed to use it and it has characteristics that distinguishit clearly from a homonym already registered as a trademark or publishedas a trade name.The industrial property rights resulting from distinctive signs (as well as the rightsresulting from an application in process) can also be encumbered or transferred 16 inwhole or in part. To that effect, as with respect to the creations of industrial application,only the formalities established in the civil code need be complied with, and to be effectiveagainst third parties they must be registered 17 with the IMPI. Furthermore, the holderof a trademark registration or a slogan (or a trade name) can grant, through anagreement, a license to one or more persons, 18 in relation to one or more of the productsor services to which the trademark or slogan applies. Any such license must be registeredwith the IMPI in order to produce effects against third parties.213Industrial Property__________15The third party will have the right to request the registration of the trademark within the three years followingthe date on which it was published in the Registry, in which case it must process and obtain the declarationof nullification thereof previously.16It should be pointed out that when there is a merger of legal entities, it will be understood that there is atransfer of rights over registered trademarks or slogans (provided there is no stipulation to the contrary).17For this purpose a request for registration of transfers must be filed, accompanied by the documents evidencingsuch transfers and the payment of the corresponding governmental fee. A power of attorney grantedby the assignee to the law firm making the registration must also be filed.18The person having a legally registered license has the power to exercise a legal action to protect the rightsover the trademark as if he were the title holder thereof. This is so unless there is some stipulation to thecontrary, since the use of the trademark by the licensee is considered to be use by the trademark titleholder himself.

In addition, when with an authorization for use with respect to a distinctive sign, technicalknowledge is also transferred or technical assistance is provided so that the personto whom it is granted can produce or sell goods or provide services uniformly and withthe operational, commercial, and administrative methods established by the holder of thetrademark, thereby maintaining the quality, prestige, and image of the products or servicesit distinguishes, this constitutes the legal institution of the franchise.4. Appellation of Origin214C H A P T E R X I IAn appellation of origin is the name of a geographic region of the country that serves todesignate a product originating from there, the quality and characteristics of which arethe result of geography, including therein natural and human factors.The protection that the LPI grants to appellations of origin is initiated with a declarationto that effect issued by the IMPI. Such a declaration of protection will be made ex oficioor at the request of the individuals or entities that engage directly in the extraction,production, or preparation of the product related to the appellation of origin, the manufactureror producer associations, or the agencies or entities of the federal governmentor the state and Federal District governments.The request for a declaration of protection must be made in writing and be accompaniedby evidence supporting the petition. Given that the obtaining of this declaration ofprotection involves compliance with the requirements established in the LPI, the IMPI willexamine the information and documents contributed and may request the petitioner tomake any necessary clarifications or additions (for which the latter will have a term of twomonths). Subsequently, if once the studies are done and the evidence is presented, theInstitute decides to grant the protection of the appellation of origin, it will issue a declarationand publish it in the Official Federal Gazette.To date the IMPI has granted protection as appellations of origin to 12 Mexican products:tequila, Olinalá boxes (small decorated wooden boxes), mezcal, talavera (pottery)from Puebla, bacanora (distilled alcohol made from a particular agave plant), coffee fromVeracruz, amber from Chiapas, charanda (alcoholic beverage made from sugar cane),sotol (type of pulque, which is an alcoholic beverage made from the maguey plant), mangoAtaulfo from Soconusco, coffee from Chiapas, and Cotija cheese.This declaration of protection does not have any specific time limit. It will depend onthe survival of the conditions that brought about the protection to begin with. In thatrespect, the protection conferred on an appellation of origin will only take effect oncethe IMPI issues a declaration thereof.It is important to emphasize that in contrast to other distinctive signs (such as trademarksor slogans), the appellation of origin is not held by one private party; rather it belongsto the Mexican State, which as title holder thereof will grant authorizations for its use.

In this respect, the authorizations for use of an appellation of origin may be requestedby interested individuals or entities from IMPI for which they must demonstrate that theycomply with the requirements indicated by the LPI. Such authorization has a duration of10 years, 19 counting from the date of filing of the request, and it may be renewed forequal periods.The right to use an appellation of origin may be transferred by the authorized userpursuant to the civil code. Such a transfer will only take effect upon its registrationwith IMPI, and presuming it is shown that the new user complies with the conditionsand the requirements established in the LPI to obtain the right to use the appellationof origin.5. Industrial SecretsAn industrial secret is information of industrial or commercial application kept as confidentialby an individual or entity as a means to obtaining or maintaining a competitiveadvantage over third parties.In terms of legal protection, industrial secrets law should be seen as a preventive issuethat permits their title holder(s) to continue enjoying the competitive advantages theindustral secrets law offers, rather than as a corrective issue resulting from their disclosure.In this regard, the elements necessary for the existence of an industrial secretshould be known by their holder(s). Such elements are:a) The secret must be industrial and/or commercial information;b) That such information has a competitive value, which is to say an economicvalue; 20c) That it is kept confidential by an individual or entity; 21d) That in order to keep it confidential sufficient measures have been taken to preserveit as such and that access to it has been restricted;e) That it is recorded in material support (documents, electronic, or magnetic mediums,optic discs, microfilm, film, etc.), above all for purposes of identifying it andestablishing the date(s) of its origin;f) In the context of employment, that the receiver of the information has beenwarned that it is confidential.215Industrial Property__________19It should be clarified that what is subject to the term of 10 years is the authorization granted to a third partyfor its utilization, not the declaration of origin in itself.20This refers to the fact that the information must be useful with regard to a specific product or service (nature,characteristics, or ends), with regard to the methods or processes of production or rendering, granting to its titleholder(s) a competitive or economic advantage over third parties (which, in short, translates into a profit).21Which is to say that it is not in the public domain, it is not obvious to a person skilled in the art, its disseminationis not mandatory by law or judicial order, and it is duly protected before third parties.

216C H A P T E R X I IIn this respect it should be emphasized that even though sometimes the terms confidentialinformation, know-how, and industrial secret are used as synonyms, not all confidentialinformation can be considered to be an industrial secret, and not all know-how can beconsidered confidential information or an industrial secret.Technical knowledge (know-how) 22 is either the knowledge necessary for the reproductionof a product or of a process in the same conditions in which it was generated,or else that information that is sufficient and even necessary for the provision of a serviceor for the development of a business. Such technical knowledge can be consideredconfidential information in the same way as other company information that is not technical,but for it to be considered an industrial secret it must, as already mentioned, havean industrial or commercial application and represent the obtaining or maintaining ofcompetitive or economic advantages over others. There are different degrees of protection,with the highest degree being that of the industrial secret, and therefore it is veryimportant to determine if certain information is simply confidential or can be consideredan industrial secret.With respect to the information that actually constitutes an industrial secret, it is importantto look for and implement measures to preserve its confidentiality, since the meredeclaration by whoever is the title holder that it is an industrial secret is not sufficient.Rather, it is necessary for there to be several measures considered appropriate for maintainingit as such. The importance of these measures lies in the fact that in the majorityof cases giving them the treatment they merit is the only form of protecting them.It is important to emphasize that there is no registration with respect to an industrialsecret since that would result in its exposure; its legal protection arises from adoptingthe measures that are considered appropriate and sufficient in order to maintain its confidentialnature. In this way, its holder(s) will have their interests protected in terms of theLPI through the restraint of its disclosure and the establishment of various types ofindemnities in the event a third party has illegally made use of 23 such industrial secrets.6. Domain NamesA domain name is the code or the electronic address that leads to a particular internetpage. Each domain name is assigned to an IP (Internet Protocol) numerical address by itshosting provider. Since people remember names better than numbers, the domain name__________22Know-how is knowledge that cannot yet be patented, that cannot be patented by legal prohibition, that ispatentable but not patented as part of a market strategy, and that does not meet the requirements to be consideredan invention.23It should not be forgotten that there is a right to benefit from the successful preservation of an industrialsecret, but there is no provision that prevents another from using it if such other party obtained it legally.This shows the importance of the measures implemented in this regard.

translates this number into words and, therefore, usually results in one or more wordsthat help the user to find a particular internet page.Each country has its own specific procedure for their registration. In some countries(as in Mexico) such registration can be made by any person, while in others, only a companythat complies with certain requirements can do so. Nevertheless, in either case, inorder for a domain name to work it must be registered with a Domain Name Server (DNS)and in the Network Information Center (NIC).The steps for their registration are: verify that the name to be requested is available, requestyour hosting provider to register the name in its DNS, and register the name in the NIC.In relation to domain names, there are other questions related to intellectual or industrialproperty rights that may be of interest. For example, with respect to a specificdomain name, exclusive use can also be obtained through a reservation of rights toexclusive use. To that effect, the Federal Copyright Law (Ley Federal del Derecho de Autor,LFDA) considers these rights to be equivalent to those of titles of periodic publications.It should also be emphasized—given the relationship there is between domain namesand that of trademarks—that there are several procedures for requesting the cancellationof a particular domain name in the case of a better right (in terms of the Rules for UniformDomain Name Dispute Resolution Policies adopted by the Internet Corporation forAssigned Names and Numbers [ICANN]).7. Administrative Proceedings Related to Industrial Property Rights7.1. Nullification, Expiration, or Cancellation217Industrial PropertyIMPI’S powers include the implementation of proceedings for the nullification, expiration,and cancellation of the industrial property rights that are governed by the LPI and, consequently,the issuance of corresponding administrative declarations.In this regard and prior to addressing the proceeding itself, a brief summary should begiven of the different premises that result in each of these (nullification and cancellation).It should be mentioned that these proceedings have as a principal consequencethe loss of the exclusive right that the patent or the registration confers, whether of a creationwith industrial application or of a distinctive sign.7.1.1. Request for an administrative declaration of nullificationThe LPI establishes several premises with respect to nullification in the case of bothpatents and utility model and industrial design registrations, on the one hand, and inrelation to distinctive signs on the other. However, in both cases the nullification of apatent or a registration occurs when the elements necessary for the validity of the administrativeact from which they were derived were not fully present.

218C H A P T E R X I IThus, the causes of nullification established by the LPI are:a) With respect to patents 24 or registrations related to industrial creations: (i) that theyhave been granted in violation of the requirements and conditions for their granting,(ii) that they have been granted in violation of the law in force when they weregranted, (iii) that during the application process the application is abandoned, and(iv) that they were granted by serious error or oversight or to someone who didnot have the right to obtain them; 25b) With respect to distinctive signs: (i) that they have been granted in violation of the LPIor the provisions in force at the time of their registration; (ii) that they are identical orconfusingly similar to another that has been used in the country or abroad prior to thedate of presentation of the request and is applied to the same or similar products orservices (provided whoever claims a better right proves having used the distinctive signwithout interruption in the country or abroad from before the date of presentation orthe date of first use declared); (iii) that they were granted based on false informationin the application; (iv) that they have been granted by error, oversight, or difference injudgment, there being another distinctive sign that is considered invaded, and (v) thatthey have been granted to the agent, representative, user, or distributor of the holderof a sign abroad, and they have been applied for without the express consent of thetitle holder abroad (it will be considered to have been obtained in bad faith). 267.1.2. Request for an administrative declaration of cancellationSimilarly, the LPI establishes different premises that result in the cancellation of industrialproperty rights (either passing into the public domain in the case of patents, utility models,and industrial designs, or the right of exclusivity being extinguished in the case oftrademarks and slogans):a) In the case of patents, (i) the expiration of its term, (ii) the failure to make theannual payments or pay the fines necessary to maintain in force the rights derivedtherefrom, or (iii) the failure to exploit the patent;b) In the case of distinctive signs, (i) the failure of the title holder or authorized userto use it for three consecutive years on the products or services for which it wasregistered, or (ii) the failure to renew.__________24It should be emphasized that when the nullity only affects one or a few claims, or a part of one claim, thenullity is declared only with respect to the claim or claims affected, or the part of the affected claims. The nullitycan be declared in the form of a limitation or clarification of the corresponding claim.25The nullity action related to the violation of provisions can be exercised at any time; an action resulting fromthe abandonment of the application or from a defective grant can only be exercised within a term of fiveyears from the date of publication of the patent or the registration in the Industrial Property Gazette.26The nullity actions mentioned in subsections (ii) and (iv) may be exercised within a term of five years,counting from the date of publication of the registration in the Industrial Property Gazette; those regardingsubsections (i) and (v), at any time, and the action for subsection (ii), within a term of three years.

It should be emphasized that in both cases (both with respect to inventions and distinctivesigns) an administrative declaration of the Institute will not be required whenthe cancellation occurs as a result of the passage of time.7.1.3. Cancellation for loss of distinctivenessFinally, IMPI can also declare the cancellation of a trademark registration when it has lostits distinctiveness for having caused or even tolerated that it be transformed into a genericname that corresponds to one or more products or services for which it is registered.The administrative declaration proceedings can be initiated ex oficio by IMPI or at therequest of someone with legal interest and grounds for the claim. The request must befiled in writing, drafted in Spanish and must contain the following information:a) Name of the petitioner and, if applicable, of its representative;b) Domicile to receive notifications;c) Name and domicile of the opposing party and its representative;d) Object of the request;219e) Description of the facts;f) Legal grounds.Furthermore, with such request the documents or document on which the action islegally based must be filed in original or certified copy, the applicable evidence offeredunless it is supervening, the payment of the corresponding fee evidenced and, if applicable,the representative capacity of the representative shown.Once the request for administrative declaration is admitted, the Institute will notifythe affected title holder, granting the latter a term of one month to file a response (objectionsand defenses). Both parties may also, prior to the closing of the procedure, presentclosing arguments in writing. After such period and once the background of the case,the arguments made by the parties and the evidence offered have been studied, the IMPIwill issue the respective administrative ruling.7.2. Administrative InfringementAdministrative infringement proceedings are also carried out before the IMPI, which isthe administrative authority responsible for industrial property matters and, therefore,the one that determines whether or not there has been an infringement of the rightsderived from a patent or a registration. 27__________27In this regard, the LPI mentions the following as infringements: (i) engaging in acts contrary to proper practiceand custom in industry, commerce, and services that amount to unfair competition and that relate to the subjectmatter regulated by this law; (ii) causing goods to appear to be patented products that are not; (iii) placingproducts on sale or in circulation or offering services with a label indicating that they are protected by aIndustrial Property

220C H A P T E R X I IThis type of proceeding is initiated with a request filed by the affected title holder andnotice served on the presumed infringer who has a term of 10 business days to file aresponse (objections and defenses). If after the legal procedures the Institute determinesan infringement has occurred, the responsible party will be sanctioned with:__________trademark when they are not; (iv) using a mark confusingly similar to another registered mark to protect productsor services identical or similar to those protected by the registered mark; (v) using a registered mark or oneconfusingly similar thereto without the consent of its owner as an element of a trade name or business name,or vice versa, provided that the said trade names or business names are related to establishments working withthe products or services protected by the mark; (vi) using, within the geographical area of the effective clienteleor in any part of the Republic in the case provided for in Article 105 of this law, a trade name that is identicalor confusingly similar to another already being used by a third party to protect an industrial, commercialor service establishment in the same or a similar field; (vii) using as marks the names, signs, symbols, abbreviations,or emblems referred to in Articles 4 and 90, subparagraphs VII, VIII, IX, XII, XIII, XIV and XV, of thisLaw; (viii) using a mark previously registered or confusingly similar thereto as a trade name or business nameor part of such a name by a natural person or legal entity whose activity is the production, importation or marketingof goods or services identical or similar to those to which the registered mark is applied without the writtenconsent of the owner of the registration or of the person empowered to give such consent; (ix) performing,in the course of industrial activities or trade, acts that confuse, mislead, or deceive the public by causing it tobelieve wrongly or assume that a relation or association exists between a given establishment and that of a thirdparty, that products are manufactured according to specifications, licenses, or authorizations from a third party,that services are rendered or products sold according to authorizations, licenses, or specifications from a thirdparty, and that the product concerned comes from a territory, region, or locality different from the true place oforigin, in such a way as to mislead the public as to the geographical origin of the product; (x) pursuing orachieving the aim of denigrating the products or services, the industrial or commercial activity, or the establishmentof another party (this provision shall not apply to the comparison of products or services protectedby the mark for the purpose of informing the public, provided that the comparison is not tendentious, false, orexaggerated within the meaning of the Federal Consumer Protection Law.); (xi) manufacturing or developinggoods covered by a patent or by a utility model or industrial design registration without the consent of theowner thereof or without the appropriate license; (xii) offering for sale or bringing into circulation goods coveredby a patent or by a utility model or industrial design registration in the knowledge that they have beenmanufactured or developed without the consent of the owner of the patent or registration or without the appropriatelicense; (xiii) using patented processes without the consent of the owner of the patent or without theappropriate license; (xiv) offering for sale or bringing into circulation goods that are the result of the use ofpatented processes in the knowledge that they have been used without the consent of the owner of the patentor of the person who holds an exploitation license; (xv) reproducing or imitating industrial designs protectedby registration without the consent of the owner thereof or without the appropriate license; (xvi) using a registeredtrade announcement or one confusingly similar thereto without the consent of the owner thereof orwithout the appropriate license for the purpose of advertising goods, services, or establishments identical orsimilar to those to which the announcement applies; (xvii) using a trade name or a name confusingly similarthereto without the consent of the owner thereof or without the appropriate license to distinguish an industrial,commercial, or service establishment in the same or a similar branch; (xviii) using a registered mark withoutthe consent of the owner thereof or without the appropriate license on goods or services identical or similarto those to which the mark is applied; (ix) offering for sale or bringing into circulation goods identical or similarto those to which a registered mark is applied in the knowledge that the said mark has been used on thosegoods without the consent of the owner thereof; (xx) offering for sale or bringing into circulation goods towhich a registered mark is applied and which have been altered; (xxi) offering for sale or bringing into circulationgoods to which a registered mark is applied after having partially or totally altered, replaced, or deletedthe said mark; and (xxii) using an appellation of origin without the appropriate authorization or license.

a) A fine for up to 20 thousand days of minimum wage applicable in the FederalDistrict;b) Temporary or definitive closure; orc) Arrest.With respect to this type of administrative procedure, the affected title holder mayrequest that IMPI take precautionary measures 28 to be carried out prior to the request foradministrative declaration of infringement or in the act of notification. For the impositionof such precautionary measures the petitioner (affected title holder) must fulfill the requirementsindicated in the LPI, among which is the granting of a bond to cover any possibledamages or losses that could be caused to the presumed infringer by such measures. 297.3. Means of AppealWhen one of the parties in a proceeding of this type considers that its rights havebeen affected by a ruling issued by IMPI, it can make use of any of the following meansof appeal:a) Motion for review. Pursuant to the terms of the Federal Administrative ProceduresLaw (Ley Federal de Procedimiento Administrativo) this motion must be filed beforethe authority that issued the act being challenged within 15 days from the notificationof the ruling. It should be mentioned that this appeal is optional and thereforeit is not required to exhaust this appeal before making use of another action;b) Nullity proceeding. This judicial proceeding must be filed before the Federal Tax andAdministrative Justice Court within a term of 45 business days which will begin torun as of the day following the notification of the ruling and it is governed by theprovisions of the Federal Law of Administrative Law Court Procedure (Ley Federalde Procedimiento Contencioso Administrativo, LFPCA). Previously the provisions of the__________28Such precautionary measures are: (i) order the withdrawal from circulation or prevent the circulation ofthe merchandise infringing rights protected by the LPI; (ii) order the withdrawal from circulation of the illegallymanufactured or used objects; the objects, packages, containers, wrapping, stationary, advertisingmaterial, and similar items that infringe any of the rights protected by the LPI; the signs, postings, placards,stationery, and similar items that infringe any rights protected by the LPI; the tools or instruments used inthe manufacture, preparation, or obtaining of any of those indicated in the above subsections; (iii) prohibitimmediately, the commercialization or use of the products with which a right protected by the LPI isbeing violated; (iv) order the seizure of goods, which will be carried out in accordance with the applicableprovisions of the LPI; (v) order the presumed infringer or third parties to suspend or cease the acts thatare in violation of the LPI; and (vi) order the suspension of the provision of the service or closure of theestablishment when the above measures are not sufficient to prevent or avoid the violation of the rightsprotected by the LPI.29It should be mentioned that the infringing company can issue an indemnity bond, thereby canceling one orall the precautionary measures adopted.221Industrial Property

Federal Tax Code governed this proceeding and they still do for those proceedingsfiled before the issuance of the new law;c) Indirect amparo proceeding. In the case of direct violations of the Constitution, it ispossible to file before the District Courts an indirect amparo claim within 15 businessdays following the notification of the ruling.8. Industrial Property Crimes222C H A P T E R X I IIn contrast to copyright where crimes are regulated in the Federal Criminal Code (CódigoPenal Federal), in industrial property the LPI itself establishes what conduct is consideredcriminal: 30a) Reoccurrence of conduct established as an infringement by the LPI, once the firstadministrative sanction imposed for this reason has become firm;b) Fraudulently counterfeiting trademarks on a commercial scale;c) Revealing to a third party an industrial secret learned by virtue of work, position,responsibility, practice of a profession, business relationship or by virtue of thegranting of a license for use, without the consent of the person keeping the industrialsecret, when the person revealing it had been warned that it was confidential,for purposes of obtaining an economic benefit for itself or for the third party or inorder to cause harm to the person keeping the secret;d) Unlawfully appropriating an industrial secret without the consent of the personkeeping it or such person’s authorized user, in order to use it or reveal it to a thirdparty, for purposes of obtaining an economic benefit for itself or the third party or inorder to cause harm to the person keeping the industrial secret or its authorized user;e) Using the information contained in the industrial secret, learned by virtue of work,position, responsibility, practice of a profession or business relationship, withoutthe consent of the person keeping the industrial secret or its authorized user, orthat has been revealed by a third party, knowing that such third party did not havethe consent of the person that keeps the industrial secret or its authorized user, forpurposes of obtaining an economic benefit or intending to cause harm to the personkeeping the industrial secret or its authorized user.9. Indemnification for Damages and LossesThe LPI establishes that in addition to the sanctions that will be imposed pursuant tosuch law, a claim may be filed for the payment of damages and losses to the affected__________30These crimes will be prosecuted by complaint of the offended party and with regard to the first two crimes, theMexican Industrial Property Institute must issue a technical opinion (as a requirement for being actionable).

party; such indemnification according to this law may in no case be less than 40 percentof the sale price to the public of each product or the provision of services that involvesa violation of industrial property rights.In this respect, it should be pointed out that the filing of a civil or commercial claimfor these purposes does not involve a new or special procedure, rather it is governed bythe applicable provisions of the civil procedures code or, in commercial cases, the CommercialCode (Código de Comercio), and will be resolved by the federal courts or the localcourts when only private interests are affected and the plaintiff has so chosen.Notwithstanding the above, while there is no special procedure in this respect, certainprocedural requirements must be met in order to file a civil or commercial claim or both.Recently, in case 31/2003–PS, the Supreme Court of Justice of the Nation resolved conflictinglower court decisions determining that in order for “the action for damages andlosses to be valid, the illegality of the act must have been shown in the proceedings and,in this regard, since the decision of IMPI is the only appropriate evidence with respect tothe violation of an industrial property right, the final decision of such Institute is a necessaryessential condition for the validity of the claim.”223Industrial Property

CHAPTER XIIIIntellectual Property1. IntroductionWithin the Mexican legal system “inventions and creations” enjoy, as in almost all othercountries, a special protection for their titleholders, derived from Section XV of Article89 of the Political Constitution of the United Mexican States, which can be summarizedas “granting exclusive privileges for a limited period of time, in accordance with theappropriate law, to authors, discoverers, inventors, or improvers of any branch of industry.”These concessions or privileges establish an exclusive right over such creations orinventions, a right of exclusivity that has required, given its complexity, a specific branchof the law that applies to the development and protection of the various legal formsencompassing different types of creations.The aim of this chapter is to help readers to understand such branch, by explainingthe characteristics, the protection, and the legal scope of intellectual propertyrights.2252. CopyrightCopyright can be considered as recognition by the State of every creator of literary orartistic works, and implies for him/her the enjoyment of exclusive prerogatives and privilegesboth personal (a moral right) and economic (an economic right). Such prerogativesand privileges are included in specific protection granted to the works from themoment that they are affixed to a material support, which is to say when they can beperceived by the senses, regardless of their merit, use, or form of expression.The aforementioned protection does not require registration or documentation of anykind. Nor is the fulfillment of any formality required; only the materialization of the workis necessary inasmuch as the work is a personal, original, and new expression of one ormore natural persons called authors.

226C H A P T E R X I I IHowever, the creator of a work (or its titleholder) can request the National CopyrightInstitute (Instituto Nacional del Derecho de Autor, INDAUTOR) to register the work in orderto have evidence of ownership rights. Although the registration of a work does not createrights (since the protection is granted by the simple materialization of the work) itis declarative and is considered preferred evidence. 1This registration process is carried out before INDAUTOR, for which the official formmust be filed, along with the necessary documents (two copies of the work to be registered,the receipt for payment of the fees, and, if applicable, the power of attorney andthe document that shows the holding of the economic rights). 2 The registration proceduretakes about 15 business days, counting from the day following the date on whichthe registration was requested; and at the end of such term a certificate of registration ofthe work is delivered to the petitioner.The Federal Copyright Law (Ley Federal del Derecho de Autor, LFDA) makes specific referenceto the different branches for which such protection will be granted, among whichare works of literature, music (with or without words), drama, dance, paintings or drawings,sculptures and sculpted works, cartoons or comic books, architecture, cinematographyand other audiovisual works, radio and television programs, computer programs,photography, applied art works including graphic or textile design, and compendiums. 3This list is not exhaustive or restrictive, since all other works that by analogy may be consideredliterary or artistic works will be included in the mentioned protection, in eachcase under the branch closest to its nature.However, not every work can be subject to protection, some works being excluded onaccount of their contents, 4 or because they are an unauthorized reproduction or imitation ofnational symbols, or statutory, administrative, or judicial texts, or their official translations. 5Under the terms of the LFDA, the protection to which we have referred implies for theholder two kinds of rights, a moral right and an economic right.__________1In spite of what has been stated, in practice a certificate showing the registration of a work is necessary inorder to be able to file a claim against a third party for copyright infringement.2With regard to computer programs or systems, a print of the first 10 pages and a print of the last 10 pagesof the source code must be annexed.3Compendiums are collections of works, such as encyclopedias and anthologies, or of other elements, such asdatabases, provided such collections constitute an intellectual creation, due to their selection or the arrangementof their contents or materials.4The following are excluded from all protection: ideas, formulas, solutions, concepts, methods, systems,principles, discoveries, processes, and inventions of any type; industrial and commercial uses of theideas contained in a work; schemes, plans, or rules for performing mental acts, games, or businesses;isolated letters, digits, or colors unless they are styled in such a way as to make them original drawings; isolatednames, titles, or phrases; simple blank forms to be filled out with any type of information, as wellas instruction sheets.5However, concordances, interpretations, comparative studies, annotations, comments, and other similarworks that involve, on behalf of the author, creation of an original work, are subject to protection.

In this regard, the original holder of the copyright is the creator (author) of the work. 6However, some of these rights may also be exercised by the right holder’s successors, andit may be that the author is an employee of an individual or an entity who may havehired him or her specifically to carry out some work, in which case the exercise of therights (mainly economic) will belong to the employer. 72.1. Moral RightsIn contrast to other legal systems, particularly that of the United States, Mexican Lawprotects the so-called moral right of authors.*A moral right is the aspect of the copyright that concerns the protection of the author’spersonality as creator and the protection of the work itself as a separate entity. This rightis perpetual, inalienable, imprescriptible, and may not be waived or encumbered, and itconfers on its holders the right and/or the power:a) To determine whether their work will be disseminated and in what form, or if itwill remain unpublished;b) To demand recognition of their status as authors with regard to the work they havecreated and to determine whether it will be disseminated as an anonymous workor under a pseudonym;c) To demand respect for their work, opposing any deformation, mutilation, or anychange to it, as well as any action or attack on the work causing it to decrease invalue or damaging the reputation of the author;d) To modify their work, to withdraw their work from the market, or to contest theattribution to the author of a work that is not of their creation.227Intellectual Property2.2. Economic RightsEconomic rights include compensation paid to the authors for the exploitation, performance,__________6When a work has been created by several authors, the copyright will belong in equal parts to each one ofthem, except when a different percentage has been stipulated. The acceptance of the majority of the authorswill be necessary to exercise the rights that correspond to them for the creation of the work.7To determine title to the rights in this case, the following must be considered: (a) if the individual or entitythat contracts the author for the work pays for said creation, this person will enjoy the copyright, but willbe obligated to mention the name of the author, not as author but as collaborator, and (b) if such creationwas made without payment, that is, there was no compensation on the part of the individual or entity thatcontracted it, the holder of the copyright will be the author.* Generally speaking, common law legal systems speak of copyright, which is a property right that can befreely transferred. On the other hand, civil law systems generally provide for authors rights, which have adouble component of economic rights and personal (or moral) rights, the latter of which are inalienable andentitle the author to claim authorship of his/her work and object to any unauthorized modification of it.

228C H A P T E R X I I Ior use of their work for commercial purposes. This right is temporary (it has a durationequal to the life of the author plus 100 years, or 100 years after the work hasbeen disseminated, whichever occurs first). It can be waived, it is subject to a statuteof limitations, and its holder can transfer it or grant exclusive or non-exclusive licensesfor its use.Economic rights confer to their holders the right or the power to authorize or prohibit:a) Reproduction, publication, editing, or material affixing of a work in copies throughany means, including printing, phonographic, graphic, plastic, audiovisual, electronic,or any similar method;b) Public communication of a work through reproduction, reading, or public performance;public exhibition by any method or procedure; or public access throughtelecommunications (internet);c) Public transmission or broadcasting of their works by cable, fiber optics, microwave,satellite, or any other analogous means;d) Distribution of the work, including the sale 8 of support materials containing it, aswell as any form of transfer of use or exploitation;e) Import into the country of unauthorized copies of their work;f) Dissemination of derivative works, in any form, such as translations, adaptations,paraphrasings, arrangements, and transformations;g) Any other public use of the work.Within the protection granted by the LFDA there is a series of limitations on the rightsand prerogatives of the holder of a copyright that can be summarized as the fact that literaryand artistic works already disseminated can be used without the authorization ofthe holder of the economic rights and without monetary compensation, provided thenormal use of the work is not affected, nor the work altered, and the original text of thework is always quoted.The LFDA indicates that the above limitation applies to the following cases:a) Quotes from the text, provided they cannot be considered a significant, simulatedreproduction of the contents of the work;b) Reproduction of articles, photographs, illustrations, and comments pertainingto current events published in the press or broadcast on radio, television, or anyother media, when this has not been expressly forbidden by the holder of theright;c) Reproduction of parts of the work for critique or scientific, literary, or artistic research;__________8When distribution is through sales, this right of opposition will be understood as extinguished with the firstsale, except in the case of computer programs and databases with respect to which the author will keep,even after the sale of copies of the same, the right to authorize or prohibit the leasing of such copies.

d) One-time reproduction of a single copy of a literary or artistic work for the personal,private use of the person making it for non-commercial purposes; 9e) Reproduction for certification in judicial or administrative proceedings;f) Reproduction, communication, or distribution through drawings, paintings, photographs,and audiovisual means of works visible from public places;g) Use of literary and artistic works in stores or establishments open to the public thatmarket copies of such works;h) An ephemeral recording, provided the broadcasting is carried out within theagreed term, no concomitant or simultaneous broadcast is issued, and the recordingmay only be used once;i) Performance of works, provided it is through communication of a transmissionreceived directly in a radio or television monoreceptor device of the type commonlyuse in private homes. No payment is made for seeing or hearing the transmissionnor does it form part of an aggregate list of services. The transmissionreceived is not retransmitted for profit, and the receiver is a small taxpayer or asmall industrial establishment.2.3. Related RightsThe LFDA also regulates other rights that it calls related rights and that refer to thosebelonging to intermediaries in the production, recording, or dissemination of works,that is, to artists, interpreters, or performers; to producers of recordings or videos; andto broadcasters.These rights are related to copyright and are the result of an evolution in relation tothe works protected by copyright. The holders of related rights are often those who areinvolved in the process of disseminating the works to the public (musicians interpret themusical works of composers, actors interpret the roles of works performed in theaters,written by playwrights, broadcasters diffuse works and recordings in their broadcastingstations, etc.).Although such related rights grant similar rights, they are more limited and are for ashorter length of time, as will be seen later with regard to those to referred to in the LFDA.229Intellectual Property2.3.1. Book publishersBook publishers (either individuals or entities) are those who select or conceive the publicationof some work and produce it themselves or through third parties. It is important__________9This exception will only benefit individuals and therefore has no application in the case of companies andother legal entities, except in the case of an educational or research institution or an institution not engagedin commercial activities.

to point out that for there to be a publisher recognized by the LFDA, there must be a publishingagreement, by virtue of which the author, or in lieu thereof, the holder of the economicrights, agrees to deliver the work to the publisher, and the latter, in turn, agreesto reproduce, distribute, and sell the work, and to make the agreed payments to the rightholder. 10As a consequence of this agreement and of the rights created for the author, book publishershave the power to authorize or prohibit:a) Total or partial, direct or indirect reproduction of their books, as well as the use of them;b) Import of unauthorized copies of their books;c) The first public distribution of the original and of every copy of their books throughsale or any other means.230C H A P T E R X I I IFinally, it is worth mentioning that the protection granted to book publishers is forfifty years from the date of the first edition of the book in question.2.3.2. Interpreters and performersThe terms performing artist or performer designate the actor, narrator, reciter, singer,musician, dancer, or any other person who interprets or performs a literary or artisticwork, a folkloric expression, or who engages in an activity similar to those just mentioned,even when there is no prepared text. As in the preceding situation, performingartists or performers also execute agreements in which they specify the times, periods,compensation, and all other terms and forms by which it will be possible to set down,reproduce, and communicate to the public their interpretations or performances.The performing artists or performers enjoy the right to recognition of their name withregard to their interpretations and performances, as well as the right to oppose anydeformation, mutilation, or other threats against their performance that could damagetheir prestige or reputation. Likewise the performing artist or performer has the unwaivableright to receive remuneration for the use or exploitation of their interpretations orperformances done with the purpose of directly or indirectly making a profit by anymeans, public communication, or dissemination.The duration of the protection granted to performing artists or performers will be 75years from the first recording of the interpretation or performance, the first interpretationor performance of works not recorded, or the first broadcasting on radio, television,or any other media.__________10The parties to such an agreement can freely agree on the contents of the publishing contract, except withrespect to the unwaivable rights defined in the LFDA. In general terms, the provisions of the publishing contractof a literary work are also applicable to contracts for publication of music, scenic representation, broadcasting,audiovisual production, and advertising.

2.3.3. Recording producersA recording producer is understood as the individual or entity who sets down sounds ortheir digital manifestation for the first time, and who is responsible for the editing, reproduction,and release of recordings (it being understood that a recording is the settingdown, in sound only, of the sounds of a song, performance, or other sounds, or the digitalmanifestation of the same).As such, recording producers have the right to authorize or prohibit the total or partial,direct or indirect, reproduction of their recordings, as well as their use, the importof unauthorized copies of the recording, the first public distribution of the original andof each copy of their recordings through sale or any other means, including distributionthrough signals or transmission, the adaptation or transformation of the recording, orthe commercial leasing of the original or a copy of the recording, provided this latterright has not been reserved by the authors or by the holders of the economic rights.The protection granted to recording producers will be for 75 years from the firstrecording.2.3.4. Video producersAs in the preceding situation, the video producer is the individual or entity who first setsdown in a video associated images, with or without sound, that give a sensation of movement,or a digital manifestation of said images of an audiovisual work or the manifestationor performance of another work or of a folkloric expression, as well of other imagesof the same kind, with or without sound. The video producers enjoy with regard to theirworks, the rights to authorize or prohibit their reproduction, distribution, or publiccommunication. The duration of such rights is 50 years from the first recording of theimages in the video.231Intellectual Property2.3.5. BroadcastersBroadcasting is the transmission 11 by any wireless means (including laser rays andgamma rays) of sound or images for its reception by the public. Therefore, broadcastersare simply entities that, having a permit or a concession from the government, broadcastsound or visual signals, or both, that can be picked up by a large group of receivers.The LFDA protects not only those who participate in an interpretation or performanceand those who produce it, but also those whose occupation is to transmit it. Therefore,broadcasters will have the right to authorize or prohibit with respect to their broadcasts,retransmission, deferred transmission, simultaneous or deferred distribution, by cable or__________11Emission or transmission is understood as the communication of works, of sound, or of sound with imagesby means of radio waves, cable, fiber optics, or other analogous processes. The concept of emission also comprisesthe sending of signals from a land station to a satellite that will later disseminate them.

any other system, the setting down on a material base, reproduction of the recordings,and public communication by any means or form directly for profit.The rights conferred to broadcasters will have a duration of 50 years from the firstbroadcast or the original transmission of the program.Finally, the LFDA also establishes limitations on the rights of performing artists or performers,recording producers, video producers, or broadcasters, by allowing the use of theirperformances, recordings, videos, or broadcasts, as long as it is not for direct economic benefit,or when it involves brief fragments used in information on current events, or for purposesof teaching or scientific research, or in the case of a public benefit, and the exceptionsmentioned above for which no permission from the holder of the rights is required.3. Reservation of Rights for Exclusive Use232C H A P T E R X I I IWhile in the majority of countries this legal concept does not exist, Mexican lawincludes among intellectual property rights (and under the regulations of the LFDA) aconcept that it calls reservation of rights for exclusive use.Reservation of rights is a power that is obtained through registration with INDAUTOR 12 and itestablishes an exclusive right to use and exploit titles, names, distinctive physical and psychologicalcharacteristics, or original applied operating features with regard to periodicalspublished in a series of segments with varied contents and to be continued indefinitely(magazines, for example); periodical broadcasts transmitted in a series of segments withvaried contents (television programs, for example); human, fictitious, or symbolic personages;persons or groups engaged in artistic activities; and advertising promotions. 13It should be pointed out that this legal construct creates rights, which is to say thatthe person who has obtained a certificate of registration has a guarantee that no otherperson will be authorized (except with the former’s consent) to use said reserved title,name, etc., during the term fixed by the LFDA, depending upon the type of reservationof rights involved.The processing of a registration of a reservation of rights requires the presentation ofa specific form, takes 14 days, and sometimes, as a result of the evaluation, an officialcommunication may be issued in which the legal obstacles for obtaining the registrationare indicated. As a consequence of the above, and in order to facilitate the process, it is__________12As was mentioned, said registration is carried out through INDAUTOR by filing the respective form and thedocuments that must be attached to it.13I understand these to be the new and unprotected mechanism that is intended to promote and offer a goodor a service, with the additional incentive of offering the public in general the possibility of obtaininganother good or service in more favorable conditions than those normally found in the market. Commercialadvertising is excluded from this legal concept.

ecommended that before filing the request for a reservation of rights, a search for priorpotentially conflicting registrations be carried out.In this respect the LFDA provides that the right of exclusive use will have a duration ofone year in relation to periodicals or broadcasts and of five years 14 for the names and thedistinctive physical and psychological characteristics of personages, including characterizedhumans, fictitious or symbolic, the names or denominations of persons or groupsengaged in artistic activities, and the denominations and the original operating featuresof advertising promotions.Just as there are works that are not protected under the law, the LFDA also establishescertain cases for which a reservation of rights is not available: (a) those that due to theirgrammatical, phonetic, visual, or conceptual similarity could be mistaken for or confusedwith another reservation of rights previously granted or in the process of beinggranted; 15 (b) those that are generic and will be used in isolation or that claim to havethe sponsorship of a company, a public or private, domestic or international institutionor organization, or any other officially recognized organization, without their respectiveexpress authorization; and (c) those that reproduce or imitate without authorizationseals, flags, emblems, or symbols of any country, state, municipality, or any equivalentpolitical division, or that include the name, pseudonym, or image of any particular personwithout the express consent of the person concerned, or that are the same or confusinglysimilar to another considered well known in Mexico. A reservation of rights alsomay not be granted with respect to subtitles, graphic characteristics, legends, traditions,or events that have become personified or that are generally known under a name thatis characteristic of them, isolated letters or numbers, translations into other languages,whimsical changes in spelling, or artificial constructions of words not subject to reservedrights, the isolated name of persons, except those that have been requested for the protectionof stage names, names of artistic groups, characterized human or symbolic or fictitiouspersonages, and the names of countries, cities, towns, or any other territorial,political, or geographic division, or their regional names or derivatives used in isolation.The certificates of reservation of rights can be renewed for equal periods of time, exceptfor advertising promotions that at the end of their term will pass into the public domain.Said renewal must be requested on a specific form, and the applicable fee must be paid.Likewise, to justify the renewal of a reservation of rights, it is necessary to prove to INDAUTORthe use of the title, name, or the physical or psychological characteristics protected.According to the terms of the LFDA, a reservation of rights can be declared null andvoid when: (a) it is equal or confusingly similar to another previously granted or in theprocess of being granted, (b) the provided information essential for its granting is false,233Intellectual Property__________14Both time periods are counted from the date of their issuance.15Unless it is requested by the holder of the rights personally.

(c) a better right has been proved by previous, constant, and uninterrupted use in Mexico,and (d) that it was granted in violation of the provisions of the LFDA.In similar fashion, a reservation of rights can be canceled upon petition of the holderof the rights or by a third party having sufficient legal interest.4. Copyright Management Associations234C H A P T E R X I I ICopyright management associations are private legal entities whose main purpose is theprotection of the rights of their partners (authors or holders of related rights), and thecollection, administration, or distribution of the royalties generated by them. 16These copyright management associations can operate in the following ways:a) By branch field or type of creative work;b) By category of holders of related rights;c) By form of use, when various types of creative works or of holders of related rightsconcur and the nature of the rights entrusted to their management justify it.Therefore, it can be concluded that the persons entitled to form an association canbelong to one or more associations, depending on the diversity of the titles or economicrights that they hold. This means that different copyright management associations canvalidly exist, each of them focused on a different right (manner of use) among which wecan mention: the right of production and public performance, 17 the right of broadcasting,the rights of mechanical reproduction of musical works, 18 and related rights.It must be emphasized that the authors, holders of related rights, and their successors,national or foreign, can join one or more of the various copyright management associations,which cannot impose on their members, as obligatory, the management of all theforms of use, nor their whole work, nor future production.To operate legally, the copyright management associations must meet several requirements:the authorization 19 of INDAUTOR to operate, which will be granted if the conditionsestablished by the LDFA exist (such authorization must also be published in the Official__________16In order to fulfill their purpose, copyright management companies at times may need the help of INDAUTOR(or of the Mexican Industrial Property Institute, since this is the competent authority in this area, as will beseen later) to request inspection visits in which the authorities verify compliance with the provisions of theLFDA, and above all, investigate the possibility that some persons may not be paying the corresponding royaltiesfor the use of one or more works.17The music that is interpreted and performed in night clubs, restaurants, and other public places.18Reproductions in compact discs, tapes, discs, cassettes, mini-discs, or other forms of recording.19In order to obtain authorization to operate as a copyright management association, it is necessary to includewith the request the catalogues of the works to be administered. It is important to mention that accordingto the provisions of the LFDA, copyright management associations must have a list of the right’s holders, therepertory of their works, and the rights that they represent.

Federal Gazette and the notarization and registration of the act of incorporation in thePublic Copyright Registry within the time periods set for that purpose.In this regard, to this date the INDAUTOR has authorized the following as such associations:a) Sociedad de Autores y Compositores de Música, S.G.C. de I.P. (SACM) (authors andcomposers);b) Sociedad General de Escritores de México, S.G.C. de I.P. (SOGEM) (writers);c) Sociedad Mexicana de Autores de las Artes Plásticas, S.G.C. de I.P. (SOMAAP) (plasticartists);d) Sociedad Mexicana de Directores Realizadores de Obras Audiovisuales, S.G.C. de I.P.(directors of audiovisual works);e) Sociedad Mexicana de Coreógrafos, S.G.C. de I.P. (SOMEC) (choreographers);f) Ejecutantes, S.G.C. de I.P. (EJE) (performers);g) Sociedad Mexicana de Autores de Obras Fotográficas, S.G.C. de I.P. (SMAOF) (photographers);h) Sociedad Mexicana de Productores de Fonogramas, Videogramas y Multimedia, S.G.C.de I.P. (SOMEXFON) (recording, video, and multimedia producers);i) Unión Iberoamericana de Humoristas Gráficos (cartoonists);j) Centro Mexicano de Protección y Fomento de los Derechos de Autor, S.G.C. de I.P.(CEMPRO) (copyright protection);k) Sociedad Mexicana de Ejecutantes de Música, S.G.C. (SOMEM) (music performers);l) Sociedad de Autores de Obras Visuales Imagen del Tercer Milenio, S.G.C. (authors ofvisual works).235Intellectual PropertyAs has been mentioned, the reason for the existence of copyright management associationsis to serve as intermediaries between holders of copyright or related rights and theusers of the protected works, since given the conditions for their use, at times it is verydifficult for single authors to maintain control, and the use of group management provesnecessary. In this regard, the purpose of the copyright management associations is theprotection of authors or holders of related rights, national or foreign, and within saidprotection, the collection and delivery to them of any royalties generated.The main purposes of the copyright management association are:a) To exercise the economic rights of their members;b) To keep in their offices, at the disposal of users, the lists of works that they manage;c) To negotiate the licenses to use the works they manage with the users, and to executethe respective agreements;d) To supervise the use of the authorized works;e) To collect and deliver any royalties generated from the commercial exploitation ofthese works;

f) To collect and deliver any royalties generated for holders of foreign copyrights orrelated rights, either directly or through the copyright management associationsthat represent them, provided there is an express mandate given to the Mexicancopyright management association.In connection with said purposes, it is worth noting that for the exercise of economicrights and the collection of royalties, it is necessary to give the copyright managementassociation a power of attorney for litigation and collections. Furthermore,and apart from the exercise of economic rights and the collection of royalties, there areother powers, such as those to negotiate and execute license agreements for the use ofthe works (e.g., to execute acts, agreements, or contracts with users that require broaderpowers) that imply the need for a broader power (a power for acts of administration orof ownership).236C H A P T E R X I I I5. Administrative Copyright ProceedingsJust as other laws establish the premises for violation of their own provisions and thepossible harm to holders of the rights, Title XII of the LFDA contains a series of provisionsregarding the protection of the rules contained therein, and. those persons whoserights, conferred to them in the terms of above law (copyright and/or related rights),may be harmed.On this matter, the LFDA provides that persons who consider themselves to have beenharmed can choose between submitting (a) to proceedings before the ordinary judicialauthorities, (b) to conciliation or mediation proceedings, or (c) to any other administrativeproceedings established in this law.5.1. Administrative Conciliation ProceedingsAn administrative conciliation proceeding is carried out through the INDAUTOR and is initiatedwith a written complaint filed by the person whose copyright, related rights, orany other similar rights have presumably been infringed. A copy of the complaint mustbe served on the person against whom it has been presented, so that this person canfile a response within the following 10 business days. Both parties will be summonedto a conciliatory meeting that will take place at the Institute, at which an attempt willbe made to convince the parties to reach a settlement.Since the purpose of this type of proceeding is for the parties to conciliate, theINDAUTOR cannot enter into substantive questions, but only try to bring the partiesto a settlement. Therefore, the priority of the Institute is for the parties to mutuallyagree to execute an agreement resolving the conflict, which will have the nature of

es judicata and of an executory document, in case either of the parties does notcomply with it.In the event no settlement is reached, the INDAUTOR will exhort the parties to submittheir dispute to an arbitration proceeding, which will be governed by the rules of theLFDA, its regulatory provisions, or on a supplementary basis, the Commercial Code, andwhich will conclude with an arbitral award that will put an end to the dispute or witha settlement reached by the parties before the arbitral award is rendered.Claims against the violations of the principles of the LFDA or the rights it protects canalso be filed through an administrative declaration proceeding as discussed below.5.2. Copyright Infringement ProceedingsCopyright infringement proceedings are carried out through the INDAUTOR by meansof a written administrative petition filed by the holder of the rights whose rights havebeen infringed. In the administrative petition, the plaintiff should assert the causes ofinfringement, as established in the LFDA, by which the plaintiff has been harmed. 20After the petition has been submitted to the INDAUTOR, the administrator will notifythe presumed infringer of the suit being filed against them, so that they can have timeto file a defense.This type of infringement refers to violations of various provisions of the LFDA, and ifthe violation is proved, the INDAUTOR will sanction the infringer with a fine of up to15,000 days of minimum daily wage.__________20As mentioned, this kind of copyright infringement refers to violations of the law, and the following areamong the various causes: (a) the execution by the publisher, entrepreneur, producer, employer, broadcaster,or licensee of a contract for the transfer of copyright in violation of the LFDA; (b) the infringement by thelicensee of the obligatory license declared in accordance with the LFDA; (c) holding oneself out as a copyrightmanagement association without having obtained the necessary registration with INDAUTOR, or a membernot providing to the latter the reports and documents mentioned in the LFDA; (d) the omission from apublished work of the expression “All Rights Reserved” (Derechos Reservados) or its abbreviation, D.R., followedby the symbol ©; (e) the omission or falsity of the information that every publisher must include inthe works it publishes in terms of the LFDA; (f) the omission or falsity in the works that are printed of theinformation that every printer must include in the terms of the LFDA; (g) the failure to include on a recordingthe symbol (P) accompanied by the year in which the first publication was made; (h) the publication ofa work without mentioning in the copies thereof the names of the author, translator, compiler, adaptor, orarranger; (i) the publication of a work in detriment of the reputation of the author as such or, if applicable,the translator, compiler, arranger, or adaptor; (j) the publication of works created in official service withoutthe prior authorization of the Federal Government or of the States or the Municipalities; (k) the intentionallymisleading use in a work of a title that may be confused with another title published before; (l) the settingdown, production, publication, communication, or use in any form of a literary and artistic work,protected according to the guidelines for national symbols and ethnic group expressions, without mentioningthe community or the ethnic group or, if applicable, the region of the Mexican Republic to which itbelongs; and (m) all other infringements derived from the interpretation of the LFDA or its regulations.237Intellectual Property

5.3. Commercial Infringement Proceedings238C H A P T E R X I I IIn contrast to copyright infringement proceedings, commercial infringement proceedingsare carried out before the Mexican Industrial Property Institute (express remission of theLFDA), which will not only sanction said infringements, but may also adopt the precautionarymeasures set forth in the Industrial Property Law and will have the authority to investigate,order, and make inspection visits, as well as request information or specific data.These administrative proceedings may also be initiated with a written administrativepetition filed by the holder of the rights whose rights have been harmed. In the petition,the holder puts forward his theory as to why the infringement as established in the LFDAtook place. 21 The written administrative petition must be served on the presumedinfringer, who will have a specific time period to file a defense and submit evidence.This kind of infringement will be penalized by the Mexican Industrial Property Institutewith a fine equivalent to 5,000–10,000 days of the minimum daily wage, dependingupon the type of violation committed. In the event the person who commits theinfringement is a publisher, broadcaster, or any individual or entity that exploits workscommercially, the fine can be increased up to 50 percent.5.4. Proceedings before Judicial AuthoritiesThe LFDA establishes that it is the Federal Courts who will have jurisdiction over disputesarising from its application. However, when such disputes only affect private interests,the plaintiff may choose to have the local courts, meaning the State or Federal DistrictCourts, hear his/her case.__________21Pursuant to Article 231 of the LFDA, the following acts in commercial matters are considered infringementswhen they are carried out with a direct or indirect intent to profit: (a) disseminate or publicly use a work protectedby any means and in any form without the prior express authorization of the author, of his/her legitimatesuccessors or of the holder of the economic rights; (b) use the image of a person without his/herauthorization or that of his/her successors or assigns; (c) produce, reproduce, stock, distribute, transportor sell copies of works, recordings, videos, or books protected by copyright or related rights, without theauthorization of the copyright holders in the terms of this law; (d) offer in sale, store, transport, or put intocirculation works protected by the LFDA that have been damaged, altered, or mutilated without the authorizationof the copyright holder; (e) import, sell, lease, or any act making it possible to have a device or systemdesigned to deactivate electronic computer program protection devices; (f) retransmit, recording,reproduce, and disseminate to the public emissions of broadcasters without due authorization; (g) use, reproduce,or exploit a protected reservation of rights or a computer program without the consent of the holderof the rights; (h) use or exploit a name, title, physical, or psychological characteristics, or operating featuresin such a way that they mislead or can be confused with a protected reservation of rights; (i) use literaryand artistic works protected by the guidelines for national symbols and expressions of ethnic culturesin violation of the law, and (j) all other infringements of the provisions of the LFDA that involve conduct ata commercial or industrial scale related to works protected by copyright.

The judicial authorities must inform the INDAUTOR of any copyright proceeding that isinitiated before them, and, in fact, this Institute will be a party to such proceedings inthe event that any recording, annotation, or inscription in the Registry is contested.Regarding the handling of these kinds of proceedings, it must be pointed out that inthe field of civil law, all actions exercised must be legally grounded, processed, andresolved in accordance with the provisions of the LFDA, its regulatory provisions, and asa supplement thereto, the civil procedures codes. In addition to other kinds of claims inthis area, a claim for damages and losses can be filed with this procedure.In this regard, on July 23, 2003, a decree was published in the Official Federal Gazettewhereby the LFDA was amended to include, among other reforms, an article that, just asin the Industrial Property Law, provides that “the reparation of material and/or moraldamages, as well as indemnity for damages and losses for violations of copyright or ofrelated or similar rights, will never be less than 40 percent of the sale price to the publicfor the original product or for the original rendering of any kind of services thatinvolves the violation of one or more of the rights protected by this law.” 22In the case of criminal law, it must be kept in mind that crimes related to copyrightare set forth in Title XXVI of the Federal Criminal Code, 23 which in terms of such codeare prosecuted based on a complaint filed by the offended party 24 (except in the caseestablished in Article 424, Section I, which will be prosecuted directly by government__________22On this specific matter it is worth pointing out that recently the Supreme Court of Justice of the Nationresolved contradictory court opinions with regard to the indemnity for damages and losses resulting froman infringement of industrial property rights, which in this case would be applied by analogy, and in whichit was decided that before going through a civil procedure to claim damages and losses, there must be a rulingfrom the competent authority (INDAUTOR or the Mexican Industrial Property Institute) in relation to theviolation of the intellectual property rights on which such claim is based.23The following are among the most important acts considered to be crimes: (a) speculation in any form withfree text books distributed by the Ministry of Public Education; (b) the publication, production, or recordingof more copies of a work protected by the LFDA than those authorized by the copyright holder; (c) thewillful use, for purposes of profit and without the respective authorization, of works protected by the LFDA;(d) the willful production, reproduction, introduction into the country, storage, transportation, distribution,sale, or leasing of copies of works, recordings, videos, or books protected by the LFDA with the purposeof commercial speculation, and without the authorization that in the terms of the Law, the holder ofthe copyright or of the related rights must grant; (e) the sale to any final consumer on the street or in publicplaces, fraudulently, for commercial speculation, of copies of works, recordings, videos, or books protectedby the LFDA; (f) the exploitation for purposes of profit of an interpretation or a performance; (g) themanufacture, import, sale, or leasing of a device or system to decipher a coded satellite signal, programcarrier, without authorization of the legitimate distributor of said signal, or the carrying out for commercialpurposes of any act intended to decipher a coded satellite signal, program carrier, without authorizationof the legitimate distributor of said signal; and (h) the publication of a work substituting the name ofthe author with another name.24In the event the copyright has entered into the public domain, the complaint will be made by the Ministryof Public Education, which will be considered the offended party.239Intellectual Property

officials) and that, in addition to the corresponding fines, the offended party may alsoclaim damages and losses:Under Article 428 of the Federal Criminal Code, the economic sanctions set forth inthis title will be applied without prejudice of the indemnification for damages, whoseamount shall not be less than 40 percent of the sale price to the public of each product,or that for rendering services that involve a violation of one or more of the rightsprotected by LFDA.Finally, the LFDA also provides for a motion for review as a means of challenging a ruling,and to that effect it refers to the Federal Law of Administrative Proceedings, whichprovides that said motion must be presented to the same authority that issued the rulingwithin 15 business days following notification of the ruling.240C H A P T E R X I I I

CHAPTER XIVEconomic Competition1. IntroductionOn December 17, 1992, Mexico, the United States of America, and Canada signed theNorth American Free Trade Agreement (NAFTA), which entered into force January 1, 1994.In this agreement the basic rules were established that would become the new FederalEconomic Competition Law (Ley Federal de Competencia Económica‚ LFCE) for Mexico.First of all, the state parties to NAFTA recognized in Chapter XV the importance of establishinga common policy in the area of economic competition for the free trade zone and,therefore, the treaty signatories were obliged to limit State monopolies and regulate thefunctions of the companies owned by the States so that no harm would be done to marketcompetition. The contracting States were also obliged to apply rules that effectivelyregulate economic competition. It is obvious that the commitments made in Chapter XVof NAFTA had a specific purpose: Mexico was the only one of the three member countries ofthe agreement that did not have a modern competition law and, therefore, the greatestcommitment was made by Mexico, which not only had to create such a law, but also hadto create the entity responsible for applying it.One of the most important purposes of the treaty is to promote foreign investment inthe State parties. For Mexico, foreign investment is of great relevance due to the fact thatthe internal savings of the country do not provide sufficient resources for its economicdevelopment. Therefore, Mexico agreed to give its markets clear rules in order to allowinvestment to be made under the best conditions possible. 1Based on its commitment to execute the treaty, the Mexican government initiated aparallel discussion to begin the work of preparing the economic competition law, which241__________1For this reason, in NAFTA the principles of national treatment, most favored nation, and transparency, whichwere already established in the General Agreement on Tariffs and Trade (GATT) of 1947 and ratified in theGATT of 1994, were ratified, but with special emphasis.

242C H A P T E R X I Vwas ultimately published in the Official Federal Gazette (Diario Oficial de la Federación) onDecember 24, 1992, entering into force on June 22, 1993. 2 The LFCE was drafted usingthe U.S. law as a model, 3 as we can see from the concepts that were included in it.During the month of April, 2006, in the second ordinary session of the third year ofthe LIX Legislature, the Congress of the Union approved a reform of the LFCE. 4 The purposeof the reform was: (i) to include the relevant rulings issued by the Judicial Branch,(ii) to elevate certain regulatory provisions to the level of law, and (iii) to incorporate newelements in order to give the Federal Competition Commission (Comisión Federal deCompetencia, CFC) additional powers.The LFCE has seven chapters, each of which we will mention in order to have a generalidea of their scope. However, our focus will be on monopolistic practices and mergers.Among the most important aspects of the first chapter of general provisions is theidentification of those who will be considered economic agents for purposes of the lawand the indication of the purpose of the law. This chapter also determines what activitiesof the State will not be considered monopolies and defines the sphere of each activity. Inthe second chapter, the LFCE enters into the material itself and refers to monopolies andmonopolistic practices, of which there are two types: absolute monopolistic practicesand relative monopolistic practices.In its third chapter, the LFCE addresses the question of concentrations and establishesrules that govern the notification of said concentrations in order for the CFC toauthorize them or impose conditions on their approval. The fourth chapter of the lawcreates the CFC as a semi-independent administrative body (for example, it has its ownbudget) of the Ministry of Commerce and Industrial Development (Secretaría de Comercioy Fomento Industrial), now the Ministry of Economy (Secretaría de Economía),and establishes its structure and operation. The fifth chapter addresses proceduralmatters before the CFC, while Chapter 6 establishes the sanctions to which the economicagents that violate the law will be subject. Finally, Chapter 7 addresses proceduresfor filing a motion for review.The internal rules of the Commission were published in the Official Federal Gazette onOctober 12, 1993, and on October 12, 2007, the new Regulation of the Federal EconomicCompetition Law (Reglamento de la Ley Federal de Competencia Económica, RLFCE)was published in order to regulate the recent amendments of the LFCE.__________2NAFTA, in force since January 1, 1994.3In this regard, see Joshua A. Newberg, “Mexico’s New Economic Competition Law: Toward the Developmentof a Mexican Law of Antitrust,” in Columbia Journal of Transnational Law, vol. 31, 1994, no. 3, p. 591,and Sergio García Ramírez, “Reflexiones comparativas de la Ley Federal de Competencia Económica: la reglaper se y la regla de la razón”, in Estudios en torno a la “Ley Federal de Competencia Económica,” UNAM, Mexico,1994, p. 53. The latter is a comparative study of U.S. and Mexican law.4Published in the Official Federal Gazette (Diario Oficial de la Federación), June 28, 2006.

In this chapter we will comment on monopolistic practices and mergers and certain relevantdecisions of the CFC in this respect. However, before beginning the analysis of theseparticular topics, it is important to provide a general overview of the LFCE, defining aseries of basic concepts for purposes of this law. These concepts will serve as a guide forour discussion.2. The Federal Economic Competition LawArticle 28 of the Constitution prohibits the exercise of monopolistic activities or the creationof monopolies. The current LFCE is the regulatory law of this article “in regard to economiccompetition, monopolies and free trade” in the market, and is applicable “to allareas of economic activity.” It must be clarified that in Mexico all commercial activities arefederal and the states do not have the authority to regulate this area.The purpose of the law is “to protect the competitive process” and, therefore, monopolies,monopolistic practices, and “other restrictions on the efficient functioning of thegoods and services markets” must be prevented and eliminated. From this perspective,three goals can be distinguished: first, the promotion of economic efficiency and thecompetitive process, although the law does not contain distributive elements; second,that when promoting the efficiency of the economy, the law does not become an instrumentof industrial promotion; and third, that when protecting the competitive process,the immediate purpose is not the simple maximization of the consumer.The subjects considered economic agents to whom the LFCE applies include individualsand entities, as well as “agencies or entities of the federal, state, or municipal publicadministration.” This means that the LFCE also governs the conduct of all public officerswho handle competition matters and who have an effect on them. This is especiallyimportant in a country like Mexico where the conduct of the federal government in thepast inclined toward promoting monopolies or attitudes that affected the free marketdue to the strong presence of the State in the economy.Thus, for example, with the intention of protecting the working class and poorer sectorsof society, organizations were created such as the National Company of Social Support(Compañía Nacional de Subsistencias Populares), which bought and monopolizedagricultural products by setting “guaranteed prices” for subsistence farmers, distortingfree trade in those markets. This may have been justified during the period in which itoccurred as an attempt to help Mexican subsistence farmers so they did not have to selltheir products at a low price to middlemen. However, this policy lasted too long and wasnot combined with other economic policies to create competitive conditions in the agriculturalsector. A policy of subsidies in the agricultural sector for so long caused greaterdamage than it was intended to prevent, to such an extent that its effects are still felt,including among others the displacement of hundreds of thousands of subsistence farm-243Economic Competition

244C H A P T E R X I Vers from their lands to the city. Other examples are, to mention just a few, the State controlof telecommunications, of a large portion of secondary and basic petrochemicals, ofthe banks, etc.—sectors that today, fortunately, are in the private sector (except in partbasic petrochemicals).Also included on the list of economic agents of the LFCE are “charters,” “trusts,” andfinally “any other form of participation in economic activity.” Charters have clearly beenincluded to prevent their members from using them to set prices for services, which happensfrequently all over the world.In compliance with the commitments made in Chapter XV of NAFTA, the LFCE alludesto the limitation of State monopolies. It states that “the functions that the State exercisesexclusively in strategic areas [...] do not constitute monopolies.” The strategic areasare those considered by Article 28 of the Constitution as areas in which only the Statecan be involved. Through a process taking place in Mexico over the last 15 years, especiallysince 1989, the Mexican State has abandoned areas in which it previously actedexclusively and that it now has handed over to the private sector, such as satellite communications,telecommunications, railways, and large sectors of the petrochemical andtelephone industries.However, the limitation of the presence of the State in strategic areas, and especiallyin those that are vital for the economy, continues to be a challenge. The continued presenceof the State in certain vital economic areas and its exercise of monopolistic activitiesin those areas also have affected non-strategic areas and can result in the distortionof markets. In recognition of this, early on the CFC limited the activities of the State oilcompany, Petróleos Mexicanos (PEMEX), by a ruling in which it clearly defined the extensionof the “strategic area” in the sale of gasoline. This question of the demarcation ofstrategic areas for purposes of competition has appeared with regularity. A similar phenomenonhas also occurred with the state governments that have become accustomedto federal government interference in the market and which the CFC has had to eliminate.5 Given present conditions, it should become more and more difficult for such attitudesto exist in the federal government or in the state governments.Having given a general description of questions regarding the scope and applicationof the LFCE, the regulation of monopolistic practices is explained below.3. Monopolistic PracticesAs mentioned, there are two types of monopolistic practices: absolute monopolisticpractices (per se) and relative monopolistic practices (rule of reason).__________5Examples include, among others, practices that were denounced before the CFC or that the latter has investigatedin representation of the states of Sinaloa, Oaxaca, or Chihuahua.

3.1. Conduct Considered as Absolute or Per Se Monopolistic PracticeThe LFCE establishes four illegal acts that are presumed to be absolute monopolistic practices.6 The first involves horizontal price fixing agreements between competitors, whichare extremely harmful to competition. Agreements such as these are considered to existfrom the simple fact of being carried out and, therefore, they are considered to beabsolute monopolistic practices, even when the presence of the economic agents in themarket is not substantial.It is considered that price fixing exists among competitors when the sale price offeredin Mexico by two or more competitors for goods and services that can be substituted forone another internationally is “perceptibly” higher or lower than their internationalprice, of course discounting taxes, transportation, or distribution charges.Another indication of price fixing is when two or more competitors establish the samemaximum or minimum price for a good or service, which is unlikely to be accidental, or aparticular sale or purchase price of the good is adhered to. This is indirect price fixing. Afinal sign of price fixing is when industry or commercial cartels fix prices for their members.Returning to the LFCE, we have indicated that in addition to price fixing, another threepractices are considered absolute monopolistic practices. 7 The first two practices are (i)establishing the obligation not to produce, process, distribute, or commercialize morethan a restricted or limited amount of goods or services, and (ii) the division and assignmentof markets. However, there is one more practice to which the LFCE tries to give specialemphasis due to the characteristics of the privatization process that the Mexicangovernment is going through. This is the practice of establishing, arranging, or coordinatingbids in public auctions.245Economic Competition3.2. Relative Monopolistic Practices (Rule of Reason)Together with the per se practices or absolute monopolistic practices to which we just__________6“Article 9. Absolute monopolistic practices are contracts, agreements, arrangements, or alliances amongcompetitive economic agents, whose aim or effect are any of the following: (i) to fix, raise, to agree upon,or to manipulate the purchase or sale price of the goods or services supplied or demanded in the markets,or to exchange information with the same aim or effect; (ii) to establish an obligation to produce, process,distribute, acquire, or market only a restricted or limited amount of goods, or to render or transact a specificvolume, number, or frequency of restricted or limited services; (iii) to divide, distribute, assign, orimpose portions or segments of the current or potential market of goods and services, according to specifiedor specifiable clientele, suppliers, time or spaces; or (iv) to establish, agree upon, or coordinate bids, orto abstain from bids, tenders, public auctions, or bidding. The acts mentioned in this article will not haveany legal effects and the economic agents engaged in such acts will be subject to the penalties establishedunder this law, notwithstanding any criminal liability that may ensue.”7See above note.

eferred, the LFCE establishes practices judged according to the rule of reason. 8 As theirnature indicates, such practices are not bad in themselves; that determination depends246C H A P T E R X I V__________8“Article 10. Subject to verification of Articles 11, 12, and. 13 of this law, relative monopolistic practicesare deemed to be those acts, contracts, agreements, procedures, or combinations, the aim or effect of whichis to improperly displace other agents from the market, substantially hinder their access thereto, or toestablish exclusive advantages in favor of one or several entities or individuals, in the following cases: (i)some of the economic agents that do not compete among themselves are: to set, impose, or establish theexclusive commercialization or distribution of goods and services, by means of the subject, geographicallocation, or specific periods of time, including the division, distribution, or assignment of customers andsuppliers; and also the obligation not to manufacture or distribute goods or services for a specific periodof time or that may be specified; (ii) to set the prices or other conditions that a distributor or supplier mustabide by when engaging in commercial activity or marketing or distributing goods or providing services;(iii) the conditioned sale or transaction when buying, acquiring, marketing, or providing other goods oradditional services, normally different or that can be differentiated, or on the basis of reciprocity; (iv) thesale, purchase, or transaction subject to the condition of not using, acquiring, selling, engaging in commercialactivity, or providing goods or services produced, processed, distributed, or sold by a third party;(v) the unilateral action based on refusing to sell, commercialize, provide to specific individuals goods orservices available and normally offered to third parties; (vi) the agreement reached among several economicagents or the invitation extended to them to exert pressure on customers or suppliers, in order todiscourage them from specific behaviors, to apply retaliations, or force them to act in a specific manner;or (vii) the systematic sale of goods or services at prices below their total average cost or their occasionalsale below the variable average cost, when there are elements to presume that these losses will be recoveredthrough future price increases, in terms of this law’s regulation; (viii) the granting of discounts orincentives by producers or suppliers to the buyers with the requirement of not using, acquiring, selling,commercializing, or providing the goods or services produced, processed, distributed, or commercializedby a third party, or the purchase or transaction subject to the requirement of not selling, commercializing,or providing to a third party the goods or services object of the sale or transaction; (ix) the use of the earningsthat an economic agent obtains from the sale, commercialization, or rendering of a service or good tofinance the losses arising from the sale, commercialization, or rendering of another good or service; (x) theestablishment of different prices or conditions for the sale or purchase to different purchasers or sellers situatedin equivalent conditions, and (xi) the action of one or more economic agents the purpose or effectof which, directly or indirectly, is to increase the costs or obstruct the productive process or reduce thedemand of their competitors.To determine whether or not the practices to which this article refers shall be sanctioned in the termsof this law, the Commission will analyze the gains in efficiency resulting from the conduct demonstratedby the economic agents and that favorably affect the competitive process and access to the free market.These gains in efficiency may include the following: the introduction of new products; the use of irregularmerchandise or defective or perishable products; cost reductions resulting from new techniques andproduction methods, integration of assets, increases in the scale of production, and the production of differentgoods and services with the same factors of production, the introduction of technological advancesthat produce new or improved goods or services; the combination of production assets or investments andtheir recovery that improve quality or broaden the attributes of the goods or services; improvements inquality, investments, and their recuperation, opportunity, and service that have a favorable impact on thechain of distribution, that do not cause a significant price increase, or a significant reduction in consumeroptions, or an important inhibition on the level of innovation in the relevant market; and any other gainsin efficiency that show that the net contributions to the well-being of the consumer derived from suchpractices surpass their anticompetitive effects.”

on the circumstances under which they are undertaken; they may even be considered topromote market efficiency. It is therefore necessary to measure them, analyze them, andstudy them closely. As a result, the LFCE requires that they be analyzed from the perspectiveof the substantial power of the economic agent 9 in the relevant market or in arelated market 10 and that such practices be engaged in with respect to goods and servicescorresponding to the relevant or related market in question. Clearly, we have a systematizationof factors considered when applying the rule of reason, but the manner inwhich these factors are set forth in the LFCE merits certain comments.The first factor established by the LFCE includes several presumptions: first, that economicagents do not compete with one another—because otherwise we would be in thepresence of per se practices—and that they fix, impose, or establish an exclusive distributionof goods and services on other economic agents in the market, which would giverise to a rigid market with undesirable effects, and could also result in serious verticalrestraint and provoke the displacement of competitors from the market. However, verticalrestraint of this type can also be analyzed from another perspective, which is thatof “a program oriented toward the search for legitimate efficiencies in the distribution ofa particular brand,” which means that on the basis of the analysis, far from being consideredmonopolistic, the restraint can be seen as a market promoter, assuming the economicagent that engages in it does not have substantial power in the relevant market,and therefore does not have the ability to fix prices, high or low, in the market.Another presumption is that such exclusive distribution leads to the “division, distribution,or assignment of clients or suppliers” and that this is a result of the power of theagent that promotes the practice or of the agent to whom the clients or suppliers areassigned. It also implies that the practice has to be analyzed in the geographic area where it247Economic Competition__________9“Article 13. The following should be evaluated in order to determine if an economic agent has substantialpower in the relevant market: (i) its market share and whether it can unilaterally set the prices or restrictthe supply in the relevant market without the competitive agents being able to act or to potentially counteractthat power; (ii) the entry barriers and the elements that may alter those barriers and also other competitors'offer; (iii) the competitors’ existence and power; (iv) the possibility the economic agent and itscompetitors have to access the input sources; (v) its recent performance; and (vi) all other criteria establishedin the regulations of this Law.”10“Article 12. The following criteria must be evaluated in order to determine which are the relevant markets:(i) the possibility to substitute the goods or services in question by other national or domestic goods or services,taking into consideration the technological potential, to what extent consumers have substitutes andthe time required for that substitution; (ii) the distribution cost of the goods; their relevant inputs; their supplementsand substitutes from other regions and from abroad, taking into account freight, insurance, customduties and non customs restrictions, the restrictions imposed by the economic agents or theirassociations and the time required to supply the those regions from the market; (iii) the costs and potentialaccess to other markets of users or consumers; and (iv) the federal, local or international standard restrictionsthat limit the access of users or consumers to alternative supply sources, or the access of the suppliersto alternative customers.”

248C H A P T E R X I Vis carried out or within the time period that has been given to the practice, as well as theduration of the exclusive distribution agreement for a specific period of time. In this way wecan analyze this type of practice from different perspectives, which can result in consideringthe practices monopolistic or competitive, depending on the elements existing in each case.A third presumption is related to “the imposition of the obligation not to manufactureor distribute goods or provide services for a specified or specifiable time period.”This presumption is complementary to the one above, in the sense that it can be considereda monopolistic practice and at the same time a competitive practice, since in anexclusive distribution agreement there can be elements that promote “loyalty and disciplineamong distributors of the product,” which permits the determination or definitionof the sales and distribution policies with greater precision and at the same timepromotes the goods and services market.Another condition is also alluded to: “the geographic situation,” which in this case doesnot refer to the substantial power of one economic agent over another, or to a verticalrestriction, but rather to geography in imperfect markets, such as those existing in Mexico,frequently isolated from one another in regions with little access, which constitutes a fundamentallyimportant factor, given that it can force the acceptance of the imposition of anexclusive distributor. For example, a particular brand may be the only one offered in aregion with limited access, if it is agreed that only that brand and no other will be sold.The distributor knows that his supplier has to go great distances over difficult roads tobring him the product, and he also knows that other suppliers may not have that capacity.In these conditions, the economic agent who promotes the practice does not have substantialpower in the relevant market; however, the geographic situation becomes so determinativethat the economic agent can obtain monopolistic benefits. Nevertheless, thisagent is a promoter of commerce in the isolated market. This shows that in the area of competitionthere are no simple, explicit definitions, since the range of possibilities is broad.An additional element is time, and an analysis of it can be applied to the above situations.In this way, due to the power that one agent may have over another or to geographiccircumstances, the prevailing economic agent can force the weak party to acceptlong periods of exclusive distribution, and this is precisely what the law prohibits. It alsoprohibits under these circumstances the division or assignment of clients or suppliers orthe imposition of the obligation not to manufacture or distribute other goods and services.As we have observed, the prohibition of the law is clear with respect to conductof this type; however, we must recall that the LFCE opens possibilities for the CFC to considerfactors based on efficiency and that, analyzed from that perspective, such practicesinvolve synergies of efficiency and can be authorized.Connected with the first practice, it is established that “the imposition of the price orother conditions that a distributor or supplier must observe upon expending or distributinggoods or providing services” may be considered a monopolistic practice, unless

this practice does not follow a scheme that leads to the formation of “one single businessunit for the distribution and marketing of products of the same brand in terms of geographicmarkets, standards of goods, and services and price policies,” in which case themonopolistic practice may be seen as acceptable due to the elements therein that promotecompetition. A typical case is the franchise that has an established image andrequires a certain consistency from it distributors, which means that clients can go toany distributor and find the same quality and price.In this regard, the CFC has declared that “vertical restraints [...] allow the formation ofspecialized distribution chains at the cost of suppressing competition [... and therefore]this scheme facilitates the organization as if it were a single business organization [… andcould be considered] as a scheme oriented toward the legitimate search for efficienciesin the distribution.”As we indicated, the factors for evaluating relative monopolistic practices need to becarefully examined according to the rules regarding “substantial power” in the “relevantmarket” of the agent that is accused of engaging in such practices. We will look brieflyat the principles that govern both concepts.The basic factor on which the law is based is substitutability, which in turn appears indifferent practices.3.2.1. The relevant marketThere are various presumptions according to which the relevant market can be determined.This factor begins with the idea that an ideal market is one in which there is totalsubstitutability of products. Consumers do not suffer any economic loss if they canimmediately substitute, without cost, one product for another. And to the extent thissubstitution is difficult; the producer can impose higher prices, because it knows that itsproduct cannot be rapidly and easily substituted for. Here we have what economic theorycalls inelasticity in the market, that is, the lack of this necessary substitutability ofgoods and services in the market and which, as we know, allows an economic agent toexercise the power to fix prices in such markets and, consequently, to obtain a monopolisticbenefit that affects the economy and especially economic competition. In this way,with this concept two decisive factors are taken into consideration for substitutability:“the technological possibilities” and “the time required for such substitution,” whichtogether give an index for the determination of the power that a particular economicagent can exercise in the market.In relation to the possibilities of substitution, the LFCEA and the RLFCE define the stepsthat must be taken in an analysis and require that the CFC indicate first the goods and servicesthat make up the relevant market and second those that eventually could substitutefor them. Once this is done, the LFCEA and the RLFCE require the following step: that thegeographic area where such goods and services are supplied and demanded be determined.249Economic Competition

250C H A P T E R X I VAs an effect of the determination of the geographic area, the CFC must analyze the distancethat consumers can go to the suppliers or that suppliers must go to the buyers“without incurring appreciable other costs,” since if they have to incur higher costs, theywill choose to buy from the monopolist in their market. The distribution cost of thegood or service and the cost and probability of going to other markets will also have tobe considered.Having made the above analysis, LFCEA and the RLFCE require that the CFC apply additionalfactors that can be decisive for the definition of substitutability of goods and services,which are the local, federal, or international economic or regulatory restrictions,the alternate supply sources, or “the access of suppliers to alternative clients.”Once the “relevant market” is determined, the concentration calculation or analysis usuallyfollows, which is the evaluation of the market structure, “not the complete analysisof competition of a transaction by which two or more companies are concentrated.” It isa calculation intended to determine the share various companies have in the market. TheCFC uses the Herfindahl index as an instrument for measurement.After having thus determined the “relevant market,” it is also necessary to determinethe “substantial power” of the economic agent of such market. For this purpose, severalfactors are established that we will examine below.3.2.2. Substantial powerThe first factor is the size and importance of the economic agent in the market. A relativelyeasy way to determine this is by indexes that allow us to identify the share of theeconomic agent in the market. By knowing the market share of the economic agent, weknow, first of all, the possibilities it has of unilaterally fixing prices or restraining marketsupply, without competitors or possible competitors being able to counteract such power.In this way, the presence of an economic agent in the market is considered a concentrationthat could eventually lead to the use of monopolistic practices when its marketshare is 53 percent, although the percentage can be less, depending on the elements andthe circumstances of each case. However, a particular level of concentration cannot beconsidered sufficient to prove the existence of substantial power; it also must be determinedif the economic agent actually possesses such power and to what extent it canunilaterally fix prices or restrain supply, which translates in the end into the capacity toincrease or decrease prices in the market and, therefore, displace competitors from it.In this regard, in order to determine the existence of substantial power, the possibleexistence of entrance barriers must be analyzed, as well as the elements “that it can beforeseen as being able to alter both such barriers and the supply of other competitors.”The market must also be analyzed by considering the presence and the power of eachof the competitors. It is possible that a certain number of competitors are not determinedor determinable. This happens frequently in countries such as Mexico where the

instruments for measuring markets are not developed, to the extent that it is not possibleto know all the economic agents in a market. However, the economic agents withgreater power can be detected, and it is possible to measure that power and the mannerin which it is divided.Likewise, it is necessary to consider the possibilities of access of the economic agentand its competitors to sources of inputs. This involves an important premise for severalreasons: first, because if it is a question of indexes that allow it to be determined if aneconomic agent has power in the relevant market, the access to sources becomes a decisiveelement. This is also a generally accepted factor in the competition laws of othercountries. In Mexico, the determination of sources of inputs has special relevance,because it is a country where sources have not had a balanced development, whichforces economic agents to go, with a costly transportation infrastructure, to other sourcesthat are far from the location of production, or to decide to import their inputs. Thesedifficulties can then be decisive in the definition of substantial power of any agent in therelevant market.The factor of “recent behavior” of the economic agent must also be taken into account.This information is also decisive, since for Mexico there are no accurate or extensivesources of information for many of its markets, as there are in other countries for eachof their markets and economic agents. Therefore, in our country, by taking into accountthe recent behavior of the economic agent, it is possible to have current information relativelyeasy to find and to which the competition authorities can go to obtain a reliableparameter. This contributes to a just determination of the substantial power of the economicagent in the relevant market.Finally, additional factors are somewhat broadly established, such as the “dominantposition” that the economic agent has with respect to the goods and services in the relevantmarket. The concept of dominant position is a very specific economic term notcontemplated in the law, but interpreted objectively can be considered as a descriptionof the situation of the economic agent or as the possibility this agent may have inthe goods and services market in question at the time of analyzing its substantialpower. In other words, what is looked for through this factor is the time, experience,investment, and administration of the economic agent in the goods and services marketin which it is involved in order to derive from such information characteristics of itspower in the market.The two remaining factors allude to the cost of or the lack of access to the goodsinvolved for consumers and the existence of “elevated cost differentials” that they mayconfront when going to other suppliers. In short, it is a question of more or less elasticityin the market that affects the rapidity with which the consumer can change one productfor another without incurring large costs and that obviously will have a directrelationship to the substantial power that the economic agent exercises in the market.251Economic Competition

4. Mergers252C H A P T E R X I VAs we mentioned at the beginning, monopolistic practices together with concentrationsform the body of the LFCE. In practice, as is common knowledge, the number of concentrationsconsidered by the competition authorities in all countries is much greaterthan the number of investigations and complaints made in relation to monopolistic practices.For that reason, mergers merit a special review.On this matter, the LFCE follows the same system as various other national competitionlaws, including the system of the European Union, in the sense that for each specificeconomically important merger a prior notice must be sent to the competitionauthorities for its approval. In this regard, the LFCE establishes that the concentrationsto which the law refers “shall be notified to the Commission before being carried out”.In addition, which concentrations are subject to prior notification are defined, includingthree types:a) Transactions whose value is superior to approximately 80 million dollars; 11b) Transactions that are greater than 35 percent of the value of the assets or shares ofone of the agents involved, provided the assets have a value or sales constitute a valueof approximately 80 million dollars;c) In the third premise, when the economic agents that participate in the transactionhave assets or a sales volume, jointly or separately, of approximately 214 milliondollars and the transaction involves an additional accumulation of assets or capitalstock greater than approximately 37 million dollars.When the LFCE establishes that the notification must be made before the legal acts creatingthe concentration are carried out, it is important to know what the law means by“notify before carrying out.” In this respect the RLFCE establishes four rules:a) That the “legal act is perfected” before either of the two following situations occur:the first is that the merger is perfected in accordance with the applicable law. Forexample, if it is a merger between companies, the General Law of Business Corporations(Ley General de Sociedades Mercantiles) is the applicable law that determineswhen a merger between two companies is perfected. This is equivalent to sayingthat we have a conflict of laws, in which internal Mexican law is designated as theapplicable law, which in turn, due to its broadness, can designate foreign law asapplicable. In this regard, an act that is carried out abroad—an agreement or contract—isconsidered perfected when the foreign law considers that the perfectionof such legal act has occurred.__________11All the amounts are approximations because the LFCE makes calculations based on multiples of the minimumwage in the Federal District. Due to the fluctuation of the peso against the dollar, we have preferred to statean approximate amount in dollars, at the exchange rate of the peso at the time this book was written.

The second situation that this first rule establishes is the following: pursuant toSection I of Article 17 of the RLFCE perfection can also be considered to occur when“the condition precedent to which such act is subject” is fulfilled;b) In a second premise, even when a specific legal act has not been carried out, thereis actual or legal control over another economic agent, or parts of such economicagent are acquired indirectly (through trusts). Here the difficulty lies in knowingat what point the control begins and, therefore, on what date the prior notificationmust be made;c) In the case of corporate mergers, at the time of the signing of the merger agreement;d) When the acquisition is carried out through successive acts, when the last of suchacts are perfected and the thresholds for mandatory notification are surpassed.Notwithstanding the above, the participants in a concentration may not close the transactionuntil they have waited 10 days after having given notice thereof and the Commissionhas not prohibited it during that period. If the merger is prohibited within theabove mentioned time period, the participants must wait for the ruling of the Commissionin order to be able to carry out the concentration.A very important case that should be added and that clarifies a rule that the CFC had establishedpreviously, although with little precision, is related to mergers carried out abroad. Foreigncompanies that have assets, subsidiaries, or investments in Mexico and that decide tomerge with another foreign company have to give notice of the merger before the material orlegal effects occur in Mexico. This means that the notification must be made before the agreementor contract that creates the concentration is perfected abroad, since it is understood thatonce the concentration is carried out abroad, it will automatically have effects in Mexico.Regarding sanctions, economic agents that violate the law may be subject to the “partialor total divestment of what has been unlawfully concentrated, without prejudice of anyapplicable fine.” This sanction is a weapon in the hands of the CFC in the event that a concentrationis perfected before authorization is granted by the CFC and ultimately suchauthority considers it to be unlawful. There is, however, the serious problem of “scrambledeggs,” which are always difficult, if not impossible, to separate.In the area of concentrations it is important to mention that their analysis by the CFCis based on the principles detailed below.First, the CFC must analyze if the notified concentration could affect (diminish, deteriorate,or impede) competition or free participation in the market, for which it has toconsider the following elements “as evidence” of such anticompetitive effect and detrimentto free participation in the market:a) That the concentration can confer on the economic agent the power to set pricesunilaterally or to substantially restrict capital or supply in the relevant market,without the competing economic agents being able to counteract such power;253Economic Competition

) That the concentration could be an attempt to improperly displace other economicagents or prevent their access to the relevant market;c) That it “substantially” facilitates the ability of the participants in the concentrationto carry out monopolistic practices.254C H A P T E R X I VThe CFC, having in mind the elements mentioned and in the event one of them may be applicableto the concentration in question, must then determine the relevant market and subsequentlyidentify the economic agents making up such market, although that identification mayonly be of “the principal economic agents that as a group supply the relevant market.” Havingdone the above, the relevant power of the agent resulting from the concentration in such marketwill be defined. In this latter regard, it is important to first evaluate the gains in efficiencythat the concentration can provide, the effects on the relevant market, as well as whether itaffects or benefits other markets, and “the shareholdings of the economic agents involved inthe transaction in other economic agents that participate directly or indirectly in the relevantmarket or in related markets.” Now, if the CFC comes to the conclusion that there are elementsthat suggest that the concentration could affect competition and the free market, it can:a) Prohibit it;b) Subject it to the conditions the Commission establishes;c) Order the divestment of what has been concentrated.With respect to subsection b), above, there are three types of conditions to which theCFC can subject the notified concentration.a) “Engage in or abstain from certain conduct”;b) Transfer to certain third parties “assets, rights, partnership interests or stock”;c) Eliminate or change conditions or terms of acts carried out for purposes of the concentration.However, the limits on the CFC in the imposition of such conditions are that “they aredirectly linked to the correction of the effects of the concentration.”Finally, there are two types of concentrations that do not need to be notified:a) Legal acts regarding shares or ownership interests of foreign companies, when theeconomic agents involved in such acts do not accumulate in Mexican territoryshares, ownership interests, interest in trusts or assets in general, additional tothose that, directly or indirectly, they hold before the transaction;b) Another premise that releases the economic agent from giving prior notice andonly obligates it to give notice five days after the transaction has been carried out,is the following: that the “economic agent has held in ownership and possession,directly or indirectly, at least during the last three years, 98 percent of the sharesor ownership interests of the economic agent(s) involved in the transaction.”

CHAPTER XVRegulated Activities1. IntroductionArticle 5 of the Mexican Constitution guarantees the right as a general rule of all personsor entities to engage in any business activity that they may choose.However, there are certain governmental restrictions with respect to the activities wediscuss below in which, for strategic or public interest reasons, the participation of privateinterests has been limited or regulated. The second part of this chapter will exploresuch activities and the restrictions to which they are subject.2552. Transportation2.1. Transportation by RailRail service is an activity reserved for the State, which can authorize concessions andpermits for private sector participation.The Communications and Transportation Ministry (Secretaría de Comunicaciones yTransportes, SCT) is the institution responsible for policies and programs, the granting ofconcessions and licenses, the determination of standards and technical specifications forrailways and the application of sanctions.Rail concessions can only be granted to Mexican companies whose foreign capital doesnot exceed 49 percent of their total capital, although it is possible in a specific case, forthe National Foreign Investment Commission to issue a resolution allowing for a higherlevel of foreign capital participation.Concessions are granted through a public bidding process and for a term of up to 50 years.They can be extended one or more times for an additional term or terms that cannot exceed50 years in total. The extension will be subject to the rules and conditions established inArticle 11 of the Railway Service Regulatory Law (Ley Reglamentaria del Servicio Ferroviario).

These concessions can take two forms:a) For the construction, operation, and use of the railways as a general communicationroute;b) For the provision of railway transportation services to the public.256C H A P T E R X VOnce the concession is granted, those concession holders in the first category will beobliged to establish traffic control centers within the country. Furthermore, the constructionor reconstruction of concessioned railways requires the prior approval by theSCT of the project and of other documents related to the work to be carried out.The concession to provide railway transportation services to the public can be for passengeror cargo service and in both cases the concession holder must provide to the personnelthat operate or assist in the operation of the railway equipment the relevanttraining and education in accordance with the Federal Labor Law (Ley Federal del Trabajo,LFT). Said personnel must also obtain a federal railway license issued by the SCT andsubmit to medical exams.The concession for the provision of railway cargo transportation services to the publicallows the concession holder to transport any type of goods, imposing on such concessionholder liability for any loss or damage to property transported by the concessionholder’s railway. The SCT regulates the transport of hazardous materials by rail.The concession for the provision of railway transportation services to the publicrequires that the concession holder take measures to guarantee the safety and security ofthe passengers at all times, as well as to accept liability for injuries the passengers or theirbelongings may suffer. The concession holder must obtain insurance covering thesepotential liabilities.The SCT can also grant licenses for:a) The provision of auxiliary services, among which are passenger and cargo terminals,the transfer and containment of liquids, equipment maintenance workshops,and supply centers for equipment operation;b) The construction of access routes, crossings and peripheral installations in the railroadright of way;c) The installation of advertising and publicity billboards in the right of way;d) The construction and operation of bridges over railways. These permits can onlybe granted to Mexican companies.2.2. Air TransportationAir transportation has been highly regulated by the Mexican government due to the variousinternational treaties in which Mexico participates. The stipulations of these treatiesrequire the relevant Mexican law to be updated.

In accordance with the Civil Aviation Law (Ley de Aviación Civil), Mexican air space isa general means of communication subject to national domain and to federal regulationand jurisdiction. The SCT regulates civil aviation and it has the authority to plan, formulate,and direct regulatory policy and programs for air transportation services; grantconcessions and permits for participation in different air transportation services; issuematriculation and flight-worthiness certificates; establish and verify the system of airroutes within national air space, as well as maintain the Mexican Aeronautical Registry.Air transportation services are divided into the following subcategories: air transportationservice to the public, which can be national or international, regular or irregularpassenger, cargo or postal shipping; and private air transportation services, which canbe commercial or non-commercial.2.2.1. Air transportation services to the publica) Regular air transportation services to the public. The SCT must grant a concession toprovide this service, which can only be granted to Mexican companies. In thisrespect, foreign investment is very limited because the Foreign Investment Lawdictates that foreign participation in such a Mexican company cannot exceed 25percent of the company’s total capital. To obtain such a concession, interested partiesmust show:i) That they possess the technical, financial, legal and administrative capacity toprovide the service;ii) The availability of aircraft and other relevant equipment that complies with theestablished requirements;iii) The availability of hangers, maintenance facilities, personnel and all of theremaining structures necessary for their operations.These concessions are granted for a term of 30 years, which can be extendedfor one or more terms of 30 more years.Those who obtain a concession to provide regular national air transportationservices to the public can also provide regular international air transportation servicesto the public if the SCT authorizes the corresponding routes;b) Irregular national air transportation services to the public. The SCT must grant a permitto provide this service, which can take the following forms:i) Charter services, through which the permit holder provides the partial or completeservice of one or more aircraft. Charter services for passengers can be:1) In the form of a tourist or excursion package where the services are sold tothe public with group or individual fares, a round trip is made, and lodgingand land transportation services are included;2) In the form of round-trip transportation of a group for special events for aspecified time period;257Regulated Activities

258C H A P T E R X V3) In the form of one-way transportation of a group with a return without passengersor round-trip transportation with the return trip on the same day.The flights or package of flights they wish to operate must be previouslyapproved by the SCT;ii) Air ambulance is a service provided for the transport of and attention to sickor injured persons from one point within the country to another or differentpoints in the country and can only be offered by aircraft equipped with onboardmedical services;iii) Air taxi is a service in which the permit holder provides the customer with theservices of one or more aircraft. This is the case with the transport of sick orinjured persons in an emergency when the previously mentioned aircraftequipped for medical emergencies are not available;iv) Irregular services of other types, provided for in the official Mexican standards(NOMs) for the purpose of technological development.Said permits will be granted for an indefinite period of time;c) Standard international air transportation services for the public. Mexican companieswhich are holders of a standard national air transportation concession will onlyneed the SCT’s authorization regarding the specific routes, which can only be usedcommercially when they have been authorized. Foreign companies will need a permitfrom the SCT in order to offer said service to and from Mexican national territory.This permit will be valid for an indefinite period of time. It is important tomention that the arrival to and departure from points within Mexican territorymust be made at international airports;d) Irregular international air transportation services to the public. The SCT must also granta permit for the provision of this service, but the service is not subject to fixedroutes, itineraries, frequencies, or schedules and it may operate from any pointwithin Mexican territory and to any destination abroad and vice versa. The typesof permits are the same as those allowed with regular national air transportationservices, with the exception that if the aircraft is foreign, it cannot transportbetween two or more points within Mexican territory. Rather, the foreign craft canonly arrive to or depart from one point within Mexican territory to or from a foreigndestination and vice versa.The four types of transportation services provided to the public that were discussed abovecan be oriented towards passengers, cargo, mail, or a combination of these purposes. Theoperation and provision of these services will be subject to the SCT’s authorization in accordancewith the fixed routes, schedules, itineraries, and frequencies assigned by the SCT.Concession holders must, among other things, obtain a registration certificate and a certificateof air-worthiness of the aircraft, as well as an insurance policy, adopt the necessary

measures in order to adequately attend disabled and aged persons, as well as provideemployees with training and orientation in accordance with the LFT. Furthermore, it ismandatory to use the air route system established by the SCT.2.2.2. Private air transportation servicesPrivate air transportation services are directed towards one or more persons or entities,other than the owner or holder of the aircraft, for the purpose of generating a profit. Theseservices are subject to a permit and may only operate in areas authorized by the SCT.These types of services are:a) Aircraft rentals to third parties;b) Specialized air transportation services, among which are aerial photography, aerialtopography, commercial publicity, aerial fumigation, artificial rain creation, parachuting,aerial inspection, and monitoring, flight training, etc.;c) Those services the SCT specifies in accordance with the NOMs.Foreign aircraft through which private air transportation services are provided will besubject to the provisions of applicable international treaties.3. Energy3.1. The Legal Regime for Natural Gas in MexicoThe Law Regulating Article 27 of the Constitution in Petroleum Matters (Ley Reglamentariadel Artículo 27 Constitucional en el Ramo del Petróleo, LRACRP) establishes that only theMexican nation can engage in the various forms of hydrocarbon exploitation that constitutethe petroleum industry. For the purposes of the LRACRP, the exploration, exploitation,refining, and first-hand sale of natural gas (hereinafter “gas”), as well as thetransportation and storage necessary to connect the exploitation of gas to its production,among other activities, are considered to constitute the petroleum industry.The LRACRP provides that gas transport, storage, and distribution services can be providedby private entities, as long as they have the proper permit.The first-hand sale of natural gas, as well as its storage, transport, distribution, importation,exportation, and any other matter related to natural gas are regulated by the NaturalGas Regulations (Reglamento de Gas Natural, RGN).259Regulated Activities3.1.1. First-hand sales of natural gasFor purposes of the RGN, first-hand sales are considered to be the “first alienation of gasof national origin by Petróleos Mexicanos (the Mexican National Petroleum Company,PEMEX) to a third party for delivery within national territory”.

Pursuant to the RGN, PEMEX must provide to the purchaser at least two price quotes forthe amount of natural gas sought; these prices will function as sales offers and willinclude the terms and conditions for the sale of gas. The two price quotes PEMEX mustoffer are the following:a) At the point of departure from a processing plant;b) At the delivery point or points determined by the purchaser, itemizing the chargesfor transportation and the price of the gas at the point of departure from a processingplant, as well as other services that PEMEX has provided.PEMEX has the capacity to authorize volume discounts or different contractual conditions,as long as it does not engage in any unduly discriminatory practices.260C H A P T E R X V3.1.2. Permits for the transport, storage, and distribution of natural gasIn order to engage in transport, storage, and distribution activities regarding naturalgas, a permit granted by the Energy Regulatory Commission (Comisión Reguladora deEnergía, CRE) is required. Such permits will only be granted to social sector and commercialcompanies.The RGN defines storage, transport, and distribution in the following manner:• Storage. The activity of receiving, holding in deposit, and delivering gas, where thegas is held in fixed facilities other than gas pipelines.• Distribution. The activity of receiving, pumping, delivering, and, as the case maybe, selling gas through pipelines of a given geographical zone.• Transport. The activity of receiving, pumping, and delivering gas through gaspipelines to persons who are not the final consumer located within a given geographicalzone.The commercial companies that hold transport and distribution permits must complywith the following:a) Have as their principal corporate purpose the provision of transportation services(if transporters) and distribution services (if distributors);b) Include in their corporate bylaws the obligation to maintain a minimum fixed capital,not subject to withdrawal, of 10 percent of the proposed investment in a givenproject.It is important to mention that the same person can be the holder of permits for transport,storage, and distribution, as long as such person complies with the requirementsestablished by the RGN.The permits will be valid for 30 years beginning from the date they are granted andthey can be renewed.

A party interested in obtaining a distribution, storage, or transport permit must providethe CRE with a petition containing the following:a) The corporate name and domicile of the petitioner;b) A certified copy of the corporate charter and bylaws as amended or the documentationthat proves its legal existence;c) The documents that prove the representative capacity and powers of the legal representative;d) The purpose, description, and technical specifications of the project;e) The description of the safety methods and procedures regarding the operation andmaintenance of the system;f) The documentation showing the technical viability of the project;g) The documents that demonstrate the petitioner’s technical, administrative, andfinancial capacity;h) The investment plans and the minimum investment commitments, including thestages and timeframes for carrying them out;i) The proposal for general conditions and rates regarding services;j) A copy of the notice to be presented to the Federal Competition Commission(Comisión Federal de Competencia) that manifests the petitioner’s intention to obtaina distribution, transportation, or storage permit;k) A description of the operating conditions, the computer and information networksystems, and the mechanisms and equipment that will be utilized for open accessto third parties;l) The date on which the petitioner will begin providing services, specifying, if applicable,each phase of the project’s development.261Regulated ActivitiesRegarding transportation services, in addition to the previously mentioned requirements,the petition should contain:a) The proposed range of services;b) The project’s transportation capacity;c) A description of the different types and forms of services and their market;d) A demonstration of the potential demand for services;e) The sources of gas supply;f) Any transportation agreements made with specific customers;g) A diagram of gas flow routes;h) Any effects of the proposed project on the corresponding transportation system.If storage services are offered, the petition should include:a) The location and characteristics of the project;b) The storage capacity of the project.

In relation to non-exclusive distribution services, the petition should include:a) The geographic zone in which the project will be developed;b) The strategies the petitioner will use to offer distribution services to new end-userswithin the corresponding geographic zone, including the cases in which the newend-users must cover any connection charge;c) The supply sources.262C H A P T E R X VOnce the permit petition is submitted, the CRE will have a month to review it. In theevent that the petition fails to comply with all of the applicable requirements mentionedabove, the CRE will notify the interested party and will grant the party one monthto submit the missing information. In the event that the interested party fails to submitthe information requested by the CRE within the established period of time, the petitionwill be rejected.If the petition complies with the applicable requirements, the CRE must publish within10 days an abstract of the proposed project in the Official Federal Gazette and establisha period of two months for the receipt of other petitions, objections, or comments inrelation to the given project.The CRE will have a period of three months to evaluate the project for which the permitis being requested.The CRE has the authority to carry out investigations; gather information that it considersnecessary; consult with other federal, state, and municipal authorities; hold hearingsand, in general, perform any act that is necessary for the evaluation and decisionregarding the granting of a permit. The CRE is also entitled to request changes to the projectfor which a three month period will be granted.Once the CRE concludes its evaluation it will grant the permit within the followingmonth and publish a description of the purpose of the permit and the name and domicileof the permit holder.The permit titles will contain:a) In all cases:i) The corporate name of the permit holder and its domicile within national territory;ii) The purpose of the permit;iii) The description and characteristics of the project;iv) The investment plans and minimum commitments, as well as the stages andtime periods for carrying them out;v) The deadline to begin providing services for each stage of the project’s development;vi) The general conditions for the provision of the service;vii) The generic description of the safety measures and procedures regarding the

operation and maintenance of the systems, which will be substituted withinthe period of time specified by the CRE by the detailed plan with specifications;viii) The insurance policies the permit holder must have;ix) Any other information that the CRE deems appropriate;b) Regarding transportation services, the permit title must include, in addition to thepreviously mentioned requirements:i) The geographic range of the transportation services;ii) The transportation capacity of the project;c) In the case of storage service, the title must also include:i) The demarcation of the geographic zone;ii) The points for the reception of gas;iii) Any exclusivity period;iv) Any minimum coverage and development plan in the given geographic zone.3.1.3. Characteristics of transportation permitsEach transportation permit will be granted for a specific capacity and geographic range.The authorized range shall be recorded with the CRE.The transportation permit holder may deliver and receive gas at any point within theauthorized range, as long as the permit holder notifies the CRE of the location of thesepoints. It is important to mention that transportation permits do not grant the permitholder exclusivity in the provision of services.Transportation services include the reception of gas at one point of the transportationsystem and the delivery of a similar quantity at a different point of the same system.263Regulated Activities3.1.4. Characteristics of storage permitsEach storage permit will be granted for a specific location and a specific capacity.Storage services include the reception of gas at one point of the storage system andthe delivery, in one or more acts, of a similar quantity at the same or another contiguouspoint of the same system.3.1.5. Characteristics of distribution permitsEach distribution permit will be granted for a geographic zone determined by theCRE, keeping in mind the factors that permit the profitable and efficient developmentof a distribution system, as well as the urban development plans approved bythe competent authorities. In general, a geographic zone corresponds to a populationcenter.It is important to note that the first distribution permit for a geographic zone willbe granted through a public bidding process and will confer to the permit holder

exclusivity rights for 12 years on the construction of the distribution system and thereception, routing, and delivery of gas within the geographic zone. The exclusivityperiod begins from the date the permit is granted.The distribution permits will not grant exclusivity rights in regards to the commercializationof gas in the given geographic zone.Customers located in a geographic zone may contract gas supply services other thanthose provided by the distributor, in which case the distributor must allow open accessto its system through the payment of the corresponding fee.Distribution services include:a) The commercialization and delivery of natural gas by the distributor to the enduserwithin a given geographic zone, or;b) The reception of natural gas at the point or points of reception of the distributionsystem and the delivery of a similar quantity at a different point of the same system.264C H A P T E R X VThe general conditions for the provision of distribution services must be approved bythe CRE, will form part of the permit title, and will include:a) The fees for the provision of services;b) The terms and conditions regarding access to and provision of the various types ofservice;c) The rights and responsibilities of the service provider;d) The arbitration procedure by which the permit holder proposes to resolve disputesarising from the provision of the services.3.1.6. Permit holder obligationsIn providing services, permit holders shall have the following obligations among others:a) To publish in a timely manner, under the terms established by the CRE, informationregarding available capacity and capacity not contracted;b) To notify the CRE immediately of any circumstance that would imply the modificationof the conditions of the provision of services;c) To obtain and keep effective the insurance policies established in the permit titlein order to cover any liabilities the permit holder may incur;d) To provide a permanent service for receiving complaints and reporting emergencies;e) To immediately address end-user emergency telephone calls;f) To inform the CRE in a timely manner of any circumstance that adversely affects ormight adversely affect the provision of services;g) To abstain from engaging in discriminatory practices;h) To respond to all requests for service within a month of their receipt in the case oftransportation or storage services, and within ten days in the case of distributors.

3.1.7. Transfer, lien, revocation, and expiration of permits3.1.7.1. Transfers of permitsThe CRE must authorize the transfer of a permit. This authorization will only be grantedwhen the potential permit holder to which the permit will be transferred:a) Meets all of the requirements to be a permit holder;b) Agrees to comply with all of the obligations imposed by the permit and with thegeneral conditions for the provision of the service.3.1.7.2. LiensThe holder of a transportation, storage, or distribution permit can put a lien on the permitand the rights stemming from that permit to guarantee debts or finances directlyrelated to the provision and extension of the service, as well as operation-related debts,notifying the CRE 10 days before the granting of the guarantee.In the event that the permit’s lien is for purposes other than those specified above, theprior approval of the CRE will be necessary.3.1.7.3. Expiration of permitsThe following are causes for the expiration of a permit:a) The expiration of the term established in the permit or any authorized renewal;b) The early termination requested by the permit holder and authorized by the CRE;c) The revocation pursuant to the law;d) The occurrence of a terminating condition.265Regulated Activities3.1.7.4. Revocation of permitsThe following are causes for revocation of a permit:a) Failing to exercise the rights the permit grants;b) Unjustifiably interrupting the services without cause or authorization from theMinistry of Energy (Secretaría de Energía, SENER);c) Engaging in discriminatory practices that harm the consumer or violating anyprices and fees that the competent authority may have established;d) Assigning or placing a lien on a permit without complying with the requirementsof the RGN;e) Failing to comply with the NOMs.3.2. Gas LPThe LRACRP establishes that the exploration, exploitation, and sale of first-hand gas isreserved to the nation and that such activity will be carried out through PEMEX.

266C H A P T E R X VThe LRACRP also indicates that, with prior approval, social and private sectors can providetransportation, storage, and distribution services for gas.Based on the foregoing and for purposes of regulating the LP gas industry, on June 26,1999 the SENER issued the New Liquid Petroleum Gas Regulation (Nuevo Reglamento deGas Licuado de Petróleo, RGLP).Among the issues that the RGLP regulates is that of first-hand sales. According to theRGLP, first-hand sales are the first sale of LP gas that PEMEX makes to a third party of nationalorigin for the purpose of delivery within Mexican territory. PEMEX’s sale of importedliquid petroleum gas to a third party, when mixed with LP gas of national origin, is alsoconsidered a first-hand sale.First-hand sales include all services that are necessary for the sale and delivery of LP gas.The CRE is responsible for issuing directives to set the maximum price for LP gas soldon a first-hand basis. The CRE also establishes the general terms and conditions that governsuch sales.PEMEX cannot engage in practices that limit or in some way impede the acquisition ofLP gas by a third party. Examples of such practices are as follows:a) Granting undue preferences to a particular person;b) Conditioning the sale of LP gas on the acquisition of some other asset or service;c) Conditioning the sale of said gas on the acquirer not selling the gas to a third party;d) Refusing to sell LP gas to a given person;e) Requiring purchasers to act in a certain manner or reprisals will be taken against them.Depending upon which is the competent institution, the SENER or the CRE can grant thefollowing permits:a) For transportation, which can be for tanker-trucks, tractor-trailers, or tanker-ships,or through gas pipelines;b) For storage, through a depository storage plant or a supply plant;c) For distribution, through a storage plant for storage or carburation through gaspipelines;d) For storage through LP gas stations for carburation for self-service;e) For transportation of pipelines for self-service consumption.Transportation and storage permits may be granted to commercial businesses. Distributionpermits may be granted to natural persons of Mexican nationality or to commercialbusinesses whose charter contains a clause excluding foreign participation.Those interested in obtaining a permit must take the following steps:a) Give notice to the Federal Competition Commission of the intention to acquire apermit;b) File a petition that must contain the following information:

i) The petitioner’s business name, domicile, and that of any legal representative,as well as the commercial trademark with which the business is identified;ii) Certified copy of the petitioner’s official identification or the legal instrumentthat proves the petitioner’s legal existence and that of any legal representative;iii) The type of permit sought;iv) The technical specifications of the equipment or facilities;v) The technical opinions of an approved inspection unit that proves that theproject, facilities, or equipment comply with the applicable NOMs.When petitioning for a permit for tractor-trailers, in addition to the foregoing requirements,the petitioner must submit a list of the tractor-trailers that will be used in providingthe service and a technical opinion for each of such vehicles pursuant to the termsof the previous section.If the petitioner seeks a permit to transport gas through gas pipelines, the followingmust also be submitted:a) A basic plan of the location that shows the general routing of the pipeline or systemof pipelines and their transportation capacity;b) General routing plans organized by sections;c) Detailed plans of the facilities;d) Technical-descriptive logs of the project;e) The investment programs and commitments;f) The documentation evidencing financial capacity;g) The documents showing the ownership, possession, or authorization to utilize thefacilities and equipment;h) The proposal for the general terms and conditions for providing the services;i) The date of initiation of operations;j) The projections of the potential demand;k) Any transportation agreements negotiated with possible purchasers;l) The diagram of generic flows of LP gas.267Regulated ActivitiesIn the case of a permit for storage of LP gas at a deposit plant, the following additionaldocumentation will be required:a) The plans for the civil, mechanical, electric, fire prevention, and planimetricsystems;b) Technical-descriptive logs of the projects;c) The safety measures in force.If the permit is for the storage of LP gas at a supply plant, the following additional documentationis necessary:

a) A list of the tractor-trailers and tanker vehicles that will be used;b) The plans for the civil, mechanical, electric, fire prevention, and planimetricsystems;c) Technical-descriptive logs of the projects;d) The safety measures in force.268C H A P T E R X VWhen the petition is for distribution through a storage plant, the following additionalinformation will need to be submitted:a) A list of the tractor-trailers and tanker vehicles that will be used;b) The plans for the civil, mechanical, electric, fire prevention, and planimetricsystems;c) Technical-descriptive logs of the projects;d) A list of the distribution and mini-tank warehouses that will be used;e) Geographic zone in which services will be provided;f) The safety measures in force.Regarding permits to distribute carburation, the petitioner must submit the following:a) A list of the tanker vehicles that will be used;b) The plans for the civil, mechanical, electric, fire prevention, and planimetricsystems;c) Technical-descriptive logs of the projects;d) The safety measures in force.Lastly, for a permit to distribute LP gas through gas pipelines, the following must besubmitted:a) Basic plan of the facilities that shows the general route of the system of gaspipelines;b) Technical-descriptive logs of the projects;c) Plans of the general routing by sections;d) Detailed plans of the installations;e) Safety measures.If the requested permit is under the authority of the SENER, this agency will issue thecorresponding resolution within 20 days from receiving a request. If the permit requestedis to transport gas by a tanker vehicle or water vessel, the SENER must make a determinationwithin 10 days after receiving the petition.In the event that the petition does not meet the requirements established by the RGLP,the interested party will have 30 days from the date of SENER’s notification thereof tocomplete its petition.

Regarding permits under the authority of the CRE, if the petition does not comply withthe requirements established by the RGLP, the CRE must notify the interested party of theomissions in the petition within 15 days after the CRE receives the petition. The interestedparty will have one month to remedy the omissions in the petition. Once the omissionsare remedied, the CRE will have 140 days to issue a determination regarding thepermit. If after the 140 days the CRE has not issued a determination, it will be assumedthat the permit has been denied.Permits will be valid for 30 years and can be extended for additional periods of 15years with the permit holder’s valid petition. It should be mentioned that permits do notconfer any exclusivity rights to the permit holder.Currently, Mexico is the leading consumer of LP gas for residential purposes. In recentyears, the growth of the demand for this fuel has exceeded PEMEX’s expectations, whichhas made it necessary to import considerable quantities of this gas in order to satisfy thedemand. For this reason it is important to search for mechanisms that foment privateinvestment in this area so that Mexico no longer needs to import the gas and can ultimatelybecome an exporter of this fuel.3.3. ElectricityFor many decades, only the State was allowed to participate in the generation, distribution,transformation, and supply of electricity; however, due to the rapid growth ofdemand for electricity and the large amount of investment that the federal governmentmust make in this area, various legal reforms were passed in 1992 that allow for privateinvestment in the generation of electricity.Notwithstanding this opening to private investment, constitutional reforms thatwould allow a more active participation of private investment in the electricity sectorare necessary. Many reform proposals have been put forward, but none of them havebeen approved by the Mexican Congress due to the political interests of the oppositionparties.Currently, electricity is regulated by the Provision of Electricity to the Public Law (Leydel Servicio Público de Energía Eléctrica, LSPEE) and the Regulation of the Provision of Electricityto the Public Law (Reglamento de la Ley del Servicio Público de Energía Eléctrica,RLSPEE). Both the LSPEE and its regulation establish that only the nation may generate,conduct, transform, distribute, and supply electricity that is destined for public use.The LSPEE does not consider the following as providing electricity to the public:a) The generation of electricity for self-supply, the co-generation of electricity, orsmall-scale production;b) The generation of electricity by independent producers for the purpose of sellingthe energy to the Federal Electricity Commission;269Regulated Activities

c) The generation of electricity from co-generation, independent production, andsmall-scale production for exportation;d) The importation of electricity by persons or entities that will only be used to supplytheir own needs.Private persons can engage in the above-mentioned activities with SENER’s priorapproval.In the following section we will explain the characteristics of the previously mentionedactivities, the requirements that must be met, as well as the steps that must be taken inorder to acquire the corresponding permits.270C H A P T E R X V3.3.1. Self-supply (Autoabastecimiento)Self-supply is considered to be the utilization of electricity for one’s own consumption,as long as said energy is generated by plants used to satisfy the needs of the group of coownersor partners.In this case, it is an indispensable requirement that the beneficiaries of the electricitybe partners or shareholders of the company holding the permit.In order for such a permit to be granted, the following requirements must be met:a) When there are several self-supply permit applicants where the generation of electricitywill derive from one single centralized source, the petitioners must either be coownersof such electricity source or they must incorporate a company whose purposewill be the generation of electricity in order to meet the self-supply needs of its partnersor shareholders. Under no circumstances may the permit holding company supplyelectricity to natural or legal persons that are not members of such company,except when an assignment of rights or a modification of plans is duly authorized;b) The petitioner will be obligated to place the excess of its production of electricityat the disposal of the CFE.3.3.2. CogenerationThe following activities are considered cogeneration:a) The production of electricity in tandem with steam or another type of secondarythermal energy or both;b) The direct or indirect production of electricity from thermal energy not used in theprocesses involved;c) The direct or indirect production of electricity utilizing fuels produced in theprocesses involved.In addition to the general requirements that must be met by any person in order toobtain a permit for the self-supply, cogeneration, or importation of electricity or any

other type of energy, the parties interested in obtaining a permit for cogeneration mustcomply with the following:a) The electricity generated be used to meet the needs of the establishments associatedwith the cogeneration, which will be the natural persons or entities who:i) Utilize or produce the steam, thermal energy, or fuels that give rise to theprocesses on which the cogeneration is based; orii) Are co-owners of the facilities or partners of the company in question;b) The permit petitioner agrees to place its excess electricity at the disposal of the CFE.The petitioners must also present, in addition to the documentation that petitioners ofall permits must present, a study of the facilities that includes at least a general descriptionof the process, diagrams of the process, thermal balances, and specific fuel requirements,as well as the availability of the excesses of electrical power and energy thatwould be expected on a typical day, formulated on a monthly and annual basis.3.3.3. Independent production of electricityGeneration of electricity in a plant whose capacity is greater than 30 MW and exclusivelydestined for sale to the Commission or exportation is considered the independent productionof electricity.Petitioners for permits to independently produce electricity must comply with the followingrequirements:a) They must be natural persons or legal entities incorporated in accordance withMexican law and having their domicile in Mexico;b) The projects contemplated in the petition are included in the respective CFE planningand programs or are equivalent;c) The petitioners must agree to sell their electricity production exclusively to the CFEthrough long-term agreements under the terms of Article 36 bis or with theapproval of the SENER in the terms of the LSPEE, or to export all or part of said production.271Regulated Activities3.3.4. Small-scale production of electricitySmall-scale production is the generation of electricity destined for:a) Sale of all of the electricity generated to the CFE, in which case the projects cannothave a total capacity over 30 MW in an area determined by the SENER;b) The self-supply of small rural communities or isolated areas that lack electricityservices, in which case the projects cannot exceed 1 MW;c) Exportation within the maximum limit of 30 MW.In this case the following requirements must be satisfied:

a) The petitioners must be natural persons or legal entities formed according to Mexicanlaw and with their domicile in Mexico;b) The petitioners must destine all of their production for sale to the CFE. In this case,the total capacity of the project, within an area determined by SENER, cannot exceed30 MW.272C H A P T E R X VThere is the possibility of a small-scale production permit where all of its electricity productionis for small rural communities or isolated areas that lack such electricity, whichthey use for their own consumption. In such a case, the interested parties should:a) Form consumer cooperatives, co-ownerships, associations, or civil partnerships, orexecute joint cooperation agreements for such self-supply purposes;b) List the persons to whom the electricity will be delivered and the conditions inwhich such delivery will be made to the end-consumer, in accordance with therespective agreements that govern the activity.3.3.5. Importation or exportation of electricityIn order to obtain an importation or exportation permit for energy, the petitioners mustobserve the following:a) Import or export activities can include the conduction, transformation, and deliveryof a given quantity of electricity, according to the specifics of each case;b) Permit holders can temporarily use the national electricity system only if they havepreviously executed an agreement with the CFE and only where such use does notput at risk the provision of electricity to the public or jeopardize the rights of thirdparties. These agreements must stipulate the compensation obtained by said entityunder the control of the permit holders.The holders of such permits are obligated to the extent applicable to:a) Reserve, to the extent possible, available electricity for public consumption when,due to Acts of God or circumstances beyond human control, public service is interruptedor restricted. This duty shall last only as long as the interruption or restriction.The permit holder will be compensated for such emergency services;b) Comply with any NOM issued by the SENER regarding the infrastructure and facilitiesrelated to the permits referred to in Article 36;c) Comply with the National Electric System (Sistema Eléctrico Nacional) dispatch and operationrules that the CFE may establish in the delivery of electricity to the public network.3.3.6. Common rules applicable to the granting of permitsPermits are valid indefinitely, except those granted for independent production, whichare valid for up to 30 years.

It is important to specify that there is no permit requirement for self-supply electricitythat does not exceed 0.5 MW, nor is there such a requirement for generating plants ofany capacity when they are exclusively reserved for self-supply used in emergency situationsstemming from the interruption of public electricity services.Petitions for permits should be filed with the SENER in the specified format and shouldprovide the following information:a) Petitioner’s corporate name and domicile;b) The purpose of the permit and, if applicable, the period of time for which it issought;c) The location of the plant, capacity of the facilities, and the places where the energywill be used;d) Energy supply program, including information regarding the source, type, substitutesand costs, and, if applicable, the use of national waters;e) Where relevant, the availability and reliability of excess capacity and associatedenergy; complementary capacity and energy requirements as back-up or subject toavailability, as well as energy transmission services;f) The additional information required for each of the different permits.Additionally, each petition should include the following documents as attachments:a) If applicable, the documents that prove the petitioner’s legal status and existence;b) A description, in general terms, of the project, including the characteristics of theplant and the surrounding facilities; the estimated annual energy production andconsumption of fuel; information regarding the use of water resources and theinformation regarding compliance with environmental and land use regulations inaccordance with the relevant laws;c) The documents that prove the ownership, possession, or authorization for use ofthe land that the facilities will occupy or, in their absence, a statement of the legalsteps taken in that regard.273Regulated ActivitiesThe SENER will examine the petition within 10 business days. Once the SENER beginsto process the petition, it will request the CFE’s opinion. This opinion should be supportedby objective elements regarding the availability and reliability of the excess capacityand energy of the project, the capacity and back-up energy requirements and thetransmission services provided for in the permit petition.The CFE will respond within the following 30 business days. In cases governed by Article111, this period will be reduced to 10 business days. However, the SENER is not boundby the CFE’s opinion.Once the above administrative steps are completed, the SENER, with the petitioner’sknowledge, will request clarifications and any additional information that may be

274C H A P T E R X Vconsidered important for purposes of completing the petitioner’s file, for the filing ofthe technical-descriptive log, and for the substantiation of the project to be developed,which should include the elements referred to in Section II of Article 83 in detail.Once the data and documents referred to in the previously mentioned article arereceived, the SENER will, within 30 business days, reach a decision on the petition and,if it is approved, will issue the permit.The permit holders will be subject to the following obligations:a) To not sell, re-sell or otherwise alienate, either directly or indirectly, any capacityor electricity, except where authorized by the Law and the RLSPEE;b) To notify the SENER of the date on which the construction work has been finishedwithin 15 business days of such date;c) To the extent possible and with compensation, to provide the electricity needed forpurposes of public consumption when, due to an Act of God or circumstancesbeyond human control, regular service has been interrupted or restricted, only forthe time period in which such regular service is unavailable;d) To comply with the legal and regulatory provisions, as well as the official Mexicanstandards and any other applicable provisions regarding works and facilities subjectto permits;e) To operate and maintain its equipment and facilities in conditions that do not posea risk to the permit holder or third parties;f) Once the operation of the facilities begins, and for the exclusive purpose of statisticsgathering,to inform the SENER, using the format determined by the Ministry, of thetype and volume of fuel used and the quantity of electricity generated, specifyingthe quantity used to satisfy the permit holder’s own needs and the quantity deliveredto the CFE or destined for exportation, as well as, if applicable, the importationof electricity.

CHAPTER XVIGovernment Acquisitions1. IntroductionIn order to secure better technical and economic conditions regarding the formationof contracts between the Mexican federal government and private parties, the PublicSector Acquisitions, Leasing, and Services Law (Ley de Adquisiciones, Arrendamientos yServicios del Sector Público, LAASSP) and the Public Works Law (Ley de Obras Públicas,LOP) 1 establish the manner and procedure through which the federal government willchoose the person or business with which it will contract for the following goods andservices:a) Acquisitions of moveable goods (such as office equipment, automobiles, ships, airplanes,etc.);b) Leasing of moveable goods and real estate;c) Services (such as the cleaning of computer equipment; lawyers and accountants;coffee service, etc.);d) Acquisitions of real estate (an office building for a governmental ministry);e) Public works constructions (building, highway, bridge, monument, power plants,and other infrastructure projects).275As can be observed, practically all of the contracts the federal government forms withprivate parties must comply with the forms and procedures established by these twolaws. Although there are differences between these two laws (especially in regards to thetime periods that must be observed in the procedures), the regulation of the formationof these contracts is very similar, so much so that both laws establish the same three contractingforms or procedures.__________1These two laws are only applicable to the contracts entered into by the federal government. Therefore,regarding contracts awarded by local governments, every state of the republic has equivalent laws establishingthe procedures and manner in which each local government is to award contracts.

Before explaining each of these forms, it should be mentioned that it is important toverify that the governmental ministry or public institution with which a private partyseeks to contract has made a specific budgetary appropriation for the purpose of formingsaid contract, as well as that the specific amount of the appropriation is sufficientregarding the costs of the contract. If there is not a specific appropriation or an insufficientappropriation, there is no legal mechanism that can obligate the State to pay anyamounts owed. In order to verify this budgeting, public institutions are required to publishtheir contracting projections twice on their internet web pages; once on November 1,which projections are a mere estimate for the following year and are not definitive; andthe definitive budget no later than March 31 of the corresponding year.2. The Contracting Procedure276C H A P T E R X V I2.1. Public BiddingPublic bidding is the general rule for contracting. It involves a competition through whichthe state selects from among the participants the contractor who offers the best economicand technical terms for the proposed contract.The procedure can be national or international, depending on the nationality of the personsparticipating in the competitive bidding and the national or foreign origin of thegoods to be acquired. 2The first step in a public bidding is the publication of an invitation to bid that states,along with other information, the type of contract that is to be executed and the goodsor services to be acquired, thereby informing the general public of the government’sintention to execute the contract.The second step is the publication of the terms and conditions of the bidding processwhich, in addition to the information contained in the invitation to bid, informs the bidderof the terms and conditions under which the contract will be executed, the specificationsof the goods or services to be acquired, and the suitability and solvency required ofthe bidder so that, on the basis of this information, the bidding party can decide whetheror not to participate in the bidding process. During this stage, we recommend that the__________2The public bid must be international in the following cases:a) When mandatory under applicable treaties;b) When, after the contracting government institution carries out the corresponding market research, thereis no offer from national providers of the good or service in the quantity or quality required, or the priceis right;c) When a national bid has been carried out, but no national proposal is put forth, or none that meets legalrequirements;d) When it is so specified for contracts financed by external loans or granted to the federal government orwith its backing.

interested parties thoroughly review the invitation to bid in order to evaluate the possibilityof participating in it. This review should analyze the general description of thegoods or services in question and evaluate the bidder’s ability to meet all the requirementsof the contract.Following the publication of the invitation to bid, a clarification meeting is held thatallows the bid participants to air and resolve all questions or uncertainties regarding theterms and conditions of the bid project, such as the scope of the services to be offeredor the specifications of the goods or works in question. Minutes are drafted of the resultsof the meeting that become part of the bid’s terms and conditions and of which the participantscan request a copy.In the event that a private party decides to participate in a bid, it must present on thedate indicated in the terms and conditions, a sealed envelope that includes the economicand technical proposals for the project, so that the state can evaluate, on the basis of thebidder’s offer, which offer is best and to which bidder to award the contract. As a practicalquestion, it is worth mentioning that the bidding procedure is extremely rigid, whichon many occasions has resulted in the government agencies disqualifying a bidder due toa failure to comply with certain formal requirements. For this reason it is important thatbidders always take the following into account when submitting their proposals:a) Representation. Even if the terms and conditions only require a simple proxy letter inorder to submit the proposal, it is recommended that a certified copy of the powergranted before a notary public be attached to the submission and that said power bereviewed to ensure that it grants the attorney in fact the power to participate in a biddingprocess and bind the party as its representative;b) Items. The proposal must be submitted for all those items in which participation issought. In the event that it is mandatory to submit proposals for specific items, allsuch items should be included;c) Address to receive notifications. A proposal should be accompanied by a written documentcontaining the address of the bidder for the purpose of receiving all typesof notifications.d) Signature. It is essential that the proposal be signed by the bidders or their representative;e) Language. Proposals must always be submitted in Spanish. Technical annexes andbrochures can be submitted in the language of the country of origin of the goods,as long as they are accompanied by a free Spanish translation (translation by anauthorized expert is not necessary);f) Currency. The currency in which the payment will be quoted and made in the bid,in accordance with the bid project’s terms and conditions and without conversionvalues, should be indicated in the proposal. In the case of international bids inwhich the bid solicitor decides to make the payments to foreign suppliers in foreign277Government Acquisitions

278C H A P T E R X V Icurrency, domestic bidders can submit their proposals in the same foreign currencydetermined by the bid solicitor. Regardless of the foregoing, it is importantto keep in mind that payments made within Mexican territory must be made inMexican currency using the exchange rate in effect on the date on which suchpayment is made;g) Alternative proposals. Bid offers should not be left open. Therefore, alternative offersshould never be included in a proposal. This is because none of the terms and conditionscan be negotiated and so the offer for the goods or services should be precise;h) Joint proposals. Applicable law establishes that joint proposals can be submitted forbids without the necessity of forming a company, as long as the following requirementsare met:• The rights and duties corresponding to each party and how compliance therewithwill be enforced must be precisely established in the proposal and thecontract to the satisfaction of the relevant government agency;• The parties must designate a representative for the purposes of signing theproposal.Following the submission of proposals, the corresponding governmental agency willhold for purposes of transparency a public meeting where the envelopes containing thesingle proposal will be opened. During this ceremony, a quantitative analysis is made ofthe documents submitted with the offer, verifying that all of the required documentationhas been provided.Thereafter, once the government entity has the opportunity to make an economic andtechnical analysis of the proposals, a subsequent public meeting is held to inform thebidders of the award containing the result of the evaluation of the proposals.Finally, the signing of the corresponding contract must occur within 20 days after thenotification of the award. A performance guarantee must also be granted within 10 daysof the signing of the contract.It is worth mentioning that if any of the bidders have observed an irregularity duringthe bidding process, whether in the terms and conditions, the clarification hearing, or theopening of proposal envelopes, that affects the outcome of the awarding of the contract,said bidder can file a protest against such an award or against the observed violation ofthe bidding procedures with the Ministry of Public Oversight (Secretaría de la Función Pública)so that the situation can be rectified.2.2. An Invitation to at Least Three PersonsFor different reasons, cases may arise in which it becomes impossible or unfeasible forthe state to issue an invitation and initiate a full bidding procedure in order to execute

a contract with a private party. In such a case, the applicable Mexican law has establishedseveral situations in which the ministry or governmental agency that seeks to contractmay choose not to engage in a bidding process, but instead to issue an invitation to executea contract or a direct award. 3Among the most relevant situations in which an invitation to contract may be made toat least three persons are the following:a) When it is intended to purchase a specific brand of good that is only sold or distributedby specific distributor(s);b) In the case of consulting, advice, or research services;c) In the case of specialized equipment or chemical or biological substances necessaryto carry out research;d) In the case of used goods;e) When the contract can only be executed with specific parties because it is forworks of art or patent ownership;f) When due to a natural disaster the failure to contract has the potential to affectpublic services or public safety or the health of the nation;g) When it is urgent to contract, and therefore there is not enough time to carry outa bidding process;h) When, in the case of goods or services, two bidding procedures have been declarednull, or in the case of public works, a single bidding procedure has been declared null;i) When in regards to contracts for the design and manufacture of prototypes, if thetests of such prototypes are satisfactory, a contract for the production of at least 20percent of the needs of the agency or entity will be formalized within a term ofthree years;j) In the case of acquisitions of goods and services relative to the operation of nuclearfacilities.279Government AcquisitionsIn summary, the fact that these are the only situations in which contracting by invitationto at least three persons or by direct award may be chosen, all supported by a justifiedreason, shows the exceptional nature of these two forms of contracting.2.3. Direct AwardsIn contrast to a public bid and an invitation to at least three persons, in the case of thedirect award of a contract, there is no competition among the possible contractors. Thusthe state must be much more cautious when choosing the party with which to contract.Regardless, the instances in which a direct award procedure can be carried out are the__________3When this invitation procedure has been selected, it must be carried out with at least three parties.

same as those for which the ministry or agency can choose to carry out an invitation toat least three persons.As can be observed, based on the foregoing, national or foreign private parties enjoybroad opportunities to interact with the government in Mexico for the purpose of carryingout projects that benefit the State as well as the private party.2.4. Government Contracts280C H A P T E R X V IOnce a contract has been awarded in accordance with any of the three previously mentionedprocedures, the private party is obligated to execute the contract under theterms and conditions provided by the public entity. In other words, there is absolutelyno possibility of negotiating the terms of the contract with the State. Only in the eventthat the contract in question is not consistent with the terms and conditions of the bidor its invitation can a private party refuse to sign a contract.In this context it is important to keep in mind that on many occasions public institutionsin practice modify certain contract terms by requiring changes in deliverydates or some good or service. In these cases it is recommended that the private partyalways document these changes because, if there is no corresponding written evidence,a dispute could subsequently arise in which the contractor may be accused ofbreach of contract. Also, it is important to document sufficiently the timely tenderingof goods or services, since in many cases the lack of such documentation allowsfor the imposition of heavy penalties for late delivery by the corresponding governmententity.On the other hand, it is worth noting that any contract compliance dispute is subjectto the provisions of the LAASSP or the LOP, as applicable, and secondarily to federalcivil legislation. Furthermore, disputes that arise between a government entity and aprivate party are in principle resolved by the federal courts, unless the parties haveagreed to submit to arbitration (which is permitted by the law as a valid dispute resolutionmethod).3. Acquisitions, Leases, Services, and Public Works in the Statesand Municipalities of the Mexican RepublicBecause Mexico is a federal republic, its component states have their own laws regardingacquisitions and public works for the acquisition of goods, lease, or service contractsand for the construction of local public works. In these laws, the same threeprocedures provided for by the federal legislation are generally repeated (public bid,limited invitation, and direct award) and a mechanism is established to defend againstany unfavorable ruling stemming from said proceedings when that is unlawful.

At the municipal level, it is common for general rules to exist regarding the mannerof acquiring goods, leases, or services and public works. Those rules establishvery simple procedures regarding a municipal council’s authorization for transactionsof a considerable value. In the remaining cases, contracting is open and at the discretionof the municipal authorities, since those transactions are less significant andless costly.281Government Acquisitions

CHAPTER XVIIEnvironmental Law1. IntroductionRecent years have seen an increase in our country of the regulation of activities withregard to environmental protection, which is clearly necessary in order to allow the naturalenvironment to coexist with human activity.Currently the authority entrusted with the oversight of environmental matters is theMinistry of the Environment and Natural Resources (Secretaría de Medio Ambiente yRecursos Naturales, SEMARNAT), which is responsible for establishing a national environmentalprotection policy that will reverse the trend toward ecological deterioration andset up the framework for sustainable development in the country, in coordination withvarious agencies and organizations.For the study, planning, and carrying out of its mandate, SEMARNAT has the followingsemi-independent administrative bodies, among other administrative units, and publicservants to support it in its activities: the Federal Environmental Protection EnforcementAgency (Procuraduría Federal de Protección al Ambiente, PROFEPA); the National WaterCommission (Comisión Nacional del Agua, CONAGUA); the National Ecology Institute(Instituto Nacional de Ecología, INE), and the National Commission of Protected NaturalAreas (Comisión Nacional de Áreas Naturales Protegidas, CONANP).The legal framework for environmental matters consists of a vast array of legal instruments,including codes, laws, regulations, and official standards. Some of these are:a) General Law of Ecological Balance and Environmental Protection (Ley General delEquilibrio Ecológico y Protección al Ambiente, LGEEPA). The matters covered by thislaw are further covered by several regulations:i) Regulation of the General Law of Ecological Balance and Environmental Protectionin relation to Environmental Impact (Reglamento de la Ley del EquilibrioEcológico y Protección al Ambiente en Materia de Impacto Ambiental) (referred toas the “Environmental Impact Regulation”);283

284C H A P T E R X V I Iii) Regulation of the General Law of Ecological Balance and Environmental Protectionin relation to Hazardous Wastes (Reglamento de la Ley del EquilibrioEcológico y Protección al Ambiente en Materia de Residuos Peligrosos);iii) Regulation of the General Law of Ecological Balance and Environmental Protectionin relation to Prevention and Control of the Contamination of theAtmosphere (Reglamento de la Ley del Equilibrio Ecológico y Protección al Ambienteen Materia de Prevención y Control de la Contaminación de la Atmósfera);iv) Regulation of the General Law of Ecological Balance and Environmental Protectionin relation to the Registration of Emissions and Transfer of Contaminants(Reglamento de la Ley General del Equilibrio Ecológico y Protección alAmbiente en Materia de Registro de Emisiones y Transferencia de Contaminantes);v) Regulation of the General Law of Ecological Balance and Environmental Protectionfrom Noise Pollution (Reglamento de la Ley General de Equilibrio Ecológicoy Protección al Ambiente en Materia contra la Contaminación Originada porRuido);b) General Wildlife Law (Ley General de Vida Silvestre);c) General Sustainable Forestry Development Law (Ley General de Desarrollo ForestalSustentable);d) National Waters Law (Ley de Aguas Nacionales) and Regulation of the NationalWaters Law (Reglamento de la Ley de Aguas Nacionales), published in the OfficialFederal Gazette on January 12, 1994, which will remain in force until the regulationof the new National Waters Law is issued;e) Federal Animal Health Law (Ley Federal de Sanidad Animal);f) Federal Plant Health Law (Ley Federal de Sanidad Vegetal);g) General Sustainable Fisheries and Aquaculture Law (Ley General de Pesca y AcuaculturaSustentables) and its respective regulation;h) Federal Law of the Sea (Ley Federal del Mar);i) Mining Law (Ley Minera) and its respective regulation;j) General Law for the Prevention and Integrated Management of Wastes (Ley Generalpara la Prevención y Gestión Integral de los Residuos) and its regulation.There are also numerous official Mexican standards (normas oficiales mexicanas, NOMs)and other rules governing environmental aspects and requirements. In addition, theFederal Criminal Code (Código Penal Federal) contains a chapter on environmentalcrimes. The states and the Federal District also have local environmental laws.In this chapter we analyze the most important areas regulated by the environmentallaws in our country. The first area we address is environmental impact assessments necessaryfor activities and works that can have a significant environmental impact and theobligations of private parties in this regard.

Thereafter we will analyze the regulation of hazardous waste in our country, which hasbeen updated recently through new laws both at the federal level and in the Federal District.Another of the topics addressed is the regulation of air pollution, including obligationsin relation to emissions of industries located in our territory, as well as licenses andauthorizations required.Space is also dedicated to the aspects we consider most relevant of the water regulationin Mexico, which has also recently been amended significantly with the entranceinto force of the reforms to the National Waters Law. Finally, we will detail the regulationof the different types of liability that can be imposed on private parties in case ofbreach of the environmental laws.2. Environmental Impact AssessmentsAs a result of the condition of our natural resources and environment, it has been necessaryto take steps to prevent contamination that could have significant consequencesto the surrounding environment. The General Law of Ecological Balance and EnvironmentalProtection and its regulations establish rules in this regard.We will start by defining environmental impact, which is understood as any change tothe environment caused by the action of man or nature.In regulating activities and works that may have a significant environmental impact,SEMARNAT establishes the conditions to which they will be subject, for which the interestedparties, whether individuals or entities, must present environmental impact statements,risk studies, or preventive reports, whichever is applicable. Specifically, whoever wishes tocarry out any work or activity related to any of the following fields will most likely berequired to get an environmental authorization from SEMARNAT, which will be decidedbased on the specific premises established in the Environmental Impact Regulation:a) Hydraulics;b) General means of communication;c) Oil pipelines, gas pipelines, carboducts, and poliducts;d) Petroleum industry;e) Petrochemical industry;f) Chemical industry;g) Iron and steel industry;h) Paper industry;i) Sugar industry;j) Cement industry;k) Power industry;l) Exploration, exploitation, and profiting from minerals and substances reserved tothe Federation;285Environmental Law

286C H A P T E R X V I Im) Installations for the treatment, confinement, or elimination of hazardous wastesand radioactive wastes;n) Exploitation of timber from tropical forests and species difficult to regenerate;o) Forestry plantations;p) Changes in the use of the land in forested areas and in jungles and arid zones;q) Industrial parks that will engage in highly risky activities;r) Real estate developments that affect coastal ecosystems;s) Works and activities in wetlands, mangroves, lagoons, rivers, lakes, and estuariesconnected with the sea, as well as on their shores or in federal zones;t) Works in protected natural areas;u) Fishing activities that could put at risk the survival of one or more species or causedamage to ecosystems;v) Aquaculture activities that could put at risk the survival of one or more species orcause damage to ecosystems;w) Agricultural and livestock activities that could put at risk the survival of one or morespecies or cause damage to ecosystems.2.1. Environmental Impact StatementAll works or activities that could cause a change to the environment must be supportedby an environmental impact statement consisting of a document by which, onthe basis of studies, any significant and potential environmental impact that work oractivity would generate is indicated, as well as how to avoid or mitigate it if the impactis negative.Once the environmental impact statement is presented, it will be evaluated accordingto the guidelines established by the LGEEPA and the Environmental Impact Regulation.The evaluation of environmental impact consists of the procedure through whichSEMARNAT establishes the conditions to which the works and activities that could causeecological imbalance or surpass the limits and conditions established in the provisionsapplicable to environmental protection will be subject.The environmental impact statement that the interested parties must present toSEMARNAT should include a description of the possible effects on the ecosystem(s) of thework or activity in question, establishing preventive, mitigating, or other necessarymeasures in order to avoid and reduce to a minimum the negative effects on the environment.SEMARNAT provides to the petitioners guidelines to facilitate the preparationand delivery of the environmental impact statement depending on the type of work oractivity to be carried out, which guidelines are published in the Official Federal Gazetteand in the Ecology Gazette (Gaceta Ecológica).

2.2. Risk StudyWhen the activities are considered by the LGEEPA to be highly risky, the environmentalimpact statement must include a risk study.That study consists of including in the environmental impact statement: (a) thepreventive scenarios and measures resulting from the analysis of the environmentalrisks related to the planned activity; (b) the description of the zones of protection inrelation to the installations, if applicable, and (c) the indication of the environmentalsafety measures.In this case as well, SEMARNAT publishes guidelines in the Official Federal Gazette andin the Ecological Gazette (Gaceta Ecológica) to facilitate the preparation and presentationof the risk studies.2.3. Preventive ReportFor certain works and activities specified in the Environmental Impact Regulation, suchas works related to hydraulics, general means of communication, oil pipelines, gaspipelines, carboducts, poliducts, or the petroleum and petrochemical industries, a preventivereport should first be presented to SEMARNAT in any of the following cases:a) When there are official Mexican standards that regulate the environmental impactsresulting from works and activities such as those planned;b) When the works or activities are expressly set forth in a partial urban developmentplan or an environmental zoning ordinance, which already has an environmentalimpact authorization;c) In the case of installations located in industrial parks previously authorized bySEMARNAT.287Environmental LawIn this regard, SEMARNAT also publishes in the Official Federal Gazette and in the EcologyGazette the guidelines for the presentation of the preventive report.SEMARNAT will review and issue a ruling on the preventive report within a term nogreater than 20 business days from its presentation. The purpose of the ruling will be:(a) to authorize the work or activity in question without the need to present any type ofenvironmental statement, or (b) request the presentation of an environmental impactstatement.It should be mentioned that constructive approval is applicable in the case of worksor activities that are totally regulated by official Mexican standards. Thus, if the authoritydoes not issue a ruling within the 20 business day term, it will be understood thatsuch works or activities can be carried out as planned, in accordance with the applicableofficial Mexican standards.

288C H A P T E R X V I IThe preventive reports, environmental impact statements, and risk studies can be preparedby the interested parties or by any individual or entity. Whoever prepares the studiesmust observe the provisions of the LGEEPA, the Environmental Impact Regulation, the officialMexican standards, and the other applicable legal rules and regulations. They must alsodeclare under oath that the results were obtained through the application of the best techniquesand methodologies commonly used by the scientific community in the country, andfrom the use of the greatest amount of information available. The preventive and mitigatingmeasures suggested must be the most effective to address the environmental impacts.The service provider or the signatory of the document will be responsible for its contents.If it is shown that the information contained in the above-referenced documents is false, theresponsible party may be subject to an administrative penalty of a fine, administrative arrestfor up to 36 hours, or suspension or revocation of the corresponding permit or authorization,in addition to any other applicable penalties under other laws and regulations.Finally, it should be mentioned that the authorization issued by SEMARNAT does notobligate local authorities (states, municipalities, or the Federal District) to issue theauthorizations corresponding to them within the scope of their responsibilities.3. WasteThe regulation of hazardous waste was significantly changed with the General Law forthe Prevention and Integrated Management of Wastes (Ley General para la Prevención yGestión Integral de los Residuos) (“Wastes Law”), published in the Official Federal Gazetteon October 8, 2003, and in force since January 6, 2004. This legal instrument establishes,among other things, rights, obligations, and administrative penalties in relation tothe activities inherent in the handling of wastes.The regulation of the Wastes Law was published November 30, 2006, in the OfficialFederal Gazette and entered into force on December 31, 2006.With the entrance into force of the Wastes Law and its regulation, all the legal provisionscontrary to it were repealed.According to the statement of legislative intent of the Congress of the Union, the primarypurpose of the Wastes Law is to guarantee the right of all persons to an adequateenvironment and promote sustainable development by the prevention of the creation,evaluation, and the integrated management of different wastes, and to prevent the contaminationof sites with these wastes, as well as remediate those already contaminated.3.1. Persons Subject to the Wastes Law and Its Regulationa) Generators. Individuals or entities that generate wastes as a result of production orconsumption processes;

) Micrognerators. Industrial, commercial, or service establishments that generate anamount of up to 400 kilograms (882 pounds) of hazardous waste per year or itsequivalent in another unit of measure;c) Small generators. Individuals or entities that generate an amount equal to or greaterthan 400 kilograms (882 pounds) and less than 10 tons in total gross weight ofwaste per year or its equivalent in another unit of measure;d) Large generators. Individuals or entities that generate an amount equal to or greaterthan 10 tons in total gross weight of wastes per year or its equivalent in anotherunit of measure.3.2. Classification of WastesWaste should be understood as the material or product discarded by the owner or possessorand that is in a solid or semisolid state, or is a liquid or gas contained in receptaclesor deposits and for which a value can be set or that must be subjected totreatment or final disposal according to the Wastes Law. Wastes are classified into thefollowing types:a) Wastes requiring special handling. Wastes generated in production processes that donot meet the characteristics to be considered solid hazardous urban wastes or thatare produced by large generators of solid urban wastes;b) Incompatible wastes. Wastes that react when they come in contact or are mixed withwater or other materials or waste, producing heat, pressure, fire, particulates, gasesor harmful vapors;c) Hazardous wastes. Wastes that possess any of the characteristics of corrosiveness,reactivity, explosiveness, toxicity, inflammability, or that contain infectious agentsthat make them hazardous, as well as containers, receptacles, packaging, and soils thathave been contaminated when being transferred to another site, in accordancewith the new Wastes Law.In order to determine if a waste meets the characteristics mentioned in theabove paragraph, a Cretib test is done, which indicates whether or not a materialis hazardous;d) Solid urban wastes. Wastes generated in residential dwellings, resulting from theelimination of the materials used in domestic activities, of the products they consume,and their containers or packaging; wastes coming from any other activitywithin establishments or on the street that generates wastes with household characteristics;in addition, the by-products of the cleaning of streets and of otherpublic places, provided they are not considered some other type of waste underthe new Wastes Law.289Environmental Law

3.3. Management Plan290C H A P T E R X V I IManagement plans are established in order to promote the valuation and the preventionof the generation of solid urban wastes, wastes requiring special handling, and specifichazardous wastes, according to criteria of environmental, technological, economic, andsocial efficiency, based on the Basic Diagnostic of the Integrated Management of Wastes,designed according to the principles of shared responsibility and integrated management,which consider the group of viable actions, procedures, and mediums and involveproducers, importers, exporters, distributors, sellers, consumers, users of sub-products,and large generators of wastes, as applicable, as well as the three levels of government.The following persons are required to formulate and execute management plans:a) Producers, importers, exporters, and distributors of products that when discardedbecome the hazardous wastes referred to in the Wastes Law, and those included inthe official standards issued for such purposes;b) Generators of the hazardous wastes referred to in Sections XII–XV of Article 31 ofthe Law and of those included in the official standards;c) The large generators and producers, importers, exporters, and distributors of theproducts that when discarded become solid urban wastes or wastes requiring specialhandling according to the corresponding official standards.3.4. Integrated ManagementOne of the goals pursued by the Wastes Law is to regulate the integrated management ofwaste, applied through reduction at the source, separation, re-use, recycling, co-processing,biological, chemical, physical, or thermal treatment, collection, storage, transportation,and final disposal of wastes, done individually or appropriately combined, adapted tothe conditions and needs of each place, meeting the objectives of valuation and sanitary,environmental, technological, economic, and social efficiency.The above activities are regulated by federal, state, and municipal authorities, accordingto the divisions made by the Wastes Law, its regulation, official Mexican standards,and other legal provisions issued in order to regulate the comprehensive management ofwastes.3.5. Shared ResponsibilityWith the entrance into force of the new Wastes Law, a new type of co-responsibilityis established called shared responsibility, consisting of principles recognizing thaturban wastes and wastes requiring special handling are generated from the carryingout of activities that satisfy the needs of society through value chains of production,

processing, packaging, distribution, and product consumption and that the integratedmanagement of such waste is, therefore, a social co-responsibility and requires thejoint, coordinated, and differentiated participation of producers, distributors, consumers,users of sub-products, and of the three orders of government as applicable,according to a plan of market feasibility and environmental, technological, economic,and social efficiency.Furthermore, it is provided that in carrying out the policies in relation to prevention,valuation, and integrated management of wastes, the issuance of legal provisions andactions derived therefrom, as well as in the generation and integrated management ofwastes, the principle of shared responsibility of producers, importers, exporters, sellers,consumers, waste handling service companies, and the authorities of the three levels ofgovernment must be observed, given that co-responsibility is considered essential inorder to ensure that the integrated management of wastes is environmentally efficient,technologically viable, and economically feasible.Thus, it can be asserted that the law imposes co-responsibility when producers, distributors,consumers, users of sub-products, and the three levels of government areinvolved in the generation of waste. However, the scope of the concept of co-responsibilityis very unclear in that the consequences and obligations for the parties involved are notspecified.In this regard, the concept of shared responsibility is also mentioned in the Regulationof the Wastes Law. However, the Regulations do not provide additional specificationsregarding the consequences, obligations, and scope of such co-responsibility andonly provide that (a) the scope of such shared responsibility shall be determined in theManagement Plans described above and in accordance with the guidelines provided inthe official Mexican standards (NOMs) that shall be issued by the Federal Governmentin this regard (which to this date have not been published); and (b) the shared responsibilitywill also be applicable for the integrated management of urban solid and specialmanagement wastes that are not subject to management plans.291Environmental Law3.6. Liability with Respect to the Contamination and Remediation of SitesAnyone responsible for the contamination of a site, as well as damages to health as aresult thereof, is obligated to remedy the damage caused, according to the applicablelegal provisions. Furthermore, the owners or possessors of private property and holdersof concessioned areas whose soils are contaminated are jointly and severally liable fortaking the necessary remediation actions, without prejudice to their right to recoverfrom the party that caused the contamination.In addition to the remediation of the contaminated site, anyone responsible for thecontamination of a site may incur civil, criminal, and/or administrative liability.

292C H A P T E R X V I IIn order to avoid any liability arising from acquiring contaminated property, it is advisableto take preventive steps, such as the characterization of the site to be acquired orleased. In order for the characterization to be recognized by the environmental authorities,it is advisable to have it done by a laboratory accredited by the Entidad Mexicanade Acreditación, A.C. (EMA).While it is not mandatory to have the evaluation done by a lab accredited by the EMA,such labs are recognized by the environmental authorities. The Regulation of the WastesLaw, while not expressly stating it, does suggest the obligation of interested parties is tocarry out the tests in laboratories accredited by the EMA.It is also worth mentioning that the Regulation of the Wastes Law provides that, whenas a result of an Act of God or force majeure, leakages, infiltrations, discharges, or spillsof hazardous materials or hazardous wastes occur in amounts greater than one cubicmeter (35 1/3 cubic feet), the party responsible for the hazardous material or the generatorof the hazardous waste shall: (a) immediately take measures to contain the releasedmaterials or wastes, minimize or limit their dispersion, or collect them and clean the site;(b) advise the enforcement agency and the competent authorities immediately that aleak, infiltration, discharge or spill of hazardous materials or waste occurred; (c) executethe measures imposed by the competent authorities, and (d) if applicable, initiate theworks to characterize the contamination of the site and carry out the correspondingremediation actions.3.7. Administrative Violations and PenaltiesThe following are some of the activities that are sanctioned in relation to wastes. Businessesare not allowed to:a) Collect, store, transport, treat, or permanently dispose of hazardous waste withouthaving lawful authorization to do so;b) Mix hazardous wastes that are incompatible;c) Throw, abandon, or permanently dispose of hazardous waste at unauthorized sites;d) Thermally treat hazardous waste without the required authorization;e) Store hazardous waste for more than six months without having the requiredextension;f) Transport hazardous waste by air;g) Transport hazardous waste through Mexican territory to another country where itspreparation, use, or consumption is prohibited;h) A waste generator’s failure to manage its wastes in an integrated manner itself orthrough an authorized service provider;i) Not be registered as a generator of hazardous waste when obligated to do so pursuantto the Wastes Law;

j) Not comply with regulations regarding the identification, classification, packaging,and labeling of hazardous wastes;k) Not comply with the requirements that the Wastes Law has established regardingthe importation and exportation of hazardous wastes;l) As generator of hazardous waste, not provide to service providers the informationnecessary for its integrated management;m) As a generator of hazardous waste, not give notice to the competent authority incase of emergencies, accidents, or loss of such waste;n) Not comply with environmental protection measures regarding the transportationof hazardous waste.In imposing penalties for violations of the Wastes Law, the provisions of the LGEEPAwith regard to wastes apply.3.8. Private Party Defense against Actions Taken by Governmental AuthoritiesIndividuals or entities affected by acts or rulings of the administrative authorities thatterminate an administrative proceeding or an instance, or that resolve a case, may filea motion for review or, when appropriate, a court appeal.The time period for filing the motion for review is 15 days from the day following thedate on which the notification of the ruling to be challenged takes effect. The review willbe conducted according to the Federal Law of Administrative Procedure (Ley Federal deProcedimiento Administrativo).The motion for review is an administrative appeal filed before the authority that issued theruling that is being challenged; the motion is heard by that authority’s superior. On theother hand, a private party can choose to file a nullity claim directly before the FederalTax and Administrative Court instead of a motion for review, or it can apply for a nullityproceeding after receiving an unfavorable ruling in the motion for review. Said proceedingis a claim that is filed before the Federal Tax and Administrative Court and is regulatedby the Federal Law of Administrative Law Court Procedure (Ley Federal deProcedimiento Contencioso Administrativo). As a final option, there is the amparo proceedingthat can be filed to claim the rulings issued by the environmental authorities wereunconstitutional because they violate the individual rights of the private parties.The LGEEPA establishes that a motion for review can also be filed with respect to worksor activities that violate the LGEEPA or other environmental provisions. In this case, themotion for review can be filed by any individual or entity of the communities affectedby the violation of the LGEEPA. It is also possible for any person, group, or associationthat is not directly affected by a violation of the environmental provisions to report sucha violation to the appropriate environmental authority.293Environmental Law

Furthermore, a complaint can be filed in accordance with the LGEEPA by persons, socialgroups, non-governmental organizations, associations, or communities before the PROFEPAor before other authorities regarding any event, act, or omission that produces or could producean ecological imbalance or harm to the environment or natural resources, or violatethe provisions of the LGEEPA or the other legal regulations governing matters related to environmentalprotection and the preservation and restoration of the environmental balance.4. Regulation of Air Pollution294C H A P T E R X V I IAir pollution is regulated in the first instance by the LGEEPA and its Regulations regardingthe Prevention and Control of Air Pollution. These laws place certain industriesunder federal jurisdiction and others under state or municipal jurisdiction, which aresubject to local law. Furthermore, the sources of air pollution are classified as fixedsources, mobile sources, or mixed sources, the latter being pollution coming from twoor more ducts or chimneys.The following industries are considered fixed sources under federal jurisdiction: chemical,petroleum and petrochemical, paint and dye, automotive, cellulose and paper, metallurgic,glass, power generation, asbestos, cement and lime, and the treatment of hazardouswaste. The operation and running of these industries that emit or could emit odors, gases,or solid or liquid particles in the atmosphere require an authorization by SEMARNAT.The Regulations establish that such industries are obliged in general to:a) Use equipment and systems that control emissions released into the atmosphere andto ensure they do not surpass the maximum allowable levels established in the correspondingenvironmental technical standards;b) Keep an inventory of their air emissions on the form specified by SEMARNAT;c) Install platforms and sampling ports;d) Measure their air emissions, register the results on the form specified by SEMARNAT,and send the records to the latter when so requested;e) Monitor the perimeter of their air pollution emissions under specific circumstances;f) Keep a logbook (bitácora) recording the operation and maintenance of their processingand control equipment;g) Give notice to SEMARNAT of the initiation of operations and of other specified circumstances.4.1. Operating LicenseIn order for the above-mentioned industries to be able to operate, an operating licenseissued by SEMARNAT is required. To obtain it, companies must provide, among otherthings, the following information:

a) Description of the process;b) Distribution of machinery and equipment;c) Raw materials or flammables that are used in the production process and theirform of storage;d) Transportation of raw materials or flammables to the processing area;e) Transformation of raw materials or flammables;f) Products, sub-products, and wastes that will be generated;g) Storage, transportation, and distribution of products and sub-products;h) Amount and nature of the air contaminants expected;i) Equipment for the control of air pollution that will be used;j) An emergency plan.If the license is granted, SEMARNAT must specify the following points in the documentrecording the license: the periodicity with which the inventory of their emissions must besent to SEMARNAT; the periodicity with which their emissions must be measured and monitored;the measures and actions that should be carried out in case of an emergency; theequipment and other conditions that SEMARNAT specifies to prevent and control air pollution.4.2. Single Environmental License (Licencia Ambiental Única)It addition to the above, any interested party can comply with its environmental obligationsby obtaining a Single Environmental License (Licencia Ambiental Única, LAU), whichmeans that the form that must be delivered to the authority contains not only the informationon its air emissions, but also the required information regarding water andwastes. Thus, instead of issuing an Operating License, SEMARNAT will issue a Single EnvironmentalLicense that covers all environmental aspects.295Environmental Law4.3. Annual Operating Card (Cédula de Operación Anual)Those entities having a fixed source under federal jurisdiction that have a license mustpresent to SEMARNAT an Annual Operating Card (Cédula de Operación Anual, COA) beforeApril 30 of each year, which contains the updated information required in order toobtain the Operating License (or the LAU, as applicable). Since the June 3, 2004, reformof the Regulation, this card is also regulated by the Regulation of LGEEPA regarding theRegistration of Emissions and Transfer of Contaminates (Reglamento de la Ley General delEquilibrio Ecológico y la Protección al Ambiente en Materia de Registro de Emisiones y Transferenciade Contaminantes).With regard to the emissions of air pollution, the characteristics of the machinery,equipment, or activities that generate them must be reported, describing the point of

generation and the type of emission, and the characteristics of the air emission dischargedthrough chimneys and ducts. In addition to the above, with regard to emissionsregulated by official Mexican standards, the results of the tests and analysis donein accordance with such standards must also be reported. Such information must bereported for each contaminant.4.4. Regulation of the LGEEPA Regarding the Registration of Emissionsand Transfer of Contaminants296C H A P T E R X V I IAs we have mentioned, on June 3, 2004, the Regulation of the LGEEPA regarding Registrationof Emissions and Transfer of Contaminants (RETC) was published in the OfficialFederal Gazette, the purpose of which was to regulate the emissions and transfer of contaminants.The information from the database of the Registry will be composed of theinformation and documents contained in the authorizations, cards, reports, licenses,permits and concessions processed by SEMARNAT or the competent authority of the governmentof the Federal District, the states and municipalities. SEMARNAT will coordinatewith these other non-federal governmental authorities in order to harmonize the informationto be introduced into their respective databases.The RETC establishes that the fixed sources under federal jurisdiction, as well as generatorsof hazardous waste and those who discharge wastewater into national bodies ofwater, will be considered establishments subject to federal reporting (through their COA).In addition, the definitions article establishes the “substances subject to federal reporting”in the following form: chemical elements or composites that are emitted or transferredby the establishments subject to federal reporting. The elements that are emittedare determined based on their environmental persistence, bio-accumulation, toxicity,teratogenicity, mutagenicity or carcinogenicity and, in general, on their adverse effectson the environment.In relation to the technical guidelines of the Registry, the Regulation adds that the substancessubject to federal reporting, the reporting thresholds (minimum amount beyondwhich its emissions must be reported), and the technical and procedural criteria forincluding and excluding substances will be determined by the corresponding officialMexican standard (norma oficial mexicana, NOM), which will take into account substancesand contaminants of the air, water, soil, and subsoil, hazardous materials and wastes, aswell as persistent organic compounds, greenhouse gases, and substances affecting theozone layer. As of this date this official Mexican standard has not yet been issued.Similarly, the RETC clarifies that the emissions and transfer of contaminants and substancessubject to federal reporting that are regulated by official Mexican standardsmust be measured using the methods, equipment, and testing and reporting proceduresspecified by the NOMs and by the Federal Law of Metrology and Standardization

(Ley Federal sobre Metrología y Normalización) and its Regulation. The emissions not regulatedby official Mexican standards or that are exempt from measurement can be estimatedthrough commonly used methodologies, such as the application of emissionfactors, estimation from historical data, balance of materials, engineering calculations,or mathematic models.Finally, it should be mentioned that the information provided by interested partiesregarding emissions and transfer of contaminates will be available to the public in generalonce the RETC is fully consolidated. Such information will consist of the name of theestablishment, its emissions and transfers of substances and contaminants and its geographiclocation.4.5. Official Mexican Standards (normas oficiales mexicanas, NOMs)Currently there are approximately 30 NOMs related to air pollution. Several of them referto methods of measurement to determine the concentration of certain types of air emissions.Others establish the maximum permissible levels of air emissions of various substances,such as sulfur, solid particulates from fixed sources engaged in the manufactureof cement and volatile organic compounds coming from the process of water-oil separationin oil refineries.5. Legal Framework Governing Water in Mexico297Environmental LawThe National Waters Law (Ley de Aguas Nacionales, LAN) and the Regulation of theNational Waters Law (Reglamento de la Ley de Aguas Nacionales) are the laws governingthis area, and the National Water Commission (Comisión Nacional de Agua, CONAGUA),a semi-independent administrative agency of SEMARNAT, is the responsible authorityregarding national waters.Although CONAGUA is a semi-independent administrative agency of SEMARNAT, in realityit is almost totally autonomous. This agency is responsible for all aspects of nationalwaters, from their supply to the oversight of the discharge of wastewater. SEMARNAT hasjurisdiction over the application of the laws in relation to Mexican marine waters.It should be mentioned, however, that the LGEEPA includes a chapter on the preventionand control of the contamination of water and of aquatic ecosystems, and that SEMARNATin theory has powers in relation to the ecological aspects of national waters.In Mexico, Article 27 of the Federal Constitution makes a broad classification of thewaters owned by the nation, and as a result in order to make use of such national watersit is necessary to have a concession and to pay the fees for the concessioned water. Furthermore,a discharge permit that establishes the conditions for discharge of the watercovered by the concession title is required.

298C H A P T E R X V I IWith regard to wastewater, the LAN has required that wastewater be treated before it isreleased into bodies of water and that it comply with the contamination limits establishedin the NOMs.In this regard Mexican law has adopted certain principles that establish:a) That water is a national security issue;b) That the integrated management of water resources by watershed is the basis ofnational water policy;c) The decentralization of the management of water resources;d) That the concessions and allocations of water must be based on the actual availabilityof the resource;e) That the conservation, preservation, protection, and restoration of water in quantityand quality is a national security matter and therefore unsustainable use andadverse environmental effects must be avoided;f) That water provides environmental services that must be recognized, quantified,and paid for, pursuant to the law;g) That the individuals or entities that contaminate water resources are responsiblefor restoring their quality and the principle of “polluter pays” will be applied.As mentioned, decentralized management and organization by watershed are established.This means that regional management is in the hands of watershed agencies(autonomous bodies assigned directly to the head of CONAGUA). They will be authorizedto apply the law, issuing use concessions and discharge permits, collecting fees,applying penalties, and applying governmental acts that are not reserved to CONAGUA,in their region.It is important to emphasize that the states, the municipalities, and the Federal District,through an assignment granted by the commission or the corresponding watershedagency, can make use of national waters for purposes of supplying public, urban, ordomestic water services. In this regard, the municipalities are responsible for ensuring thesupply of potable water and treating the wastewater of their municipality.We consider the following to be among the most important obligations for private parties:a) For the use of national waters, it is necessary to have a concession for theextraction and consumption of water, to have equipment to measure the waterconsumed, and to pay the fees for the water used;b) For the discharge of wastewater it is necessary to: have a discharge permit; treatthe wastewater prior to its release into receiving bodies of water; have a legalconnection to the municipal drainage system; comply with the limits of contaminationestablished in their permit and in the NOMs or the guidelines forConstruction Products (CDP); have the discharge meters in place; pay the feesfor wastewater actually discharged; and present a report every two years that

contains the chronological analysis and water quality indicators of the dischargedwater.Furthermore, it is required to register the concessions in the Public Registry of WaterRights. The transfer of title to a concession without modifications is carried out througha request for authorization.The failure of a concession holder to take the necessary measures to prevent the contaminationof the concessioned waters will result in:a) The application of penalties, the severity of which will depend on the damagecaused to the water quality and the environment;b) The payment of fees corresponding to the volume and quality of the discharges;c) The possible suspension or revocation of the concession.The concession can also be revoked if discharge of wastewater in national bodies ofwater is in violation of the law.In addition to the administrative, criminal, or civil penalties that apply in the case of a violationof a NOM or the conditions of the wastewater discharge permit, the LAN also establishesliability for individuals or entities that discharge wastewater in violation of the applicablelaws and regulations and that contaminate a body of water, who will be liable for remediationof the environmental damage caused by the removal of the contaminants from theaffected body of water or, when that is not possible, by the payment of an indemnification.6. Environmental Liability299Environmental LawEnvironmental liability in Mexico can be divided into civil, administrative, and criminal liability,although it can be said that in practice primarily administrative liability is imposed.In the administrative sphere, PROFEPA has the authority necessary to execute the actionsand impose the administrative penalties established by the law, which are explained below.6.1. Inspection and AuditingPROFEPA has the powers of inspection and auditing in order to ensure compliance withthe environmental laws and regulations and to establish the measures that must be takento correct irregularities observed.6.2. Safety MeasuresWhen there is an imminent risk of serious environmental damage or hazardous consequencesfor public health, PROFEPA has the authority to impose safety measures, among

which are temporary or definitive, partial or total closure of the plant that is the sourceof the contamination.6.3. Administrative Penalties300C H A P T E R X V I IClosure is an administrative penalty that can be imposed in cases of imminent risk, aswell as in cases of failure to meet the deadlines and conditions imposed by the authorityin specific circumstances, and in cases of recurrence. Administrative penalties alsoinclude fines of from 20 to 40,000 days of minimum wage, administrative arrest for upto 36 hours, and the suspension or revocation of concessions, licenses, permits, andauthorizations, among others.With regard to criminal liability, the Federal Criminal Code (Código Penal Federal) containsa specific section on environmental crimes and environmental management whereseveral environmental crimes are established in relation to technological and hazardousactivities, bio-diversity, bio-security and environmental management. To cite an example,anyone who emits or discharges contaminants in the air or water in violation ofapplicable laws and standards and anyone who authorizes or orders such violations, canbe imprisoned from one to nine years and fined up to 3,000 days of minimum wage. Ifthese activities are carried out in a protected natural area, the prison sentence can beincreased by three additional years.In addition to the penalties established specifically for each of the environmentalcrimes, the Federal Criminal Code establishes that the following measures must also betaken: (a) actions necessary to reestablish the conditions of the natural elements affected;(b) the suspension, modification or demolition of the constructions, works or activitiesthat have caused the environmental crime; (c) the reincorporation of the naturalelements, samples or species of wild flora and fauna, and (d) works in benefit of thecommunity, etc.With regard to civil liability, the LGEEPA provides generally that whoever carries outworks or activities that affect the environment must remediate any damages caused andassume the costs such remediation involves. More specifically it establishes that in additionto any criminal or administrative penalties that may be applicable, any person thatcontaminates or deteriorates the environment or affects the natural resources or the biodiversitywill be liable and will be obligated to remediate any damages caused in accordancewith the applicable civil law. The statute of limitations on environmental liabilityis five years from the occurrence of the corresponding act, event or omission.Other environmental laws develop this concept further. The General Law for the Preventionand Integrated Management of Wastes (Ley General para la Prevención y GestiónIntegral de los Residuos) is the newest and the strictest in this regard. This law provides inrelation to civil liability that anyone responsible for the contamination of a site, or harm

to health as a result of such contamination, will be obligated to repair the damage causedin accordance with the applicable legal provisions.This law also provides that the owners of private property or those possessing it andthe holders of concessions over areas where the soil has been contaminated will bejointly and severally liable for carrying out the necessary remediation actions, but mayfile recovery actions against whoever caused the contamination of the site.It should be mentioned that currently there are no official parameters for the remediationof contaminated sites. Therefore, SEMARNAT has discretion in establishing parametersfor evaluating the remediation actions carried out by private parties.In this regard, the parameters and scope of civil liability in environmental matters needsfurther development. In Mexico in civil matters a traditional focus has been maintainedwhich has not been expanded to incorporate concepts such as the remediation of damagecaused to the environment itself. Thus for the purpose of filing a claim before thecourts, the civil law only recognizes the standing of a person that is affected directly in hisperson or property. Therefore, the legal interest of, for example, a non-governmentalorganization or an organization that represents a community to be able to file a claim todemand remediation of environmental damages still needs to be developed and specified.Another impediment in the area of civil liability is the requirement of proving a causalrelation, which requires that it be proved that the action or activity of the accused is thedirect, immediate, and only cause of the damage. In environmental matters it is alwaysdifficult to prove cause with certainty. Furthermore, the repair of damages in civil mattersgenerally involves the payment of damages and losses, while in environmental matters thepreferable remedy is the remediation of the adverse effects on the environment. Finally,conclusive evidence of the cost of the damage is required in order to impose the paymentof such damages, and in environmental matters the parameters for evaluating the value ofthe damages caused do not exist.It should be mentioned that there is no civil or administrative law that increases the liabilityof the responsible party (for example, an obligation to pay double damages or punitivedamages) in the case of having known of and not immediately cleaned up thecontamination, except for the fact that the damages will continue to accrue and the responsibleparty will be obligated to indemnify any third party harmed by such damages.301Environmental Law

CHAPTER XVIIIAdministrative Litigation1. IntroductionIn Mexico, the actions of governmental authorities are governed by the principle of legality,which has a constitutional basis. When a governmental authority acts unlawfully, the lawestablishes control mechanisms. There are two means of control under Mexican Law. First,there is self-regulation within the administrative bodies themselves, through administrativeappeals. Second, there are two judicial means of control consisting of administrativecourt proceedings processed before administrative courts (autonomous from the JudicialBranch) and the amparo proceeding before the courts of the Federal Judicial Branch.In the Mexican legal system there are multiple special administrative bodies and courtsthat exercise specific powers in different spheres of economic activity. While such bodiesand courts cannot be excluded from the administrative and judicial means of controlexplained below, we consider that their existence and jurisdiction merit a more detaileddescription at the end of this chapter.3032. Administrative AppealIn general terms, the activities of the authorities belonging to the federal public administrationin relation to private parties is regulated by the Federal Law of Administrative Procedures(Ley Federal de Procedimiento Administrativo, LFPA). Such law applies to the acts,procedures, and rulings of the centralized federal public administration (the Presidency ofthe Republic, the ministries of State, the administrative departments, the Federal ExecutiveJudicial Advisory Board [Consejería Jurídica del Ejecutivo Federal]) and of the parastatal federalpublic administration (decentralized bodies, companies with state investment, nationalcredit institutions, auxiliary national credit organizations, national insurance, bond andtrust institutions) with respect to their governmental actions, the services that the State providesexclusively and the contracts that only private parties may execute with the State.

304C H A P T E R X V I I IThe LFPA provides that private parties may defend themselves against acts of authoritiesbelonging to the public administration through a procedure called the administrativemotion for review (recurso administrativo de revisión), the purpose of which is toreview an administrative act considered illegal, either by amending it, annulling it orconfirming it according to the guidelines established by the LFPA.The deadline for filing a motion for review is 15 days from the day following the dateon which the notice of the administrative act takes effect.The administration act must contain certain elements and comply with certainrequirements, among which are the following: (i) to be issued by a competent body, (ii)to have a purpose that can be subject to an administrative act, (iii) to be in the publicinterest, (iv) to be in writing, signed by the authority issuing it, (v) to be grounded inlaw and fact, (vi) to be issued free of mistake or duress, (vii) to mention the body issuingit and the place and date of issuance, and (viii) in the case of appealable administrativeacts, mention must be made of the available appeals.When the administrative act does not comply with the above-mentioned requirementsand with the applicable law, a motion for review may be filed. The motion must be filedbefore the governmental authority that issued the challenged act and it will be reviewedby the superior of the issuer.The ruling issued in the motion for review may nullify the administrative act. The legalact that is declared null and void will be invalid, will not be presumed legitimate orenforceable and private parties will not be obligated to comply with it. The act that isdeclared annullable will be considered valid, will enjoy the presumption of legitimacyand enforceability and will be curable by the administrative bodies with full compliancewith the requirements indicated by the law.Furthermore, the ruling must be based on law and when a specific act or the initiationof a retrial is ordered, such must be done within four months. In this respect, inpractice exceptional cases arise in which the reticence of the authority to comply with aparticular ruling lasts for more than four months, in which case the private party hasseveral administrative liability actions it can file against the reticent public officials.It is important to note that the ruling issued in the administrative review is also anadministrative act, not a judicial decision. Therefore, the administrative review is aprior step that, as a general rule, must be exhausted before seeking judicial reviewthrough an administrative law court proceeding (juicio contencioso administrativo) and,finally, the amparo proceeding (juicio de amparo).However, there are certain situations under which the possibility of initiating courtactions is direct and, therefore, the filing of the administrative review prior to accedingto the courts is optional.In general the rulings issued in the administrative reviews are the result of constantmeetings and informal and “friendly” discussions with the authority in which it is

attempted to convince the latter of the existence of an irregularity in its actions. Theserulings are typically issued in from two to six months.Finally, it is important to mention that the Federal Court of Tax and AdministrativeJustice (Tribunal Federal de Justicia Fiscal y Administrativa, TFJFA) is authorized to try,through the administrative court proceeding which is addressed in the following section,the rulings of the motion for review or administrative rulings (against which the filing ofsuch review is optional) when one of the affected parties is not in agreement with it.3. Judicial Review3.1. Administrative Court ProceedingThe Mexican Constitution confers power on the Congress of the Union to issue laws thatestablish administrative law courts having full autonomy to issue their decisions andwhich are responsible for resolving disputes arising between the federal public administrationand private parties, such courts being the TFJFA.The TFJFA is an administrative law court of reversal. Its jurisdiction is broader than justfiscal matters; however, it does not encompass all administrative law matters. Theprocess before the Court may be initiated against administrative acts that cannot be challengedby an administrative review or when the filing of the latter is optional for theaffected private party.The TFJFA consists of one superior Chamber and regional chambers. The jurisdictionof the regional chambers is determined according to the domicile of the authority thatissued the administrative act being challenged.The TFJFA handles proceedings that are filed against the definitive rulings issued byadministrative authorities that terminate an administrative proceeding, a legal petition orresolve a case, pursuant to the LFPA. Its jurisdiction also includes claims filed against rulings(i) issued by federal tax authorities, (ii) that impose fines for infringement of the federaladministrative rules, (iii) regarding civil and military security, (iv) on public workscontracts, (v) on civil servant and private party liability, (vi) on foreign trade, and (vii) thatdecide administrative reviews. Administrative rulings (acuerdos) that, although they arenot regulations, have a general application, can also be challenged in this proceeding.More specifically, the procedure for the administrative law action is governed by theFederal Law of Administrative Law Court Procedure (LFPCA). The claim must be filed inwriting directly before the competent regional Chamber, within 45 days from the dateon which the notice of the challenged ruling takes effect. The claim must contain the rulingthat is challenged, the authorities against whom the claim is filed, the facts on whichthe claim is based, the applicable evidence, and bases for the challenge, and must complywith the formalities established in the LFPCA.305Administrative Litigation

306C H A P T E R X V I I IIn the initial brief or thereafter the suspension of the execution of the challenged actmay be requested, provided a sufficient guarantee is granted to cover any damages andlosses that may be caused to the other party or a third party.Once the claim is admitted the defendant is notified and is granted 45 business daysto respond. In the event the answer is not filed within such time period, the facts allegedin the claim will be presumed true.In relation to the evidence, any type of evidence is admissible except the testimony ofauthorities through response to interrogatories. Although the time periods established inthe procedural rules suggest the possibility of obtaining a ruling in a relatively short periodof time, due to its accumulated work load, proceedings filed before the TFJFA may takeone to three years to resolve depending on their complexity.The final decision may determine the following with respect to the challenged ruling:(i) recognize its validity, (ii) declare its annulment, (iii) declare its annulment for certaineffects, clearly specifying the manner and terms in which the authority must complywith it, or (iv) declare the existence of a subjective right and order compliance withan obligation.When the decision obligates the authority to carry out a particular act or initiate a proceeding,such must be done within four months from when the decision becomes firm.While in practice not all decisions are complied within such time period, the percentageof matters in which the administrative authorities voluntarily comply is very high.The rulings of the regional chambers or of the TFJFA that declare or deny dismissal andnonsuit and definitive decisions may be challenged by filing the motion for reviewbefore the competent Collegiate Circuit Court (Tribunal Colegiado de Circuito) in the seatof the respective regional Chamber, through a brief filed within 15 days from the dateon which the notice takes effect. Finally, it should be mentioned that the Mexican Constitutionalso provides for local jurisdiction over administrative law actions regardingdisputes arising between the state public administration and private parties, which in theFederal District are carried out by the Federal District Administrative Law Court.3.2. Indirect Amparo ProceedingIn addition to the administrative review and the administrative law action, Mexican lawprovides for the constitutional control of all acts of authority and administrative courtsthrough the amparo proceeding (juicio de amparo). In this proceeding the acts and decisionsof other bodies and courts are analyzed from the perspective of possible violations of therights contained in the Constitution. It is the final control of legality and constitutionality.Under the Mexican legal system the principle of legality has been interpreted by thecourts to permit the last instance review through the amparo proceeding of almost allacts of authority, whether federal, local or municipal.

In order to pursue an amparo the means of defense established in the administrativelaws must first be exhausted (although in exceptional circumstances an affected partymay be permitted to immediately resort to the amparo proceeding).Finally, it is important to mention that when reference is made to administrative actsthe following are included: regulations, decrees, rulings, official Mexican standards, circularsand forms, guidelines, methodologies, official notices, directives, rules, manuals,provisions whose purpose is to establish specific obligations when competitive conditionsdo not exist, and any other acts analogous to the above issued by the agencies ofthe federal public administration. Such acts must be published in the Official FederalGazette to take full force and effect in Mexico.The judgment that is issued in an amparo proceeding has effects on the specific caseand is not erga omnes, and therefore the judgment issued in a particular proceeding onlybenefits the person that filed it and not other persons that could be affected by the actof authority and that have not filed an amparo action. Generally the amparo judgment isissued within a period of six months to one year from the initiation of the proceeding.4. Other Administrative Bodies and CourtsAs indicated at the beginning of this chapter, there are certain highly specialized administrativebodies and courts that regulate specific economic activities. Thus, as an exceptionto the principle of the division of powers, in Mexico there are certain cases in whichthe public administration carries out judicial functions for specific areas, among whichMexican Law contemplates the following: (i) labor courts known as Conciliation andArbitration Boards, (ii) agrarian courts, (iii) National Banking and Securities Commission,(iv) National Insurance and Bond Commission, (v) Federal Consumer ProtectionAgency, (vi) certain administrative appeals in the area of water and intellectual propertyin which, due to the necessity of involving any possible affected third parties, the proceedingbecomes a legal action among private parties and the administrative act thatresolves it contains a decision in favor of one of them, (vii) arbitration in the area oftelecommunications, (viii) National Medical Arbitration Commission, and (ix) FederalEconomic Competition Commission.307Administrative Litigation5. Legal or Governmental ArbitrationThere are laws in various domestic arenas, in labor, banking, insurance and finance,that make reference to the possibility of resorting to arbitration resolved before the stateagency itself. These arbitrations are sui generis because, in spite of the fact that it is aState body resolving them, they can only be initiated and be binding if the partiesinvolved agree that the state body resolve the dispute. Thus the authority of the state

308C H A P T E R X V I I Ibody does not originate from its sovereign power as a governmental entity but ratherfrom the will of the parties involved.Laws applicable in the economic arena that contain the figure of arbitration are primarilythe following: Law Regulating Article 5 of the Constitution (Ley Reglamentaria del Artículo5º Constitucional), Investment Companies Law (Ley de Sociedades de Inversión), SecuritiesMarket Law (Ley del Mercado de Valores), Federal Law of Banking and Bond Institutions (LeyFederal de Instituciones y Fianzas), Credit Institutions Law (Ley de Instituciones de Crédito),Federal Law of Industrial Property Protection (Ley Federal de Protección a la Propiedad Industrial),Federal Tourism Law (Ley Federal de Turismo), Federal Consumer Protection Law (LeyFederal de Protección al Consumidor), General Law of Mutual Insurance Institutions andCompanies (Ley General de Instituciones y Sociedades Mutualistas de Seguros), General Law ofCredit Assistance Organizations and Activities (Ley General de Organizaciones y ActividadesAuxiliares de Crédito), General Law of Cooperative Companies (Ley General de SociedadesCooperativas), Law of the National Banking and Securities Commission (Ley de la ComisiónNacional Bancaria y de Valores), Law of Retirement Savings Systems (Ley de los Sistemas deAhorro para el Retiro), Federal Copyright Law (Ley Federal de Derechos de Autor), and Lawof Business Chambers and Alliances (Ley de Cámaras Empresariales y sus Confederaciones).The laws and regulations applicable to public service that contain the figure of arbitrationare basically the following: Federal Law of Parastatal Entities (Ley Federal de lasEntidades Paraestatales), Law of Athletic Encouragement and Promotion (Ley de Estímuloy Fomento del Deporte), Law of Religious Association and Public Displays of Worship(Ley de Asociaciones Religiosas y Culto Público), Organic Law of Petróleos Mexicanos andPublic Bodies (Ley Orgánica de Petróleos Mexicanos y Organismos Públicos), Regulation ofthe Law of the Provision of Electricity to the Public (Reglamento de la Ley del ServicioPúblico de Energía Eléctrica), Law of Ports (Ley de Puertos), Law of the Provision of Electricityto the Public (Ley del Servicio Público de Energía Eléctrica), Law of Public SectorAcquisitions, Leases and Services (Ley de Adquisiciones, Arrendamientos y Servicios del SectorPúblico), Law of Public Works and Related Services (Ley de Obras Públicas y ServiciosRelacionados con las Mismas), Law of Navigation (Ley de Navegación), Regulation of theNational Waters Law (Reglamento de la Ley de Aguas Nacionales), Law Regulating Article27 of the Constitution in Petroleum Matters (Ley Reglamentaria del Artículo 27º Constitucionalen Materia del Petróleo), Civil Aviation Law (Ley de Aviación Civil), Federal TelecommunicationsLaw (Ley Federal de Telecomunicaciones), Energy Regulatory CommissionLaw (Ley de la Comisión Reguladora de Energía), Airport Law (Ley de Aeropuertos), FederalVegetable Varieties Law (Ley Federal de Variedades Vegetales), Internal Regulation of theNational Commission of Medical Arbitration (Reglamento Interno de la Comisión Nacionalde Arbitraje Médico), Law of Protection and Defense of the User of Financial Services (Leyde Protección y Defensa al Usuario de Servicios Financieros) and the Bank Savings ProtectionLaw (Ley de Protección al Ahorro Bancario).

6. The Amparo Proceeding against LawsAs we have indicated in several chapters of this book, one of the particularities of the Mexicanlegal system is the possibility of challenging any act of authority through the amparoproceeding. The apex of this amparo system constitutes the challenge of laws issued bythe Congress that private parties consider to be unconstitutional. In this type of amparoproceeding legislative actions are questioned and the judicial courts analyze whether ornot a particular law complies with the guidelines and fundamental rights contained in theMexican Constitution.By virtue of the above, the Mexican legal system protects private parties against legislativeacts. However, this protection is limited given that it only applies to the personthat files the amparo claim and the decision issued does not benefit all those that did notfile a claim.There are two time periods for filing an amparo claim against a law. The first is 30 daysfollowing the entrance into force of the law if such law generates obligations as soon asit becomes effective. Otherwise the term for the filing of the amparo claim is 15 businessdays from the act of authority in which for the first time the law that is consideredunconstitutional is applied.Finally, the judgment that is issued in the amparo proceeding against a law may bechallenged through a motion for review, which will be resolved by the Supreme CourtJustice in all cases in which there is not any binding court precedent determining theinterpretation of such Court on the constitutionality or unconstitutionality of the law.309Administrative Litigation

CHAPTER XIXCommercial CompaniesRegulated by theSecurities Market Law1. IntroductionA new Securities Market Law (Ley del Mercado de Valores) was recently published andentered into force on June 28, 2006. This new law constitutes, in addition to an enormouslegislative effort, a new period in the history of Mexican Commercial Law, havingcreated new sub-types of the stock corporation (sociedad anónima), as well as the evolutionof stock market law in Mexico.In addition, this new law establishes a regulatory regime with standards of conductand specific liabilities for those who participate in the management of issuers.Furthermore, this law not only formalizes stock market practices that were becominginstitutionalized in practice and/or by means of secondary regulations whose constitutionalitywas questionable, but also corporate practices that, every day, are becomingmore rooted in commercial traffic outside of the stock market.Similarly, we consider that it was necessary to incorporate into our stock market regulationthe guiding principles of the international standards regarding corporate governance,disclosure of information, and protection of minority rights, in order to provide bothdomestic and foreign investors with the legal security necessary to protect their interests.Although many see the new Securities Market Law as nothing more than an adaptationof the Mexican legal system to the Sarbanes Oxley Act (“Sox Act”), we feel that while bothlaws obey similar realities (since a large part of both attempts to regulate the interaction ofinvestors in public companies with those who manage them, and the latter’s liability to theformer), the new Securities Market Law has a focus and scope very different from the Sox Act.The Sox Act emphasizes procedures and requirements regarding internal control andcertification. The cost of adopting the new regulations, however, has led many issuers toconsider removing themselves from the list and has deterred others from listing.In contrast to the Sox Act, the purpose of the new Securities Market Law is to establishthe legal base to promote the participation of a greater number of companies in the311

312C H A P T E R X I Xstock market, through a system of weights and counterweights in the exercise of majorityand minority shareholder rights and in the liabilities of those who administer or managethe company. In this regard, the Securities Market Law takes as a base the agencyconflict that occurs in Mexican issuers, in which the share holdings are not pulverizedas they are in U.S. issuers, but rather there is normally one controlling shareholder orgroup of shareholders and a small number of minority shareholders to whom the newlaw grants protections against possible abuses by the controlling shareholders.In this chapter the commercial companies that the new Securities Market Law regulatesare briefly analyzed, both with respect to corporate aspects (as a special commercial law)and administrative aspects (as it regulates their interaction on the stock market). Suchcommercial companies are the Investment Promotion Corporation (Sociedad Anónima Promotorade Inversión, SAPI), the Stock Market Investment Promotion Corporation (SociedadAnónima Promotora de Inversión Bursátil, SAPIB), and the Stock Market Corporation(Sociedad Anónima Bursátil, SAB).2. Investment Promotion Corporation(Sociedad Anónima Promotora de Inversión, SAPI)The new Securities Market Law creates the sub-type of company called the InvestmentPromotion Corporation, which is regulated as an intermediate company between a traditionalstock corporation (sociedad anónima) and a stock market corporation (sociedadanónima bursátil) which is the company known as “issuer” under the former SecuritiesMarket Law.With the SAPI, the intention is to encourage the traditional corporation to adopt a systemof corporate governance that gradually approaches that of a company listed on the stockmarket, primarily by the granting of certain incentives regarding flexibility in the regulationof capital and voting rights.In addition, the SAPI is created in order to encourage investment in Mexico in venturecapital, since in contrast to what has happened in other countries, Mexico has not beenable to consolidate that market. In that regard, venture capital is considered to be the“type of investment carried out through a vehicle that receives committed contributions,by institutional and qualified investors, with a professional management team, in orderto participate in specified companies or projects.” 1The financing of small- and medium-sized companies in Mexico is very limited, sincepractically speaking it can only be obtained through bank credit or through the issuance__________1Commentary of Jaime Cortés Rocha found in Rocío Haydee Robles Peiro, “Capital de riesgo: laalternativa de financiamiento para micro, pequeña y mediana empresas,” in Breviarios jurídicos,Porrúa, México, 2005, p. VIII.

of debt instruments. Therefore, we consider that it was fundamentally important tomake changes in this area in order to promote investment in venture capital in Mexicoas an alternative means of financing such companies.The doctrine in this area considers that there are several factors that have not allowedan upswing in the venture capital market in Mexico, among them being the lack of alegal vehicle adequate to act as a receptor of such investment.As a result of the above, in the new Securities Market Law, the SAPI and the Stock MarketSAPI (SAPIB) were regulated as potential vehicles for receiving investment and, as hasalready been mentioned, as an intermediate type of company between a traditional stockcorporation (sociedad anónima) and one that is quoted on the stock market.In reality, the name Investment Promotion Stock Corporation (Sociedad Anónima Promotorade Inversión) can be misleading in that it suggests that it is a company whose purposeis precisely to “promote investment.” However, the intention is that the SAPI be acompany that “receives investment” of so-called “seed capital” by which medium- andlong-term projects are financed through the participation of investors in the capitalstock, thus sharing the risks of the company.The gradual adoption of best corporate practices in a SAPI is intended to provide possibleinvestors in this type of company with greater legal security with regard to the managementof their investment, the exercise of minority rights, and more attractive andflexible mechanisms for withdrawing or divesting than those available under the GeneralLaw of Business Corporations (Ley General de Sociedades Mercantiles, LGSM).The principal characteristics of the SAPI are summarized below:a) They are incorporated as stock corporations (sociedad anónima), with either fixedcapital or variable capital;b) The adoption of the form of “investment promoter” is voluntary;c) They may include in their corporate by-laws provisions according to which:i) Restrictions of any nature are imposed on the circulation of shares of the sameseries or class representing the capital stock, different from those set forth inArticle 130 of the LGSM; 2ii) Causes are established, in addition to those set forth in the LGSM, for the exclusionof shareholders, the exercise of the right of separation or withdrawal, orthe redemption of shares, and it is permitted to determine the price or the basisfor making such determination in any of the above cases;iii) The issuance of the following types of stock is regulated:1) Non-voting stock;__________2According to Article 130 of the LGSM, it can be agreed that shares may only be transferred with theauthorization of the board of directors. This is the only restriction that such law allows to be establishedon the circulation of the shares. While in practice other types of restrictions are established,they may be considered by a judge to be legally questionable as in violation of the such article.313Commercial Companies Regulated by the Securities Market Law

314C H A P T E R X I X2) Restricted voting stock;3) Stock with non-economic corporate rights other than the right to vote oronly with the right to vote;4) Stock that limits or broadens profit-sharing rights or other special economicrights;5) Stock that grants the right to veto or requires the favorable vote of one ormore shareholders for the adoption of resolutions of the general shareholdersmeeting;iv) Mechanisms are implemented to follow in the case of a deadlock with respectto specific matters;v) The right of preferential subscription is broadened, restricted, or denied;vi) The limitation of liability for damages and losses caused by the members of theboard of directors and relevant officers for the acts they execute or the decisionsthey adopt is permitted;d) In contrast to the stock corporation, the SAPI must be managed by a board of directors.It should be mentioned that the SAPI may choose to adopt the managementand oversight regulatory system in the new Securities Market Law for the StockMarket Corporation, which we will analyze below, in which case its board membersand general director will be subject to the regulations regarding organization,operations and liabilities established for the Stock Market Corporation, beingrequired to have an audit committee instead of an examiner. Otherwise, that is tosay if the SAPI chooses to maintain the LGSM’s regulatory system for managementand oversight for the stock corporation, the organization, operations, and liabilitiesof its board members and examiner will be subject to that law’s rules;e) The shareholders of a SAPI may covenant among themselves:i) Non-compete agreements that are limited in subject matter, geographic area,and in time to no more than three years. On this point it should be mentionedthat each specific case must be analyzed to ensure that such non-competeagreements comply with the economic competition law;ii) Stock purchase or sale options, such as:1) That one or more shareholders may only transfer all or part of their shareswhen the purchaser must also acquire all or part of the shares of another orother shareholders under equal conditions (tag along);2) That one or more shareholders can require another shareholder to transferall or part of its shares when the former accept an offer to buy under equalconditions (drag along);3) That one or more shareholders have the right to transfer or acquire from theother, who will be obligated to transfer or acquire, as applicable, all or partof its shares at a determined or determinable price;

4) That one or more shareholders are obligated to subscribe and pay a certainnumber of shares representing the capital of the company at a determinedor determinable price;iii) Transfers and other legal acts related to the ownership, transfer, or exercise ofthe preferential right, either with other shareholders or with third parties;iv) Resolutions to exercise the right to vote in meetings, as an exception to the provisionsof Article 198 of the LGSM;v) Resolutions to sell shares in a public offering. It should be emphasized thataccording to the last paragraph of Article 16 of the new Securities Market Law,the mentioned covenants between shareholders do not bind the company,except in the case of a court order.Although such legal provision has been considered unfortunate in that itlimits the enforcement of such covenants in relation to the company, except inthe case of a court order, we believe that such provision provides legal certaintyto the shareholders that execute these covenants, who now have an expresslegal basis to enforce such covenants among themselves; furthermore, if wetake into account the general legal principle res inter alios acta, according towhich contracts only bind those who execute them, we think that such provisionof the new law is correct, since if the covenants are executed between theshareholders, they should only be binding on them. In addition, we considerthat such provision does not limit the right of the company to be party to suchcovenants, in which case, if the company is a contracting party, such covenantswould be binding on it.In view of the above, we think that it is correct for the new Securities MarketLaw to recognize and validate the covenants between shareholders that incorporate practice are frequent, above all in joint ventures and strategic alliances;f) The SAPI can buy back its stock, with a resolution of the board of directors. Thebuy-back of shares was reserved exclusively to companies listed on the stockexchange and the new Securities Market Law has extended it to the SAPI, as anexception to the general prohibition with respect to stock corporations regulatedby the LGSM on acquiring their own shares;g) The SAPI are not obligated to publish their financial statements;h) They are not subject to the inspection and oversight of the National Banking andSecurities Commission, since their shares are not registered on the National SecuritiesRegistry.From the above indicated characteristics it can be concluded that the nature of the SAPIis that of a specialized stock corporation whose shares are not issued in a series or inmass to circulate on the securities market, with a special corporate governance and with315Commercial Companies Regulated by the Securities Market Law

316C H A P T E R X I Xregulatory exceptions to the LGSM in regard to capital, voting rights and minority rights,and which may eventually and voluntarily adopt the SAPIB regulatory regime, which isanalyzed below.From a strictly commercial law point of view, we consider that there is a possibilitythat the SAPI will become a much used sub-type of company due to its flexibility andmodernity, in contrast to the rigidity of the traditional stock corporation. We considerthat for certain co-investment agreements, strategic alliances, or joint ventures, the SAPIcan be very useful.Furthermore, it should be emphasized that in practice it is very common to see theexecution of contracts among shareholders and other types of covenants seeking toestablish precisely the types of agreements that now the new Securities Market Law regulatesfor the SAPI, with the risk that in the case of disputes, the validity of such contractsor agreements executed by the shareholders of a stock corporation could be questionedby the courts under the argument that they had been executed at the margin or in violationof the LGSM. As we have already mentioned, from the entrance in force of the newSecurities Market Law the validity of such agreements of the SAPI will be recognized,which will make them more attractive that other types of companies for certaininvestors.3. Stock Market Investment Promotion Corporation(Sociedad Anónima Promotora de Inversión Bursátil, SAPIB)In contrast to the SAPI, the stock market investment promotion corporations (sociedadesanónimas promotoras de Inversión Bursátil, SAPIBs) can request the registration of theirshares or negotiable instruments representing them (such as certificates of participation[certificados de participación ordinarios] and stock market certificates [certificadosbursátiles]) in the National Securities Registry. It should be pointed out that such stockor instruments representing them can only be acquired by institutional investors, qualifiedinvestors, and investors that know and expressly assume the risk of investing inthese types of companies.For purposes of adopting the stock market form, the SAPI must change its corporatename in order to add the word “Bursátil” or its abreviation “B.”Furthermore, the shareholders meeting of the SAPI that intends to adopt the stock marketform must:a) Resolve the adoption of the regulatory regime of the Stock Market Corporationwithin a maximum term of three years from when the registration in the NationalSecurities Registry (Registro Nacional de Valores, RNV) of its shares or instrumentsrepresenting them becomes effective;

) Establish a program of gradual adoption of the regulatory regime applicable to theSAB within the above-mentioned three-year term;c) Amend its corporate by-laws in order to adjust the structure of its capital stock tothe regulatory regime of a SAB, as well as to provide for the causes and consequencesof the cancellation of the registration in the RNV of its shares or instrumentsrepresenting them;d) Include at least one independent board member on its board of directors.It should be pointed out that in contrast to a SAPI, the corporate by-laws of a SAPIB cannothave provisions by which:a) Restrictions of any nature are imposed on the circulation of the shares of a singleseries or class, representing its corporate stock, other than those established inArticle 130 of the LGSM;b) Causes are established other than those in the LGSM, for the exclusion of shareholders,exercise of the right of separation or withdrawal or redemption of shares,and it is permitted to determine the price or the basis for its determination in theabove cases;c) The issuance of the following types of shares is regulated:i) Non-voting stock;ii) Restricted voting stock;iii) Stock with non-economic corporate rights other than the right to vote or onlywith the right to vote;iv) Stock that limits or broadens profit-sharing rights or other special economicrights;v) Stock that grants the right to veto or requires the favorable vote of one or moreshareholders for the adoption of resolutions of the general shareholders meeting.The stipulations mentioned in subsections a), b) and c) may only be established in SAPIby-laws in its non-stock market form.From the above it can be appreciated that while the SAPIB continue enjoying a regulatoryregime of exception from several rules generally applied to stock corporations, someof the benefits of flexibility in the regulatory regime of the capital structure and votingrights enjoyed by the SAPI are not applicable to the SAPIB, since presumably they will bechanging to the SAB regulatory regimen within a term of three years, which as we will seefurther on, in contrast to the regime applicable to the SAPI, is much stricter than that ofa stock corporation governed by the LGSM.It should be noted that the SAPIB, as issuers, are subject to the inspection and oversightof the National Banking and Securities Commission and must comply with the obligationof revealing relevant information, among other obligations of a company listed on317Commercial Companies Regulated by the Securities Market Law

the Stock Market, such as the presentation of continuous reports regarding corporateactions; quarterly reports on the financial statements; annual reports covering the annualfinancial statements and reports prepared by the chairman of the corporate practicescommittee, as well as reports on any corporate restructuring.We consider that in order for the SAPIB to really become an investment vehicle, effectivelysparking the growth of venture capital in our country, it will be indispensable thatit be allowed a tax exemption that stimulates investment in this type of company. Otherwise,notwithstanding the incentives being granted by the Mexican Stock Exchange toencourage investment in SAPIBs, the above-noted objective will not be achieved.4. Stock Market Corporation (Sociedad Anónima Bursátil, SAB)318C H A P T E R X I XThe new Securities Market Law incorporates a new type of stock corporation previouslyknown as an “issuer,” to which the name Stock Market Corporation (Sociedad AnónimaBursátil, SAB) is given.The SAB is subject to both the new Securities Market Law and the LGSM in matters notprovided for in the former.The novelties existing with respect to the SAB are significant, given that on the one handthe structure of their corporate governing bodies is changed (corporate governance) andon the other hand the duties of the managers of such companies is regulated in detail.Moreover, the principle of consolidated application of the new law to all the companiescontrolled by the SAB is recognized, as was inevitable from a legal point of view.With respect to the restructuring of corporate bodies of the SAB, the following shouldbe mentioned:a) Before the new Securities Market Law, the management and oversight of the companieslisted on the Stock Exchange was conferred to two corporate bodies: theboard of directors and the examiner.In practice, such a dualistic regulatory regime was inoperative since, on the onehand, the board of directors, meeting quarterly, in reality could not manage thecompany, but rather only issued general instructions for its operation, and on theother hand, it was, practically speaking, impossible for the examiner to haveunlimited oversight of the company, as was required of each body within theirrespective competencies by the LGSM, as the supplemental regulation of the priorSecurities Market Law.In view of the above, the new Securities Market Law adopted the monist corporateorganization, according to which the management and the oversight of theSAB was unified in a single corporate body.Thus in the corporate governance of the SAB, the figure of the examiner is eliminated,however the examiner’s functions do not disappear but rather they are

edistributed between the board of directors, through the audit committee, and theexternal auditor.The new Securities Market Law regulates and defines the duties of the generaldirector, who is responsible for the management and day-to-day operations of thebusiness of the company, in accordance with the strategies and general instructionsestablished by the board of directors.As can be appreciated, the provisions regarding corporate governance of the SABestablished in the new law are closer to the functions that each corporate bodyactually carries out. In addition, such functions are specified with regard to theirpurpose and scope, which was not the case previously (for example, the generaldirector and the external auditor were not regulated and, therefore, the scope oftheir obligations and responsibilities was imprecise);b) With regard to minority rights, the new Securities Market Law establishes a stricterregulatory protection in order to avoid possible abuses of controlling shareholders.Below the principal minority rights regulated by the new law are summarized:i) The shareholders holding 5 percent of the voting shares, including limited orrestricted or non-voting, can exercise a civil action against board membersor officers;ii) The shareholders holding 10 percent of the voting shares, including limited orrestricted, may appoint and remove, in a general shareholders meeting, onemember of the board of directors;iii) The shareholders holding 10 percent of the voting shares, including limited orrestricted, may request the chairman of the board of directors or the chairmanof the corporate practices and audit committee or committees to call a shareholdersmeeting;iv) The shareholders holding 10 percent of the voting shares, including limited orrestricted, may request the postponement, on one occasion, for a period of threedays, of the vote on a matter about which they do not feel sufficiently informed;v) The shareholders holding 20 percent of the voting shares, including limited orrestricted, may oppose the resolutions of the general shareholders meetingswith respect to those matters they are entitled to vote on.Notwithstanding that, in general terms, we consider the adoption of themonist regulatory regime of company management that we referred to in subsectiona) immediately above to be correct, we think that a minority right that inpractice was highly efficient for avoiding abuses was the appointment of an examinerby the minority shareholders, which will not be possible under the new corporategovernance structure of the SAB; therefore the advisability of appointing anexternal auditor by and at the expense of the minority shareholders will have tobe analyzed;319Commercial Companies Regulated by the Securities Market Law

320C H A P T E R X I Xc) With regard to the regulation of liability of the managers of the SAB, which is providedfor in the new law, it should be mentioned that the principle governing suchliability is summarized in the obligation that they have to perform their postprocuring the creation of value in benefit of the company, without favoring a particularshareholder or group of shareholders, for which they must act diligently,adopting reasoned decisions, in good faith and based on the information they haveand/or that is provided to them for such purposes.The above-noted principle is complemented by the duty to abstain from actingin case of a conflict of interest, thus avoiding the obtaining, for him/herself or forothers, by virtue of the position he/she holds, economic benefits illegitimately andin prejudice to the SAB.The above can be summarized as the concepts of duty of care and duty of loyaltytaken from U.S. law and adapted to the Mexican legal system.On this point it should be mentioned that notwithstanding the negative impactthat the above-mentioned regulation of the liability of board members and secretarieshas had, we believe that the situation is not so serious as some have suggested,since the liability arising from the duty of care can be limited in the by-lawsand, in addition, the new law incorporates as an exclusion from liability the socalled“business judgment rule” from common law.Moreover, with respect to the duty of loyalty, it will be necessary for a boardmember or secretary of a SAB, without legitimate cause and by virtue of his/herposition, to obtain a profit for him/herself or a third party in order for there to beliability for the damages and losses caused to the company, which, even if it had notbeen included in the new law, would constitute a form of unjust enrichment underthe Federal Civil Code and the civil codes of the states and the Federal District;d) Another innovation of the Securities Market Law published on December 30, 2005is the suppression of the right of withdrawal that was previously granted to theshareholders of the variable portion of the capital stock, who, as of the entranceinto force of the new law, ceased to enjoy such withdrawal right.

CHAPTER XXInsolvency and Bankruptcy1. IntroductionAntecedents regarding bankruptcy and commercial insolvency in Mexican legislation dateback to the nineteenth century, when the applicable law was part of the civil and commercialcodes. In 1943, a specialized bankruptcy law, entitled the Bankruptcy and Suspensionof Payments Law (Ley de Quiebras y Suspensión de Pagos), was published in theOfficial Federal Gazette. However, this law no longer responded to Mexico’s economicreality, which resulted in the issuance of a new law, the Business Reorganization Law (Leyde Concursos Mercantiles), which took effect as of May 15, 2000.Any legal system that seeks to regulate the insolvencies of commercial enterprises should,as much as possible, aim to protect creditors, borrowers, and the company itself, the latterunderstood as a producer of wealth. That is to say, each one of these elements involves multiplelegal and social interests that merit equal protection and so a system that only protectedcreditors and distained the interests of the borrower, or vice versa, would not be viable.The Business Reorganization Law’s fundamental objective is the protection of the companyas a source of wealth, around which multiple interests revolve, such as: those of theemployees that do not want to lose their source of employment; those of shareholderswho seek to protect their investment; those of financial creditors who seek a return onthe capital they have invested; those of suppliers who seek not only the payment of theircredit, but also to maintain a customer; and those of society in general which does notwant to lose a source of wealth and employment for the community.In these terms, the essence of the reorganization process in regard to company insolvencyshould lie in the effort to reorganize companies through conciliation and settlementbetween the creditors and debtor where possible and, where not, in the liquidation and saleof assets in an organized manner in order to satisfy the creditors’ valid demands for payment.In concrete terms, the Business Reorganization Law seeks to incorporate both elementsas successive stages within the same process. That is to say, first efforts should be321

322C H A P T E R X Xmade to conciliate the parties and, if that is unsuccessful, then bankruptcy and liquidationwill follow, although in some cases the parties may resort directly to bankruptcy andcut short conciliation efforts when these are viewed as unrealistic.The reorganization process is one of the so-called universal processes, considered assuch because they involve all of a business’ assets, all the creditors and debtors and, ifapplicable, the liquidation or sale of all of the merchant’s rights and obligations, leavinguntouched by this process only those rights that specific laws categorize as inalienable,exempt from attachment, or not subject to a statute of limitations.Clearly, a law like the Business Reorganization Law covers many highly varied matters,and therefore the following discussion will be limited to indicating the aspects of theLaw we consider most relevant from a legal point of view and which are of particularinterest to business operations. In this regard, it is important to address issues such asthe persons to whom the Business Reorganization Law applies, the entities that participatein the reorganization process, the persons authorized to initiate it, the statutorypremises of business reorganization and its stages, and the special protection providedto creditors.2. The Business Reorganization Law2.1. Persons Subject to the Business Reorganization ProcessThe Business Reorganization Law governs the insolvency of and payments to creditorsby individuals or entities who qualify as merchants in accordance with the CommerceCode (Código de Comercio). The law also governs trust assets that are used in businessactivities, as well as the Mexican branches of foreign businesses, with the understandingthat in this last instance, the reorganization process will only govern assets and rightslocated within Mexican territory.Individuals or entities that are not merchants, or merchants that have current and outstandingdebts that altogether do not exceed the equivalent of 500,000 investment unitsup until May 15, 2005, or 400,000 investment units after that date, will not be subjectto the Business Reorganization Law, unless these “small businesses” expressly agree to begoverned by it in writing.2.2. Entities Involved in the Business Reorganization ProcessDistrict judges with jurisdiction in the merchant’s domicile are competent to handle thebusiness reorganization process and they will be the central authority and director of thereorganization proceeding. The Business Reorganization Law also provides for the participationof business administration specialists who will assist the judge in decision-

making when administrative, industrial, commercial, economic, or financial matters areinvolved. These specialists are the inspectors, conciliators, and bankruptcy trustees.In order to assemble a group of professional specialists, the law stipulates the creationof the Federal Institute of Business Reorganization Specialists (Instituto Federal de Especialistasde Concursos Mercantiles) as an auxiliary entity to the Federal Judicial Board(Consejo de la Judicatura Federal), which is the body that authorizes and keeps a registryof the persons qualified to act as inspectors, conciliators and bankruptcy trustees, andappoints them in specific reorganization proceedings.3. Persons Authorized to Petition for a Judicial Declarationof Business ReorganizationWhen a statutory presumption of business reorganization exists, the merchant, his creditors,or the Public Prosecutor (Ministerio Público) can petition the court to declare thereorganization of a merchant.If the merchant himself requests a declaration of its reorganization, it will be sufficientto show that a statutory presumption of business reorganization exists. If a creditor orthe Public Prosecutor requests a declaration of business reorganization, the merchantmay go before the judge to attempt to discredit the claims against it. At the same time,an inspector will be designated to inspect the merchant to determine if the statutory presumptionsfor the declaration of business reorganization exist.4. Statutory Presumptions of Commercial BankruptcyA merchant will be declared to be in reorganization when it fails to pay its debts universally.If the creditors or the Public Prosecutor request the declaration of reorganization, themerchant will be considered in universal breach if it is in arrears to two or more creditors:a) There are debts more than 30 days past due that represent 35 percent or more ofthe total of the merchant’s debt on the date of the reorganization suit;b) The merchant does not have sufficient assets to guarantee the payment of at least80 percent of its past due debt on the date of the reorganization suit.323Insolvency and BankruptcyIf the merchant himself requests a declaration of reorganization, satisfying either oneof the statutory presumptions indicated above in sections a) or b) will be sufficient.5. Stages of Business ReorganizationThe primary objective of the Business Reorganization Law is to attempt to keep the businessin the hands of its owners and only when this is impossible, arrange its organized

liquidation, seeking to maximize the result of the sale of the merchant’s assets in orderto satisfy payments to creditors. For this reason there are two successive stages of thereorganization process: conciliation and liquidation.As a result of the particular necessities of certain commercial actors, such as banks andauxiliary credit institutions, and due to the important role these actors play in society,the law provides certain particular or specific rules applicable only to specific reorganizationproceedings.In the following section, the stages of conciliation and bankruptcy of the businessreorganization process will be addressed in general terms.5.1. Conciliation324C H A P T E R X XIf the judge before whom the petition or suit is filed considers that the previously mentionedstatutory presumptions of business reorganization are present, he or she mustissue a judgment declaring this reorganization. This decision will be recorded in the correspondingpublic registries and an abstract will be published in the Official FederalGazette and in one newspaper of major circulation.A business reorganization judgment triggers the beginning of the conciliation stage,the purpose of which is to seek, with the aid of a designated conciliator, an agreementbetween the merchant and its creditors that will permit the merchant’s business to survive.Clearly, an agreement between a merchant and its creditors could include a moratoriumor forgiveness of the merchant’s debt payments if deemed satisfactory by theparties involved.Furthermore, such a judgment must, among other things, order the restraint of themerchant and the suspension of debt payments contracted prior to the judgment,excepting those payments that are indispensable for ordinary business operations, suchas payment of labor or tax-related payments. Lastly, in order to quantify the merchant’sdebts, such debts must be accelerated and considered due and payable.During the conciliation stage, the merchant manages the business unless, upon thepetition of the conciliator, the judge determines such an arrangement to be inadvisable.One of the conciliator’s most important duties is the acknowledgement of the merchant’sdebts, for which the conciliator will have to prepare a list of creditors based onthe merchant’s accounting records. Therefore, it is possible for a creditor to be recognizedas such without the need to act on his own behalf for such recognition. Of course,inadequate or deficient accounting records of the merchant could have the effect ofexcluding a creditor, who would only know about the reorganization from the aforementionedpublications.The conciliation stage cannot last more than 185 days beginning with the last publicationof the reorganization judgment, but it can be extended twice, for a period of 90

calendar days each, but without exceeding a total time period of 365 calendar days fromthe date of publication of the judgment.In order for an agreement to be effective, it must be signed by the merchant andacknowledged creditors representing more than 50 percent of the sum of:a) The amount that has been acknowledged of the totality of the at-large creditors; andb) The amount acknowledged of secured creditors or those with a property guaranteethat sign the agreement.As long as the agreement satisfies the legal requirements, the judge reviewing the mattermust approve it. The agreement will bind all of the acknowledged creditors, exceptfor the acknowledged creditors with a property guarantee who have not signed theagreement. These creditors can proceed to foreclose on their credits, which underscoresthat a property guarantee such as a pledge or mortgage places the creditor in a veryadvantageous position with respect to other creditors who lack such a guarantee or areunsecured creditors.In very general terms, from the point at which the business reorganization is declareduntil the conclusion of the conciliation stage, no seizure or foreclosure order can beenforced on the merchant’s assets, except for debts owed to employees for salaries orwages and indemnifications corresponding to the two preceding years. Unfortunately,this exception permits some merchants to attempt to remove some or all of their assetsfrom the reorganization process through secret agreements with their employees.The approval of an agreement will terminate the reorganization proceeding. The merchant’sbreach of the agreement will trigger the re-initiation of the reorganization process.5.2. Bankruptcy325Insolvency and BankruptcyIf the conciliation period lapses without an agreement being reached or if the merchanthimself so petitions, the judge handling the case must issue a judgment in which themerchant is declared in bankruptcy, the purpose of which will be to sell the merchant’sbusiness or the production units or assets of the business in order to pay the creditorsthat have been acknowledged in the conciliation stage.The bankruptcy judgment will compel the merchant to deliver the possession andadministration of the assets and rights that make up the merchant’s estate to the designatedtrustee and will prohibit creditors from paying any amount, under penalty of doublepayment. From the date of the bankruptcy judgment, any act by the merchant willbe null and void by operation of law.The bankruptcy trustee will have 90 days after taking possession of the business toprepare and deliver the following documentation to the judge:a) A statement regarding the merchant’s accounting records;

) An inventory of assets; andc) A balance statement as of the date on which the trustee assumes the administrationof the merchant’s business.326C H A P T E R X XThe trustee must proceed to sell the merchant’s assets and attempt to obtain the bestprice possible from that sale. The trustee should even consider the possibility of maintainingthe merchant’s business in operation.In any case, the merchant’s assets must be sold through the auction procedure set forthin the Business Reorganization Law unless a better price can be obtained through a differentprocedure previously approved by the judge.The Business Reorganization Law distinguishes different types or grades of creditors,who will be paid from the sale according to the following order and manner:a) Creditors owed salaries or indemnifications from the two prior years, which is tosay any amounts owed to the merchant’s employees;b) Creditors owed amounts for administering the estate during the bankruptcy declarationprocess;c) Creditors owed normal amounts incurred in securing the merchant’s estate orassets subject to reorganization;d) Creditors owed for judicial or extrajudicial proceedings benefiting the merchant’sestate assets subject to reorganization;e) The inspector, conciliator, and bankruptcy trustee’s fees and costs that are strictlyindispensable to their work and duly documented;f) Creditors with a property guarantee (mortgage and pledge), the money owed towhom will be paid with the proceeds from the sale of the mortgaged or pledgedproperty;g) Creditors owed amounts related to labor matters other than those mentioned insection a) and tax debts;h) Secured creditors;i) Unsecured creditors, which is to say, those who do not belong in any of the previouslymentioned categories. These creditors will collect on a prorated basis andwithout distinction of dates.Therefore, in the foreclosure process secured creditors do not lose their payment preferencesor priority status, which underscores the importance of securing such preferencesin order to ensure the recovery of the investment.The creditors who do not receive full payment of monies owed to them will preservetheir rights and actions against the merchant for the remaining balance. Within this categoryare creditors with a property guarantee or secured creditors whose credit has notbeen completely paid with the result of the sale of the merchant’s secured property.

6. Specific Protections of Creditors’ RightsThe Business Reorganization Law establishes two institutions for the protection of creditors’rights against acts attributable to the merchant. These institutions aim at removingassets from the reorganization process or stall the progress of the reorganization.On the one hand, there are different types of acts that are considered to be carried outto defraud creditors and are considered null and void. The following acts are consideredacts to defraud creditors:a) Any act or contract executed before the business reorganization judgment throughwhich a creditor is defrauded and as long as a third party knows of the merchant’sfraud. This last requirement is not necessary in acts of charity, such as a donation;b) Acts such as pardoning of debt by the merchant, the payment of debts not pastdue, or operations not carried out under market conditions when carried out as ofthe date the bankruptcy is made retroactively effective. The date of retroaction isthe 270 th calendar day immediately prior to the date of the judgment declaring thebusiness reorganization.Furthermore, a merchant may be considered to have committed a crime for engagingin acts to defraud or harm his creditors and that result in aggravating the general defaultor stall the reorganization process.327Insolvency and Bankruptcy

CHAPTER XXIState Liability1. IntroductionWith a reform of Article 113 of the Political Constitution of the United Mexican States(Constitución Política de los Estados Unidos Mexicanos) on June 14, 2002 a new form ofstrict and direct State liability for damages and losses caused to private parties was incorporatedinto Mexico’s legal system.Before this reform, State liability was not recognized constitutionally and was only lightlyregulated by Article 1927 of the Federal Civil Code (Código Civil Federal), which establisheda double regime of joint and several and secondary liability in relation to the damagesand losses caused to private parties by public officials in the exercise of their duties.In effect, according to this regime the State was jointly and severally liable for the damagesand losses caused by its officials, provided that such harm had been caused byunlawful and willful misconduct, while it was secondarily liable in relation to the assetsof the public servant in question “in all other cases.”This regime had many inconvenient aspects. The first and most notable was the needto prove in court the unlawful and willful misconduct of the public official causing thedamage in order to be able to demand indemnification from the State as jointly and severallyliable.In addition, even in a case where the willful act of the official was proved in court,there was a greater problem: there were no indemnificatory parameters applicable to theState, nor any budget stipulated for these indemnifications, the circumstances for which,added to the political implications, made any decision against the State unenforceable.Thus, with the reform of Article 113 of the Constitution, a breakthrough occurred inMexican legal history by creating a new and effective liability regime against the State,a regime in which State liability is strict and direct, regardless of whether the conductof the public official causing the damage was unlawful or willful, and thereby eliminatingthe distinction between joint and several liability and secondary liability.329

330C H A P T E R X X INevertheless, this reform was just the first step to accessing the benefits established bythis new regime. It was still necessary to have a law regulating and implementing theapplication of Article 113 of the Constitution.With this in mind, the Permanent Constitutional Convention (Congreso ConstituyentePermanente) established a maximum term of two years from the entrance in force of thereform for the federal and local authorities to issue the necessary laws to regulate andestablish the effective enforcement of the reform.Having this deadline, the Congress of the Union issued the law entitled Federal Lawof State Liability (Ley Federal de Responsabilidad Patrimonial del Estado), published in theOfficial Federal Gazette on December 31, 2004.As can be inferred, this law is of great relevance to all private parties, Mexican or foreign,that for some reason may have suffered harm or losses caused by the State. This lawattempts to clarify the ambiguous terms in which the constitutional reform was draftedand, above all, attempts to make effective a right that for many years was denied to privateparties in our country: the right to be indemnified for the damages and losses causedby the State. It is necessary to determine in what cases, to what extent, in what terms,how, and when this right can be asserted.2. Statutory Presumptions for IndemnificationThe State is only liable for the payment of damages and losses caused by administrativeacts, regardless of the state body that engages in them, whether Executive, Legislative,Judicial or any other public entity.This limitation excludes the damages and losses caused by acts materially legislativeand judicial, and therefore private parties may not demand an indemnification for damagesand losses caused to them by a law or a court decision.Despite the criticisms that can be made of it this limitation was introduced in the Constitutionitself, which eliminates the possibility of the validity of an amparo proceeding. Thereasons on which the Permanent Constitutional Convention based said limitation were fundamentallythat the immense majority of the acts by which harm is caused to private partiesoccur in the administrative sphere, in addition to the fact that, for budget reasons, itwould be very difficult to attend and satisfy all the claims filed against damages and lossescaused by judicial decisions and, above all, by the laws, given their general nature.In addition, for the State to be obligated to respond for the damages and losses itcauses to private parties through its administrative activity, there is an additional requirement:this activity must be irregular.This concept of irregular administrative activity raises some doubts with respect to thescope of State liability, since it would seem that the concepts of irregular and unlawful aresimilar, thereby basically erasing the strict nature of State liability.

Although Article 1 of the law attempts to define what should be understood for irregularadministrative activity, from our point of view the manner in which the law wasdrafted is not clear, and therefore it can be anticipated that, in applying the rule, this willbe a highly discussed point in the courts and it will have to be resolved by case law.In effect, the second paragraph of Article 1 of the Federal Law of State Liability establishes:“For purposes of this Law, irregular administrative activity shall be understood asan activity that causes harm to the property and rights of private parties that do not havethe legal obligation to suffer it, given that there is no legal basis or legal cause to justifythe harm in question.”As can be seen from the drafting of the above paragraph, irregular administrative activityis an activity that a private party has no legal duty to suffer, which occurs when thereis no legal basis or legal cause that justifies the administrative act involved, which in theend means that the administrative act is not grounded in law (since there is no legal basisor, in fact since the conduct does not fall under the presumption established by the law,which is to say there is no legal cause).Thus, an irregular administrative act is an act that is not grounded in law nor in factand, in this regard, an irregular administrative act is necessarily an unlawful act, whichputs in doubt that State liability is strict liability. Therefore, we insist, this is a problemthat will have to be solved by the decisions of the Mexican courts.In relation to cases in which the State is liable for damages caused to private parties,it is worth mentioning Article 20 of the law, which establishes that “the nullification ofadministrative acts by an administrative proceeding or by an administrative court proceedingdoes not presume in itself the right to the indemnification.”This article raises certain doubts about the new system of State liability.On the one hand, it clearly establishes that the liability proceeding will be completelyindependent of the nullity proceeding regarding the administrative act causing the damage.However, according to the reasoning expressed in the preceding paragraphs, the task of thejudicial body in the nullity proceeding and in the State liability proceeding is confused sincein the latter proceeding both bodies will decide whether or not the administrative act inquestion has a legal basis and if the administrative act has an adequate basis in fact.Under these circumstances, the cited article indirectly allows a double assessment ofthe same facts and simultaneously tolerates the existence of contradictory decisions,since under this article a judicial body could decide on the nullity of the administrativeact, basing its decision on a failure to ground it in fact and in law, while the judicial bodythat hears the liability proceeding could deny a right to indemnification, arguing that thechallenged administrative act was not in fact irregular because there was a legal basis anda legal cause that justified it.As can be seen, the drafting of Article 20 creates problems caused by the concept ofirregular administrative activity, which must be clarified by the Mexican courts, since331State Liability

under the current drafting the law tolerates the possibility of contradictory decisionsthat, although referring to different consequences, analyze and decide upon the samecauses.Finally, with regard to cases in which a private party has a right to be indemnified inaccordance with Articles 12, 13, and 14 of the law, the State is liable not only for thematerial damages, but also for pain and suffering (daño moral) and personal injury,including death.3. Extent of Indemnification332C H A P T E R X X IThe extent to which a private party can be indemnified depends on the type of damageit suffered. If the damage is material and, therefore, quantifiable, the private party has aright to a complete indemnification of damages, which amount will be calculated infunction of the commercial value of the goods and based on the criteria established in theExpropriation Law (Ley de Expropiación), the Federal Tax Code (Código Fiscal de la Federación),the General Law of National Assets (Ley General de Bienes Nacionales), and otherapplicable laws, depending on the case.If the damage caused is personal injury, the amount of the indemnification will be calculatedaccording to the Federal Labor Law (Ley Federal del Trabajo), based on correspondingmedical opinions. In the case of death, the indemnification will be calculatedaccording to Article 1915 of the Federal Civil Code (Código Civil Federal).Finally, if the damages are for pain and suffering (daño moral), the amount of theindemnification cannot exceed 20,000 times the general daily minimum wage in forcein the Federal District.4. Terms of IndemnificationEach of the public federal entities will be liable for indemnifying, from its own budget,the damages and losses caused by its public servants in the “irregular” exercise of theirduties. This indemnification shall be paid in Mexican currency; however, payment inkind may be agreed upon.The amount to be indemnified must be adjusted as of the time the payment is madein compliance with the ruling ordering it. In the case of a delay in compliance with theobligation, the amount to be paid must be adjusted in accordance with the provisions ofthe Federal Tax Code (Código Fiscal de la Federación).The law also establishes the possibility of the indemnification being paid in installmentsduring subsequent fiscal years, in which case the liable public entity must makea projection that, based on the funds available and the obligations assumed, makes thepayment of the indemnification possible.

While one of the problems with the prior State liability regime was the lack of budgetaryprovisions that specifically assigned funds for the payment of indemnifications forcausing harm to a private party, this law does contain such provisions.In accordance with Article 6 of the law, each of the federal public entities must includein their respective draft budget the funds necessary to cover obligations arising fromtheir liability; however, this same article establishes a limit; the funds approved underthis item in the budget cannot exceed the equivalent of 0.3 percent of the programmableexpenditure of the Federal Outlay Budget.As a result of this limitation on the funds allocated to the payment of indemnifications,the priority of payment takes on greater relevance if we consider that the amount ofthese funds could be exhausted during the fiscal year in question.With this in mind, the law provides that if the funds budgeted for the payment ofindemnifications for state liability are insufficient to completely pay the debt, the affectedprivate party will be entitled to have the balance covered in the subsequent fiscalyears with the corresponding adjustment of the unpaid balance in accordance with theprovisions of the Federal Tax Code.In consideration of the above, in order to have control of the priority of payment ofthe debts of public entities, the law provides for the creation of a public registry in whichthe definitive decisions ordering payment of indemnifications are recorded. It also establishesthat they shall be paid taking into account the chronological order of the dates onwhich the decisions ordering such payment were issued.As can be observed, the above regulation clearly indicates an effort of the legislativebody to make the reform of Article 113 of the Constitution effective and above all viablefor the economic conditions of our country.333State Liability5. Form and Time Periods for Claimingthe Right to IndemnificationThe affected private party must file its indemnity claim before the Federal Tax andAdministrative Court, and the procedure will be governed by the Federal Law of AdministrativeCourt Procedure (Ley Federal de Procedimiento Contencioso Administrativo).With regard to the statute of limitations for filing an indemnity claim, the action formaterial damages expires one year from the date on which the damage occured, or ceasedproducing effects if the damage was continuous. An action for personal injury or “moral”damages expires in two years.While it is necessary to obtain a decision against the State in order for the State toindemnify a private party for damages and losses caused by its irregular administrativeactivity, Article 26 of the law recognizes the possibility of the parties agreeing to terminatethe dispute by determining the amount of indemnification to pay.

The law also establishes the right of the State to recover the indemnification from thepublic official that caused the damage.Without doubt, this new system of state liability constitutes a huge step forward in theefforts of the Mexican State to become a genuinely democratic State in which the rightsof private parties before the State, in addition to being recognized, are effectivelyobserved, which undoubtedly will make it much more attractive for nationals and foreignersto invest their money in our country, knowing that in the event they suffer fromarbitrary acts of the government, the legal and institutional instruments now exist forthem to be indemnified in a manner that satisfactorily compensates them for damagesand losses caused to them.334C H A P T E R X X I

CHAPTER XXIIDispute Resolution1. IntroductionIn Mexico, as in other countries, there is a system for the determination of applicablelaw. The general principle in commercial matters is the freedom of the parties tochoose the law they prefer to govern their contracts. However, this freedom is subject,as in other legal systems, to public order or public policy regulations. In effect,the Commerce Code (Código de Comercio) establishes that in commercial agreements“each party is bound in the manner and terms that it intended to be bound and thevalidity of the commercial act does not depend on the observance of formalities orparticular requirements” (Article 78), which indicates a broad freedom for the contractingparties with respect to establishing the law applicable to their contract andrelief from formalities that could affect the liberty of contract. This broad latitude inthe Commerce Code is complemented by the freedom the parties have to submittheir contracts to dispute resolution by arbitration. As we will see throughout thischapter, Mexican law establishes, in addition to the above possibilities, rules for thedetermination of the jurisdiction of judges and for the recognition and enforcementof foreign judgments. We will also provide an overview of the different proceduresprovided for in the Mexican procedural system and we conclude with our legal treatmentof arbitration.3352. Choice of Applicable Law and Jurisdiction2.1. Applicable LawThe determination of applicable law is governed by the civil codes of the different statesof the Republic. In commercial matters the Federal Civil Code (Código Civil Federal, CCF)is applicable, Article 12 of which states:

Mexican laws govern all persons in the Republic, as well as the acts and events occurringin its territory or jurisdiction and those submitted to such laws, except whenthose laws establish the application of a foreign law and except as set forth in treatiesand conventions to which Mexico is a party.336C H A P T E R X X I IAs a general rule, such provision is governed by a territorial focus, based on whichMexican judges exercise jurisdiction over persons and acts found or occurring withinMexican territory, applying Mexican law. As an exception, the application of foreignlaw is provided for when Mexican laws establish such application (conflict rules orremittance rules) or when there is an international treaty that governs a particular situation.The latter results from the hierarchical superiority of the international treatieswith respect to Mexican laws, in accordance with the interpretation that has beengiven in Article 133 of the Constitution.With regard to the conflict rules or remittance rules that govern the legal system inMexico, there are five circumstances under which the application of foreign law in Mexicocan be recognized: (a) as vested rights, (b) when the legal status of persons is governedby the law of their domicile, (c) when personal and real property are governedby the law of the place of their location, (d) when acts are governed in relation to theirform by the laws of the place of their execution, but the parties can agree that the actthat has effects in Mexico will be governed by Mexican laws and, finally, (e) when thelaw applicable to contracts will be the place of their performance, unless the partieshave “validly” chosen another law.The rules for the application of foreign law are reasonably clear: foreign law willbe applied by the Mexican judge “as it would be by a foreign judge,” which is to saywith the best effort possible to make the application homogeneous. In the applicationof foreign law, substantive rules will be applied and, with exception, conflict orremittance rules that refer back to the application of a different law from the law thatthe conflict rule or remittance rule of the judge originally ordered it to apply. TheMexican judge is obligated to fill the legal vacuum when the foreign law providesfor an institution not recognized by Mexican law. In this regard a deeper exercise ofcomparative law would have to be carried out. In the event that there are questionsthat must be resolved prior to the application of the foreign law, the Mexican judgecan resolve these preliminary questions according to the law that governs them,avoiding the denaturalization of the case submitted to him or her with the applicationof a single law; the Mexican judge is also obligated to apply the foreign law ina harmonizing manner and to resolve in equity. However, Mexican courts are notaccustomed to this modern system in the application of foreign law, and therefore itis necessary to prepare memoranda explaining the forms of application, which canfacilitate this process.

Finally, it should be indicated that Mexican law allows, in principle, for the parties toa legal relationship to submit to a foreign law, but with the exception that the Mexicanjudge will not apply the foreign law in the following cases:a) When fundamental principles of Mexican law have been fraudulently evaded, inwhich case the judge must establish the fraudulent intention of such evasion; andb) When the provisions of the foreign law or the result of its application are contraryto fundamental principles or institutions of Mexican public order.2.2. JurisdictionThe determination of what judge or court is competent to resolve a dispute will bemade according to national procedural rules. The operating rules of every judicial systemare those regarding competency and procedure, and due to their function theserules are applied nationally. In other words: competency is the power of the judge toexercise the jurisdiction corresponding to him/her in a given case. Competency mustbe decided according to the procedural laws and subsequently, if the matter so requires,the corresponding substantive laws will be applied.In positive Mexican law there is a series of general principles that help to resolve problemsof jurisdiction, such as the territorial competency rules in Article 24 of the FederalCivil Procedures Code (Código Federal de Procedimientos Civiles, CFPC) and Article 156 ofthe Civil Procedures Code for the Federal District (Código de Procedimientos Civiles para elDistrito Federal, CPCDF), which establish the following criteria for choosing a competentjudge to hear a dispute:a) Forum loci executionis. The judge of the place where the respective obligation mustbe fulfilled, the designated place, or the place that the defendant has designated forbeing judicially summoned;b) Lex rei sitae. The judge of the location of the property, in the case of an action inrem over real property or disputes arising from a lease agreement; the judge of theplace of registration in the Public Registry of Property, when the action is the cancellationof such registration. It is important to mention that in relation to land andwater, resources of the exclusive zone and acts of Mexican authorities, Mexicancourts have exclusive jurisdiction;c) Mobilia sequntur personam. The judge of the domicile of the defendant, in the caseof in rem actions over personal property or personal or civil status actions;d) Lex loci executionis. The judge of the place of domicile of the debtor, in case of personalbankruptcy proceedings.337Dispute ResolutionIn cases of voluntary jurisdiction, the judge of the domicile of the petitioner is competent;in the case of real estate, it is the judge of the place of the location of the property.

3. Enforcement of Foreign Judgments338C H A P T E R X X I IIn general terms, for a foreign judgment to be recognized in Mexico it must be valid,which is to say that in its country of origin it has been issued in accordance with the foreignlegal system supporting it. Mexican courts cannot examine or decide on the fairnessor unfairness of the decision, or on the factual or legal basis on which it is supported; theywill be limited to examining its authenticity and enforceability.In Mexico the competency assumed by a foreign court for purposes of enforcementof judgments may be recognized when such competency has been assumed for reasonscompatible or analogous to domestic law, except in the case of matters of exclusivecompetency of Mexican courts, such as: (a) land and water located in Mexicanterritory, (b) matters relating to the exclusive economic zone, (c) acts of authority ofthe Federal agencies, and (d) internal governance of embassies, among others.The enforcement of foreign judgments in Mexico is regulated first by internationaltreaty law and then by internal law. As party to international treaty law, Mexico hassigned the following international treaties governing the enforcement of foreignjudgments:a) Inter-American Convention on Extraterritorial Validity of Foreign Judgments andArbitral Awards;b) Convention on Competency in the International Sphere for the ExtraterritorialValidity of Foreign Judgments;c) Convention between the United Mexican States and the United Kingdom of Spainon the Recognition and Enforcement of Foreign Judicial Judgments and ArbitralAwards in Civil and Commercial Matters.The recognition of foreign judgments is also regulated by internal Mexican lawthrough the CFPC and the CCF.Such laws provide that both local judges and federal judges can recognize and enforceforeign judgments. The competency to recognize judgments in civil and family matterscorresponds to the agencies of each state since such matters, according to the Constitution,are state matters.Commercial matters are concurrent: they can be heard by either federal or stateauthorities. The competent judge to hear and execute a judgment will be determineddepending on the court chosen by the parties and, in the absence of such a designation,by the domicile of the one against whom the judgment is enforced or the locationof the goods within Mexican territory.All foreign judgments must pass through the exequátur procedure to obtain theirrecognition and enforcement.

3.1. Exequátur ProcedureExequátur is in theory a rapid procedure that should take from 11 to 30 days in whichthe judge listens to the losing party of the decision and analyzes any evidence it may present;the substance is not addressed, only the validity of the decision is reviewed. This procedurecan drag on, however, lasting up to two years. In the end, the Mexican judgegrants his or her recognition of the foreign judgment or rejects its effects in Mexico. Thedecision of the judge can be appealed whether the enforcement is granted or denied.3.2. Requirements for EnforcementUnder Mexican law, in order for foreign judgments to be enforceable they must complywith minimum requirements: of form, in the terms established in Mexican law (apostille,translation into Spanish, etc.); that the decision is not the result of the exercise ofan in rem action; that the judge that issues it was competent to do so according to internationallyrecognized principles; that the losing party was granted the right to be heard(see exequátur requirement); that the judgment is res judicata or a final judgment; thatthe matter of the judgment is not under litigation before Mexican courts; and that it isnot contrary to public order.4. Proceedings before Mexican Courts339Dispute Resolution4.1. Jurisdiction in Civil and Commercial MattersWhen initiating a lawsuit before Mexican courts it is essential to determine if the matteris civil or commercial in order to know what laws will be applicable to the dispute. In theevent that the lawsuit is civil, the Civil Code of the respective state (or the Federal District)will apply. When the lawsuit is commercial, the Commerce Code will apply andsupplemental to that the Federal Civil Code. Furthermore, in both cases, in proceduralmatters the provisions of the procedural code of each state or the Federal District mayapply, depending on the competent court.The competency of the courts that will hear the disputes is determined by territory,subject matter, amount, and degree. Both civil proceeding and commercial proceedingcan be processed and resolved before federal courts or state courts, without distinction.In practice, disputes are generally processed before state courts and, as an exceptionbefore federal courts. The court proceedings will be carried out before a single judgeand the hearings are public, except those dealing with family law matters. The resolutionsissued in the first instance can be appealed when either of the parties decidesto do so.

It has been established as a general rule relative to the jurisdiction of a claim that itmust be filed before the court of the domicile of the defendant. This rule is applied bothto individuals and to entities. It is also accepted that the parties can consent to choosinga different jurisdiction, which can be recorded in a contract.4.2. Processing TimeThe time for processing a civil or commercial proceeding is between one and five years,depending on the complexity of the matter, the procedural strategy of the parties, andthe workload of the courts. Normally, when multiple procedural appeals are pursued thetime is prolonged.4.3. Provisional Precautionary Measures340C H A P T E R X X I IIt is important to mention that under Mexican law precautionary measures are limitedto those set forth in the law, consisting of the provisional seizure of assets and the arrestof persons, and therefore in principle, no other type of provisional measure is legally recognized.As an exception, in commercial matters the judge can suspend the execution of the resolutionsadopted in general shareholder meetings, provided the shareholders representing33 percent of the capital stock judicially challenge the resolutions and grant an adequatebond to cover the damages and losses that could be caused to the company by the failure toexecute such resolutions, in the event the decision declares the challenge to be unfounded.In general terms, in order for a Mexican judge to be able to order precautionary measures,the person requesting them must show his/her right to request them and the needfor the measures.The right to request the provisional measure once a judicial proceeding has begun isevidenced before the judge with the simple existence of the action filed against the personwith respect to which the precautionary measure is requested. It is also requiredthat a guarantee be presented to cover the damages and losses that could be caused bythe measure.With regard to the need for the measure, it must be shown that there are sufficientreasons to justify the precautionary measure. In this regard, both Article 1168 of theCommerce Code and Mexican court precedent have established the following as validreasons:a) When there is a well-founded fear that the person against whom a claim will befiled or has been filed will disappear or hide;b) When there is a well-founded fear that the assets on which an in rem action will beexercised will be hidden or lost;

c) When there is a well-founded fear that the debtor, in the case of personal actions,will hide or sell the only assets he or she possesses over which the application ofthe measure has been requested.4.4. Ordinary Civil ProceedingsCivil judicial disputes will be resolved according to the letter of the law or its legal interpretation,or according to general principles of law.The Civil Code governs all persons that are in Mexico, as well as the acts and eventsthat occur in its territory or jurisdiction and those that are submitted to such laws,except as provided in treaties and conventions to which our country is a party.The process of an ordinary civil proceeding is governed by the provisions of the civilprocedures code, either local or federal, depending on its scope of application, in whichthe following is basically established:4.4.1. Initiation of the proceedingThe initiation of the proceeding takes place with the filing of the claim before the commonfiling office of the competent court. The competency of the court is determined bytaking into account the subject matter, amount, degree, territory and, in general, the specialcharacteristics of the matter in dispute.An ordinary civil proceeding can be processed before local or federal courts, dependingon the matter in dispute. Generally, in the case of matters involving the compliancewith and application of federal laws or international treaties or when the Federal Governmentis a party, it should be processed before federal courts.Civil judges are competent in relation to amount when the matters in dispute are overownership or other in rem rights over real estate, provided their value is greater than60,000 pesos (≈ 5,456 US dollars), or in the case of other disputes, the amount of whichexceeds 20,000 pesos (≈ 1,819 US dollars). These amounts are adjusted annually.Competency in relation to subject matter of such judges is divided in function of thesubstantive nature of the matter. Thus, there are judges specialized in family law, realestate leasing, bankruptcy, etc.Once the claim is filed a term is granted to the defendant to respond. Thereafter thejudge will indicate the date and time for the conciliation hearing within the next 10 days.If as a result of this hearing the proceeding has not been terminated by agreement by thefollowing day, then the judge will open the proceeding to the period for offering evidence,which is for 10 calendar days.341Dispute Resolution4.4.2. EvidenceIn the search for the truth regarding the points in dispute the judge can avail him or herself

of any person, whether a party or someone foreign to the case, without any limitation otherthan that the evidence is not prohibited by the law or immoral.The courts can decree at any time, whatever the nature of the business, the carryingout or broadening of any evidentiary investigation, provided it is conducive to findingthe truth about the disputed points.The evidence must be prepared in advance in order to be exhibited in the hearing.Once the evidence has been received, the court will direct the parties or their attorneysor representatives to make their arguments. This stage is called the closing arguments(alegatos) and the parties can present their conclusions in writing.342C H A P T E R X X I I4.4.3. DecisionOnce the evidentiary stage and closing arguments are concluded, the judge will issue thedecision. It is issued in writing and contains a brief description of the facts, as well asthe opinion and legal analysis made by the judge on which he or she supports the decisionand ruling.4.4.4. Procedure for executing the decisionA decision that has become final and is immediately available for execution, or whichmust be executed because the corresponding bond has been granted, will be executedby the judge who heard the first instance claim. All the expenses and costs caused by theexecution of the decision will be covered by the losing party.4.5. Commercial ProceedingsCommercial proceedings are those intended to air and resolve disputes arising fromcommercial acts. Furthermore, when one of the parties is a merchant (including all commercialcompanies), the rules to be applied are the rules applicable to acts of commerce,contemplated in the commercial law and regulated in the Commerce Code. A person isconsidered a merchant when such person engages in some commercial transaction.Commercial law establishes in the Commerce Code three types of commercial proceedings:summary proceedings, special proceedings and ordinary proceedings. Thesummary proceeding is used when the claim is based on a document ready for execution(such as a promissory note, acknowledgment of debt, etc.); the special proceedingis used when there is a specific treatment for a specific premise in thecommercial laws; and the ordinary proceeding is for all other cases.The ordinary proceeding follows almost the same process as explained in the sectionon the civil proceeding. The summary commercial proceeding, on the otherhand, differs from a civil proceeding in that there must be an instrument that isready for execution. The claimant must present its claim accompanied by the instrument

to be executed; then the judge will issue a ruling, in the form of a writ of attachment,so that the debtor shall be required to make payment. If the debtor does notpay, the debtor’s property shall be attached to the extent necessary to secure theamount owed, the costs and the charges, placing them under the responsibility ofthe creditor.The distinction from an ordinary proceeding is that in a summary proceeding firstthere is the attachment and thereafter the debtor is summoned to appear in person, tomake the payment or file its defense. Subsequently the proceeding follows stages similarto those of an ordinary proceeding.In addition, the Commerce Code grants private parties the capacity to freely choose,in compliance with such code, the commercial proceeding that best suits their interests,whether a traditional proceeding before courts or arbitration.4.6. Costs of the LawsuitBoth in civil and in commercial matters, costs are not charged for judicial acts, evenwhen they involve witnesses assisting the court or the court actions taken outside of thelocation of the proceeding. Each party is responsible for the costs and expenses arisingfrom court actions it requests. In principle, the expenses will be paid by the party thatfailed to comply with its obligation.The payment of lawyers’ fees is normally established based on a percentage of theamount in dispute or that may be recovered. This percentage results from an agreementbetween the lawyer and his or her client and is calculated taking into consideration thespecific characteristics of the case, the degree of complexity of the matter, the capacity ofthe client to pay and the reputation of the lawyer handling the case. In the majorityof cases, it is negotiated.Finally, it should be mentioned that the federal and local procedural codes providethat the losing party will be responsible for the payment of the costs (attorneys’ fees) ofthe opposing party according to specific established rates or fees.343Dispute Resolution4.7. Appellate ReviewThe purpose of the appeal in both civil and commercial matters is for the superior courtto confirm, revoke or modify the lower court ruling. The litigant who believes he/she hassuffered some harm, third parties that have left the proceedings and other interested partiesharmed by the judicial ruling can file an appeal.The appeal must be filed in writing before the judge who issued the challenged ruling;he or she must then provide a copy to the opposing party. Then the case file is transferredto the superior court, which is a chamber formed by magistrates who review and

esolve the appeal. The parties may only offer evidence when supervening events haveoccurred; there is also a stage for pleadings and a hearing. The appeal proceeding concludeswhen the parties are summoned to hear the decision.4.8. Amparo Proceedings344C H A P T E R X X I I4.8.1. GeneralThe amparo is a proceeding established in the Constitution whose purpose is to resolvedisputes arising from laws or acts of governmental authorities that violate the individualrights contained in the Constitution.Among the acts of authority against which the amparo can be filed are the final judgmentsand rulings that terminate a proceeding when a violation is committed during theproceeding or in the decision itself.The amparo proceeding against final judgments issued in civil or commercial mattersis processed before the collegiate courts and is always initiated by the aggrieved party.The judgment applies to private individuals and companies and is limited to coveringthem and protecting them in the specific case, without making any general declarationwith respect to the law or the act generating it. As a general rule, before acceding to theamparo proceeding all ordinary appeals provided for in the law applicable to the matterin question must be exhausted.The proceeding is initiated with an initial claim brief. Thereafter a term is given to theauthority to make its declarations in relation to the contested acts, evidence is offered,closing arguments are made and finally the final hearing is held, after which the judgmentis issued.4.8.2. Suspension of the contested actIn the amparo proceeding the suspension of the contested act can be ordered, the principalpurpose of which is to keep the subject matter of the amparo alive, preventing theact that is being contested from irreversibly being carried out before the amparo proceedinghas been definitively resolved.The suspension can be requested on the court’s own initiative or at the request of aparty and it is processed in a case file separately from the principal case file. The petitionfor suspension is presented on the court’s own initiative when delay is not possiblebecause not ordering the suspension could cause irreparable harm to the party. It isdecreed in the same case file in which the claim is admitted, either granting it or denyingit. It remains in effect until the proceeding is resolved.It is also possible for the party in question to request the suspension of the acts thatwould cause it irreparable harm, either in the initial claim brief or thereafter before theexecution of the contested act.

The district judge will decide on the provisional suspension, taking care not to causeharm to the public interest or violate principles of public order. Afterwards he or she willset the date of the ancillary hearing in which the truth or nonexistence of the contestedacts will be analyzed and the definitive suspension resolved on.In addition, the judge can request the party to grant a guarantee (bond, mortgage,pledge or cash deposit) if considered necessary.4.8.3. Appeals and enforcement of the decisionThe decision issued in an amparo proceeding can be appealed as an exception when theunconstitutionality of an article of the Commerce Code or of the Civil Code has beenalleged in the first instance. Such an appeal will be heard by the Supreme Court of Justiceof the Nation if there is not yet any specific court precedent with respect to theunconstitutionality alleged.Subsequently, due to the fact that the decision that is issued is final and is consideredres judicata, it is sent to the civil court that originally heard the dispute for its execution.The enforcement, in the case of decisions issued in civil or commercial matters, consistsgenerally of ordering the judge who heard the case or the Appeals Chamber torestore to the private party its violated right through a new decision or the rehearing ofvarious procedural acts.4.8.4. Expenses and lawyers’ feesIn the amparo proceeding neither expenses nor lawyers’ fees can be claimed due to thefact that this lawsuit is different from the above-explained proceedings. In the amparoproceedings the affected party is always the private party and the State is always theopposing party. In this regard, in Mexico it is not considered that the State is liable forthe sole fact that its decisions or rulings are declared unlawful.345Dispute Resolution5. National and International Arbitration5.1. GeneralIn Mexico, as with proceedings before state courts, arbitration is permitted and widelydeveloped as an alternative means for private parties to resolve the disputes betweenthem. However, the disputes between private parties that can be subject to arbitrationare restricted, the following matters not being subject to arbitration:a) Criminal liability;b) Agrarian law matters;c) Family law and civil status law matters;

d) Personal and commercial bankruptcy;e) Labor disputes; 1f) Territorial resources and waters within Mexican territory;g) Resources within the exclusive economic zone of the sea.346C H A P T E R X X I IIn short, conflicts related to civil and commercial private law questions can be submittedto arbitration, while questions regarding unwaivable rights cannot be submittedto this method of dispute resolution.In Mexico, the power to legislate in commercial matters belongs to the federal governmentand civil matters are reserved to the states of the Republic. In this respect, theFederal Congress has issued commercial laws that include rules of arbitration and thestate congresses have issued, within their scope of competency, arbitration rules that areincluded in the local civil procedures codes.Although there is no article that defines when a dispute is civil in nature, it can bedefined by the exclusion of commercial disputes. Thus, it will be a civil arbitration whenthe dispute does not involve a commercial act or a relationship in which one of the partiesis a merchant (or a business entity).In both civil and commercial matters arbitrations can be presented in a local or internationalcontext, although international civil arbitration is practically nonexistent andeven in the national context its application is very limited. In this regard we can statethat practically all disputes between private parties that are economically significant arecommercial, and therefore civil arbitration is rarely applied. Furthermore, as has alreadybeen mentioned, in civil matters there is a restriction on arbitrating matters related tothe right to alimony, divorce, actions annulling marriage and, in general, those mattersconcerning the civil status of persons.Commercial arbitration is international when the parties, at the time of executing thearbitral agreement, have their residences in different countries, or when the performanceof a substantial part of the obligations of the commercial relationship or the place withwhich the object under litigation has a closer relationship is located outside of the countryin which the parties reside. By elimination, when none of these circumstances of foreigncontact exist, the arbitration will be national.Moreover, the legal regulation of international commercial arbitration in effect in ourcountry can be found in several legal instruments, both national and international. Thethree basic sources of law on arbitration in Mexico are (a) international law, (b) internallaw, and (c) the rules of Ius Mercatorum.__________1There has recently been a trend to attempt to include individual labor disputes among the matters that canbe subject to arbitration.

The international law relevant to commercial arbitration in force in Mexico consists ofessentially the following conventions: (a) the Convention on the Recognition andEnforcement of Foreign Arbitral Awards, known as the New York Convention, and (b)the Inter-American Convention on International Commercial Arbitration, also called thePanama Convention.The second source, the internal regulation in Mexico on international commercialarbitration (also applicable to national arbitration), is Chapter IV of the CommerceCode, which is entirely dedicated to the arbitral proceeding and which incorporated theModel Law on Arbitration of the United Nations Commission on International TradeLaw with minimal changes.In addition to international and national regulations, a third source of arbitral law inMexico is the rules of international custom created by commercial usage and custom.5.2. Arbitral InstitutionsThe Commerce Code recognizes and authorizes both ad hoc arbitration and institutionalarbitration, giving the parties full liberty to choose the procedural rules they considerconvenient. In this regard, it is important to identify the principal institutionsresponsible for administering both national and international arbitration in Mexico:a) Arbitration and Mediation Commission of the National Chamber of Commerce(Comisión de Arbitraje y Mediación de la Cámara Nacional de Comercio, CANACO). Theprincipal purpose of this commission is to provide its own rules for resolving disputessubmitted to both national and international arbitration, free of charge. The majorityof the cases taken before the CANACO are national. In addition to the above, theCANACO also administers arbitrations whose proceedings are carried out in accordancewith the rules of arbitration of the Center of Commercial Arbitration and Mediationfor the Americas (Centro de Arbitraje y Mediación Comercial para las Américas,CAMCA) and the Inter-American Convention on International Commercial Arbitration(Convención Interamericana sobre Arbitraje Comercial Internacional, CIAC). It is located atPaseo de la Reforma no. 42, Colonia Centro, CP 06048, México, Distrito Federal;b) Mexican Arbitration Center (Centro de Arbitraje de México, CAM). This is a privateinstitution whose mission is to administer commercial arbitrations. The rules ofarbitration and the structure of the Center are inspired by the rules of the InternationalChamber of Commerce (ICC). The CAM offers services such as the selectionof arbitrators, experts, and members of dispute resolution panels; the administrationof proceedings; and consultations on the drafting of arbitration clauses andthe provision of information related to commercial arbitration. The CAM offices arelocated in the World Trade Center building, Montecito no. 38, 14 th floor, office 38,Colonia Nápoles, CP 03810 México, Distrito Federal;347Dispute Resolution

348C H A P T E R X X I Ic) International Court of Arbitration of the International Chamber of Commerce.This is a nonprofit institution whose primary objective is to promote internationalcommercial arbitration in the business sphere. The International Court of Arbitrationof the ICC has its principal offices in Paris, France. However, the ICC has localchapters in various countries. In Mexico the chapter was formally established in1985 and it also has its offices in the World Trade Center building, 14 th floor, Office20. While the Mexican chapter is responsible for the promotion and disseminationof arbitration, it is the Secretariat of the ICC based in Paris which administers internationalarbitrations. It has wide recognition in the Mexican legal forum, and infact it is the institution with the greatest number of international arbitrations in thecountry;d) American Arbitration Association (AAA). Founded in 1926 by two organizations:the Arbitration Society of America and the Arbitration Foundation, it is currentlybased in New York and has regional offices. Merchants whose activity revolvesaround the economy of the United States of America make use of it. It was originallycreated for the resolution of internal disputes and has issued additional rules,administered by the International Center for Dispute Resolution (ICDR), to resolveprivate disputes in the international sphere;e) Inter-American Convention on International Commercial Arbitration. This institutionwas founded in 1919 as a result of the Panama Convention and has jurisdiction in thewestern hemisphere. Its rules are similar to those of the United Nations Commissionon International Trade Law (UNCITRAL) and it functions with national sections in Mexicothrough the National Chamber of Commerce of Mexico City. It has its headquartersin Colombia and in Washington, in the Organization of American States (OAS).It governs disputes under the Free Trade Agreement for the Americas (FTAA).5.3. Arbitration Agreement and Arbitration ClauseThe Commerce Code defines the arbitration agreement as the agreement by which theparties decide to submit to arbitration disputes that arise between them with respect toa specific legal relationship, contractual or noncontractual. The arbitration agreementcan be adopted in the form of an arbitration clause included in a contract, or in the formof an independent agreement.Generally, the arbitration clause is included in the contract and therefore it is agreedto before a dispute arises. The arbitration clause is in itself a contract that should clearlyand precisely specify, among other things, the scope of present or future disputes to besubmitted to arbitration. It will include the names of the parties, the arbitrator, the powersgranted to the arbitrator, the applicable law, the procedural rules and the authorityto resolve the disputes based on law or on equity.

In accordance with the guidelines of the New York Convention and the Model Law,the Commerce Code establishes that in order for the validity of the arbitration agreementto be recognized it must be recorded in writing and set forth in a document signed bythe parties or in an exchange of letters, telexes, telegrams, faxes or other means oftelecommunication that provide a record of the agreement, or in an exchange of statementsof claim and defense in which the existence of an agreement is alleged by oneparty and not denied by another.Due to the fact that the arbitration agreement is considered an independent contract,as such the basic requirements for existence and validity applicable to contracts underMexican law must be complied with. The elements of existence are the following:a) The purpose of the contract, which should make reference to the fact that the partieswish to submit present or future disputes to arbitration;b) Consent: the parties must state their desire to submit present or future disputes toarbitration;c) Formality, consisting of the requirement that the arbitration agreement be recordedin writing, and therefore a verbal agreement between the parties is not sufficientto submit to arbitration.The following are the elements of validity:a) The purpose of the contract must be legal and the matter must be arbitrable;b) The consent may not be vitiated, which is to say granted in error, bad faith, underduress, or as the result of an unconscionable bargain;c) The parties must have full legal capacity to sign the arbitration agreement.349Dispute ResolutionMoreover, the arbitration agreement is considered an independent agreement evenwhen found in a clause of a contract. In the event that the contract is declared null andvoid or nonexistent, such a declaration does not necessarily imply that the arbitrationagreement is also null and void or nonexistent.The Commerce Code has established as a general rule that Mexican judges are obligatedto refer the parties to arbitration when a dispute that is submitted to their jurisdictioninvolves a matter that has been submitted to an arbitration agreement by theparties in conflict.5.4. The Arbitral TribunalArbitrators must have the capacity to exercise the functions entrusted to them in the specificcase by the parties. They must also reveal, at the time of their appointment and duringthe entire arbitral proceedings, any circumstances that could create doubt about theirimpartiality or independence.

350C H A P T E R X X I IThe parties can directly appoint the arbitrator or he or she may be appointed by anarbitral institution, a judge, or a third party established by the parties. This arrangementwill depend on the arbitration agreement. In addition, the parties can freely agree on theprocedure for appointing the arbitrators, either incorporating institutional rules of arbitrationor through an ad hoc proceeding established in the arbitration agreement.The Commerce Code establishes that the parties can freely appoint the number ofarbitrators and if there is no agreement just one arbitrator will be appointed. In the eventthat such procedure has not been established and the parties are not able to come toagreement on the appointment of the arbitrator, he or she will be appointed, at therequest of either of the parties, by the judge.Likewise, in the absence of an agreement between the parties and if in the arbitrationclause or arbitration agreement it is agreed that the dispute will be resolved by an arbitraltribunal of three members, the Commerce Code provides that each party willappoint one arbitrator and the two so appointed will in turn appoint the third. In theevent that one party does not appoint an arbitrator within 30 days from the receipt of arequest from the other party to do so, or if the two arbitrators cannot agree on the thirdwithin 30 days from their appointment, the appointment will be made, at the petitionof either of the parties, by the judge.In addition to the above, the parties can freely agree on the procedure for recusing thearbitrators. In the absence of an agreement or silence regarding the agreed-upon rules ofarbitration, in the case of an institutional arbitration, the party wishing to recuse an arbitratorwill send to the arbitral tribunal, within 15 days from the date on which it knowsof the appointment of the arbitrator or of the circumstances that give rise to doubts withrespect to his or her impartiality, a brief explaining the reasons for the recusal. The arbitraltribunal will decide on such recusal and if this action does not prosper, the recusingparty can ask a judge, within 30 days from being notified of the decision rejecting therecusal, that its validity be determined, which decision cannot be appealed.When an arbitrator is impeded from exercising his or her functions or for other reasonsdoes not exercise them within a reasonable time period, he or she will cease to holdsaid position either by resignation or removal. Thereafter a replacement will be appointedaccording to the same procedure by which the replaced arbitrator was appointed.The arbitral tribunal has the authority to decide on its own jurisdiction and rule onany defenses regarding the existence or validity of the arbitration agreement. The defenseof lack of jurisdiction of a tribunal must be filed no later than at the time of presentingthe response to the claim. The arbitral tribunal can resolve this question at that time orin the award on the merits of the case.If, before issuing the award on the merits, the arbitral tribunal declares itself to havejurisdiction, either of the parties within 30 days from the notification of the decision mayrequest a judge to definitively resolve the matter without appeal. However, such petition

for a declaration of lack of jurisdiction will not suspend the arbitral proceeding, andtherefore the arbitral tribunal can go forward with its activities.5.5. Place of ArbitrationThe Commerce Code establishes that the parties can freely determine the place of arbitration.If the parties do not state the location, the tribunal may designate it. In any case,if there is no express provision in this respect, the tribunal has the freedom to meet andconduct the proceeding in any place it chooses.5.6. Law Applicable to the ArbitrationThe parties have the power to freely choose the law applicable to the substance of the dispute,and normally they will choose the law that has a relationship to the domicile of theparties and the purpose or nature of the contract. If the parties do not indicate the lawthat will govern the substance of the dispute, then the arbitral tribunal, taking intoaccount the characteristics and connections of the case, will determine the applicable law.5.7. Arbitral ProceedingFirst of all, in the arbitral proceeding the parties must be given equal treatment and eachone must be given full opportunity to assert its rights. The parties have the freedom todetermine the procedure that will be applied to their arbitration. In the absence of anagreement, as already mentioned, the tribunal can carry out the arbitration in the matterit considers appropriate, following the guidelines established in the Commerce Code.In this manner, in an ad hoc arbitration, if the parties have not chosen the arbitral procedure,the tribunal can determine it as it considers appropriate. On the other hand, ininstitutional arbitration the tribunal must follow the rules of procedure established bythe institution before which the arbitration is being carried out.The parties can freely agree on the language to be used in the activities of the arbitration,which will be applicable to all the written briefs submitted by the parties, allthe hearings and any award, decision, or communication issued by the tribunal. In theabsence of such an agreement, the tribunal will determine the languages to be used inits activities.The arbitral activities with respect to a particular dispute will be initiated on the dateon which the respondent has received the request to submit the dispute to arbitration.The guidelines in relation to the arbitral proceeding are the following:a) Within the term agreed by the parties or by the tribunal, the Claimant shall statethe facts on which the claim is based, the disputed matters and the relief it is351Dispute Resolution

352C H A P T E R X X I Irequesting. The respondent must answer all points in the claim, unless the partieshave agreed otherwise in that respect;b) Unless agreed otherwise by the parties, they can amend or expand their claim orresponse unless the arbitral tribunal considers such change invalid due to the delayit has caused;c) Unless otherwise agreed by the parties, when the respondent does not present itsresponse within the time period established by the parties or the arbitral tribunal,the latter will go forward with the proceeding without considering that such failureis in itself an acceptance of the allegations of the claimant;d) The parties can establish the specific rules regarding the presentation and acceptanceof the evidence during the proceeding. In the event that the parties have notdone so, the arbitral tribunal can freely decide whether or not to admit the evidenceand the weight that will be given to it, as it considers appropriate;e) Except as agreed otherwise, the parties can formulate allegations and includetherein all the documents they consider relevant in their possession, or make referenceto the documents or evidence they will present subsequently;f) The arbitral tribunal will transfer all the declarations, evidentiary documents, experttestimony, or other information that one of the parties submits to the other party;g) The arbitral tribunal has the authority, unless the parties do not permit it, to appointexperts on the matter in question in order to provide their opinion, and to requestthe parties to appoint experts to offer all the relevant information, documents, ormerchandise necessary. Furthermore, the tribunal itself or by request of one of theparties, may request the expert to appear at the hearings, and the parties can interrogatehim or her on the disputed points;h) Unless agreed otherwise, the arbitral tribunal will decide if a hearing should be heldfor the presentation of evidence or oral arguments, or if the actions will be substantiatedon the basis of documents and other evidence. If the parties have not agreednot to hold hearings, the tribunal will hold such hearings during the appropriatestage of the proceeding at the request of either of the parties. In any case, the partiesmust be notified sufficiently in advance of the hearings and the meetings of the tribunalto examine merchandise or other goods or documents;i) Finally, it is important to indicate that the arbitral tribunal or either of the partieswith the approval of the tribunal may request the assistance of a judge for the gatheringof evidence.5.8. Provisional Precautionary MeasuresEven when an arbitration agreement exists, the parties can, prior to the arbitral proceedingsor during them, request a judge to adopt provisional precautionary measures.

In order for a Mexican judge to be able to order the imposition of precautionary measuresit is necessary for the person that requests it to demonstrate the right to request itand the need for the measure.In relation to the existence of the right to request the measure, the petitioner must onlyshow the appearance of having a substantive right to exercise against the other party. Itis not necessary to fully prove its validity and existence, since that will be addressed inthe arbitral proceeding.The need for the measure, as was already mentioned in relation to civil and commercialproceedings, is shown:a) When there is a well-founded fear that the person against whom a claim will befiled or has been filed will disappear or hide;b) When there is a well-founded fear that the assets on which an in rem action will beexercised will be hidden or lost;c) When there is a well-founded fear that the debtor, in the case of personal actions,will hide or sell the only assets he or she possesses over which the application ofthe measure has been requested.In relation to the request for provisional or precautionary measures, it should be mentionedthat when judicial intervention is requested, the first instance federal judge or thelocal judge of the place where the arbitration takes place will be competent to hear it.Apart from the above, it is provided that the arbitral tribunal itself may, once formedand the arbitration initiated, and at the request of one of the parties, order the adoptionof the necessary provisional remedies with respect to the object in dispute. In addition, itmay require from either of the parties a sufficient guarantee in relation to this measure.The guarantee may consist of a bond and shall guarantee the damages and losses thatcould be caused to the respondent; its amount will be set at the discretion of the judge.With regard to the provisional remedies adopted by the arbitral tribunal, it is subjectto debate whether the tribunal can order provisional remedies different from those listedin the Mexican Law on Judicial Courts (Ley Mexicana para los Tribunales Judiciales) orif it has greater discretion in this respect.353Dispute Resolution5.9. Arbitral AwardThe arbitration proceeding will terminate by final award, unless:a) The claimant withdraws its claim, unless the respondent justifiably requests thatthe dispute be definitively resolved;b) The parties agree to terminate the tribunal proceeding;c) The tribunal proves that the prosecution of the proceeding is unnecessary orimpossible.

354C H A P T E R X X I IThe arbitral award shall be issued in writing and signed by all the arbitrators or by amajority thereof. The decision shall include the date of issuance and place of arbitration.After the award is issued, the tribunal must notify each of the parties by the delivery ofa copy signed by the arbitrators.The arbitral tribunal will decide the dispute in accordance with the laws chosen bythe parties. If the parties did not indicate the law that should govern the merits of thecase, the arbitral tribunal, taking into account the characteristics or connections ofthe case, will determine the applicable law and will have in mind trade usages regardingthe case.In the event that the arbitration has been resolved according to law, the arbitral decisionshall be grounded in law and fact, unless the parties have agreed otherwise or unlessthe decision contains a settlement between the parties. The arbitral tribunal will decideas an amiable compositeur or in equity only if the parties have expressly authorized it todo so. Within the 30 days following the notification of the award, unless the parties haveagreed to another time period, either of them may, with notification to the other, requestthe arbitral tribunal to:a) Correct the award: for any error in calculation, copying, typography or similarnature;b) If the parties so agree, provide an interpretation of a point or a specific part of theaward. If the arbitral tribunal considers it justified, it will make the correction orprovide the interpretation within 30 days from the receipt of the request, whichcorrection will be integrated into the award;c) Issue an additional award with respect to the claims made in the arbitral proceedings,but omitted in the award. If the arbitral tribunal considers it justified, it willissue the additional award within 60 days.In the event that during the arbitral proceedings the parties reach a settlement resolvingthe dispute, the arbitral tribunal will terminate the proceedings and if both partiesso request and the tribunal does not object, it will record the settlement in the form ofan arbitral award. This award will have the same nature and effect as any other awardissued on the merits of the dispute.5.10. Arbitration CostsArbitration costs are understood as the fees of the arbitral tribunal, the travel expensesand other expenses incurred by the arbitrators, the cost of expert advice or of any otherassistance requested by the arbitral tribunal, travel and other expenses incurred by thewitnesses (provided they are approved by the arbitral tribunal), the cost of representationand legal assistance of the winning party if such cost is claimed during the arbitral

proceeding and only to the extent that the arbitral tribunal decides that the amount isreasonable, and fees and expenses of the institution that has appointed the arbitrators,if such fees and expenses apply.The parties can freely choose the rules regarding the costs of the arbitration. In theabsence of an agreement between the parties, the arbitral tribunal will set the costs inthe award in the terms explained below.The fees of the arbitral tribunal will be a reasonable amount, having in mind theamount in dispute, the complexity of the matter, the time dedicated by the arbitrators,and other relevant characteristics of the case. The fees of each arbitrator will be indicatedseparately and the arbitral tribunal itself will set them. When a party so requestsand the judge consents to carry out this function, the arbitral tribunal will set its feesonly after consulting with the judge, which can make to the tribunal the observations heor she considers appropriate in that respect.The costs of the arbitration will be charged to the losing party. However, the arbitraltribunal can prorate the costs between the parties if it decides that prorating is reasonable,having in mind the circumstances of the case.The arbitral tribunal will take into account the circumstances of the case in order todetermine the costs of representation and legal assistance, which can be paid by one ofthe parties or prorated between them. This decision will be stated in the text of the orderof conclusion of the proceeding or in the award.Once the tribunal is formed, it may request from each of the parties the deposit of anamount as an advance on the fees of the arbitral tribunal, travel expenses and otherexpenses of the arbitrators, and the cost of expert advice or of any other assistancerequested by the tribunal. Also, in the course of the proceedings, the tribunal mayrequest additional deposits from the parties.When a party so requests and the judge agrees to carry out this function, the arbitraltribunal will set the amount of the deposits only after consulting with the judge, whocan make any observations he or she considers relevant to the tribunal.If after 30 days from the communication of the request of the arbitral tribunal thedeposits requested have not been fully made, the tribunal will inform the parties of thisfact in order for each of them to make the requested payment. If such payment is notmade, the tribunal can order the suspension or the conclusion of the proceeding.Once the award is issued, the tribunal will deliver to the parties a statement of accountof the deposits received and reimburse to them any balance not used.355Dispute Resolution5.11. Nullity of the AwardA written award is final, unappealable and binding on the parties who must comply withit. If any party does not comply, the courts must be turned to for enforcement. However,

if the seat of the arbitration was Mexico, it is provided that arbitral awards can be annulledby a judge when the party filing the action proves that:a) One of the parties to the arbitration agreement is affected by some legal incapacity,or that such agreement is invalid by virtue of the law to which the parties havesubmitted it, or Mexican law;b) It was not duly notified of the appointment of an arbitrator or of the arbitrationproceedings, or has not been able, for whatever reason, to assert its rights;c) The award refers to a dispute not contemplated in the arbitration agreement orcontains decisions that exceed the terms of the arbitration agreement;d) The composition of the arbitral tribunal or the arbitral proceeding does not complywith the agreement executed by the parties; or when the judge proves thate) Under Mexican law the object in dispute cannot be subjected to arbitration or thatthe award is contrary to public order.356C H A P T E R X X I IThe petition for nullification must be filed within three months from the date of notificationof the award. Thereafter, the judge may suspend the nullification proceedingswhen appropriate, and so requested by one of the parties, for the term he or she determinesin order to give the arbitral tribunal the opportunity to restart the arbitral proceedingsor adopt any other measure that in his or her judgment would eliminate thereasons for the nullification petition.The nullification proceeding will be an ancillary proceeding. According to suchproceeding, once it is filed, the judge will order notice to be given to the other partieswith three days to respond. Once such period has passed, if the parties did notfile evidence and the court does not consider it necessary, the parties will be summonedto a hearing within the following three days, which will be held whether theparties attend or not.If the parties have offered evidence, an evidentiary period of 10 days is opened andthereafter the hearing is held. Within the next five days the court will issue its decision,which cannot be appealed.6. Recognition and Enforcement of Arbitral AwardsIn Mexico an arbitral award, from whatever country has issued it, will be recognizedas binding, and after the presentation of a written petition to a judge, it will beenforced.When the place of the arbitration is outside of Mexican territory, the first instance federaljudge or the competent local judge of the domicile of the person against whom theaward is executed or the location of the goods, will hear the recognition and enforcementof the award.

The party invoking the award or requesting its enforcement must present the originalof the award duly authenticated or a certified copy thereof and the original of the arbitrationagreement. In the event that the award or the arbitral agreement is not in Spanish,the party invoking it must present a translation into Spanish of such documents,done by an official translator.In our country the recognition or enforcement of the arbitral award, from whatevercountry in which it was issued, can be denied when the party against whom the awardis invoked proves before the competent judge of the country in which the recognitionor execution is requested that:a) One of the parties to the arbitration agreement was affected by legal incapacity;b) It was not duly notified of the appointment of an arbitrator or of the arbitrationproceedings, or has not been able, for whatever reason, to assert its rights;c) The award refers to a dispute not contemplated in the arbitration agreement orcontains decisions that exceed the terms of the arbitration agreement;d) The composition of the arbitral tribunal or the arbitral proceeding does not complywith the agreement executed by the parties; or when the judge proves thate) Under Mexican law the object in dispute cannot be subjected to arbitration or thatthe award is contrary to public order.The above are identical to the causes for invoking the nullity of the arbitral award.In addition to the above-mentioned causes, the recognition and execution of theaward can be denied when it is not yet binding on the parties or it has been annulled orsuspended by the judge of the country in which or according to whose law such awardhad been issued.In this regard, the judicial courts in Mexico cannot examine nor decide on the fairnessor unfairness of the award, or on the legal or factual grounds on which it is supported.They will be limited to examining its authenticity and to deciding whether or not itshould be executed under national law.Finally, it should be mentioned that the recognition and execution proceeding is carriedout in an ancillary proceeding in the same time periods as stated in relation to thenullification of the award proceeding.Aside from the above, both the ruling issued by the judge in a nullity proceeding and theruling issued in an enforcement of the award proceeding can be challenged through theamparo proceeding. It is important to restate in this regard that what will be examined in allcases in the amparo proceeding is the ruling issued by the judge either with respect to thenullity or the enforcement of the award, but never the award issued by the arbitral tribunal.In this respect, it should be mentioned that the parties cannot invoke the amparo proceedingagainst the award, by virtue of the fact that the arbitrator is not a state authority and, therefore,does not issue acts of authority that can harm the constitutional rights of a private party.357Dispute Resolution

The amparo proceeding will be primarily related to the violation of the principle oflegality. The matter thus commonly has to do with whether or not the judge correctlyapplied the causes of nullity or of denial of the recognition and enforcement of the arbitralaward. Therefore, the court that hears the amparo proceeding must examinewhether the judicial ruling that is challenged has been correctly issued and indicate, ifsuch is the case, that the judge incorrectly evaluated the causes of nullity or recognitionof the award. We repeat that under no circumstances is the amparo court allowedto review the substance of the award.7. Mediation358C H A P T E R X X I IIn Mexico mediation is recognized as an alternative dispute resolution mechanism thatallows the use of a means other than a judicial procedure, with the purpose of allowingthe parties to reach a settlement recorded in a settlement agreement.Among its distinctive characteristics are that it is a consensual mechanism thatrequires the expression of the will of all the parties involved to submit to it. Furthermore,it allows the parties to be involved in the process within a context of flexibility,specialization and confidentiality.It presumes the involvement of a third party who only facilitates the dialogue, thecommunication, and the understanding between the parties. The function of the thirdparty consists of helping to generate an environment favorable for the construction of aresolution and to support the parties in the drafting of and compliance with the agreementreached. In contrast to the arbitrator, the mediator never imposes a solution nor isable to give proposals, as the conciliator can.Mediation can be private or public, depending on whether it is carried out in a privatemediation center or if it is conducted according to judicial regulations.7.1. Private MediationIn private mediation, the parties can agree to submit the dispute to a chosen ad hoc mediator,or they can make use of an institutional mediation proceeding in which previouslydrafted procedural rules are applied.In both ad hoc and institutional mediation, it is advisable to establish a time periodafter which, if an agreement has not been reached by the parties through such mediation,another dispute resolution mechanism will be used.In institutional mediation there are several centers with mediation rules, both in thenational and the international context, such as these mentioned below:a) In the national context, the CANACO and the Mexican Mediation Institute (InstitutoMexicano de Mediación) stand out;

) In the international context, in Mexico, the ICC, pursuant to the Alternative DisputeResolution Rules (ADR Rules) and the AAA, through its specific rules, alsoactively participate in mediation proceedings.7.2. Mediation in a Judicial SettingDuring the last decade in Mexico, the judicial branch has promoted initiatives in the socalledCenters of Alternative Justice, which are commonly located in the judicialsupreme court of each state and the Federal District.The Centers of Alternative Justice have worked to create a law governing this area, basicallythrough reforms of the organic law of local judicial powers and the creation of alternativejustice laws applicable at the local level. These centers regulate public mediation ineach state, the creation of public centers of mediation, the certification of mediators bythe superior court of justice of the state, basic mediation guidelines, and the materialscope of application (civil, family, and commercial). Furthermore, they regulate the creationof the private mediation centers.The following states have public mediation centers: Quintana Roo, Querétaro, Monterrey,Oaxaca, Baja California Sur, Sonora, Guanajuato and the Federal District. Currentlyother states are in the process of establishing alternative justice systems.8. Conciliation359Dispute ResolutionIn Mexico conciliation is also widely used. Conciliation is different from mediation inthat it is an alternative dispute resolution method in which the third party can proposea solution, unlike in mediation. In several Mexican laws, it is provided as a mechanismto resolve disputes prior to the courts, in order to lower the number of disputes thatreach the judicial courts. Conciliation, in this regard, is used basically in two instances:judicially and administratively.In the judicial instance, the holding of a conciliation hearing is contemplated as a priorstep within the judicial proceeding, both in labor and civil matters. In such a conciliationhearing it will be attempted to reconcile the parties so that they reach a peaceful resolutionof their dispute.In addition, in some disputes in certain areas, Mexican law promotes the possibility ofconciliating the interests of the parties prior to a judicial lawsuit. For such purposes,some administrative instances are authorized to act as conciliators.As an example we can mention the conciliation of disputes between suppliers and consumersbefore the Consumer Protection Agency, conciliation between doctor and patientin the National Commission of Medical Arbitration, and the conciliation engaged in bythe National Commission for the Protection and Defense of Users of Financial Services.

9. Free Trade AgreementsMexico has executed the following free trade agreements, among others:a) Free Trade Agreement with Colombia and Venezuela;b) North American Free Trade Agreement;c) Free Trade Agreement with Costa Rica;d) Free Trade Agreement with Israel;e) Free Trade Agreement with the European Union;f) Free Trade Agreement with Chile;g) Agreement to strengthen the Economic Relationship between the United MexicanStates and Japan.360C H A P T E R X X I IIn some of these treaties dispute resolution mechanisms were agreed to in favor of theinvestors that allow them to initiate investment arbitration against the State if it breachesits obligations assumed in the respective treaty. The free trade agreements executed byMexico that allow investors to initiate investment arbitrations are specified below.9.1. North American Free Trade Agreement (NAFTA)The North American Free Trade Agreement (NAFTA) was signed in December 1992 and enteredinto force in January 1994, in order to eliminate trade obstacles among the contracting States.Chapter XI of this agreement establishes the rules applicable to foreign investment in theterritory of the three contracting states (Canada, the United States of America, and Mexico).Foreign investment under NAFTA refers to both the investor and the investment. In thisregard, the treaty includes all types of investment made in stocks and bonds, mediumand long term loans and debt instruments among affiliate companies, tangible and intangibleproperty, including intellectual property rights, franchises and know-how, and contractualinterests or rights derived therefrom.Section B of Chapter XI of NAFTA establishes a supranational arbitration mechanism forresolving disputes between an investor and a state party to the treaty. The arbitrationmechanism seeks to ensure due legal process before an impartial tribunal.9.1.1. Standing for the investor to file a claimAn “Investor of a Party” to the Agreement may make use of the dispute resolution mechanismin NAFTA. This term is defined as “a Party or a state enterprise thereof, or a nationalor an enterprise of such Party, that seeks to make, is making, or has made an investment.”9.1.2. Violations of NAFTAThe purpose of the arbitration mechanism established in NAFTA is to resolve disputes that

arise from violations of obligations contained therein, particularly those contemplated inSection A of Chapter XI, which establishes the principles according to which foreigninvestment shall be governed under said Agreement.The above-mentioned principles establish guidelines in the following areas: a generalbasis of respect for foreign investment; treatment of the investment, national treatment,most-favored-nation treatment, and minimum standard of treatment; social opening;performance requirements; senior management and boards of directors; and transfersand expropriation and compensation.9.1.3. Procedural rulesThe investor, before submitting a claim to arbitration, must first attempt to resolve thedispute by consultation and negotiation. If these fail, it may submit the claim to arbitration,provided that more than three years have not elapsed since the date on which theenterprise first acquired knowledge of the breach.In addition to the above, in order to submit a claim to arbitration the investor mustwaive its right to initiate or continue any proceeding before a Mexican judicial or administrativecourt.A NAFTA arbitration may be governed by any of the following rules of arbitration: theInternational Center for Settlement of Investment Disputes (ICSID), the Additional FacilityRules of the International Center for Settlement of Investment Disputes and the ArbitrationRules of the United Nations Commission on International Trade Law (UNCITRAL).It should be mentioned that Mexico is not a party to the ICSID Convention, and thereforeit must be subject to the Additional Facility Rules or the UNCITRAL rules, as is thecase with Canada, since to date only the United States of America is party to this conventionand both contending parties must be members to submit disputes to it.In practice, Mexico has submitted to the ICSID Additional Facility Rules, as occurredwith the issuance of the first arbitral decision by a NAFTA Chapter XI tribunal, which wasresolved by a panel of arbitrators consisting of Benjamín R. Civiletti, Claus von Wobeser,and Jan Paulsson, in the case of Robert Azinian v. the United Mexican States.361Dispute Resolution9.1.4. Composition of the arbitration tribunalThe tribunal shall comprise three arbitrators, one appointed by each of the parties and thethird, who shall preside over the tribunal, appointed by agreement of the disputing parties.If either of the parties does not appoint an arbitrator or the parties do not agree on theappointment of the presiding arbitrator of the tribunal, the Secretary General of the ICSIDwill appoint such arbitrators, choosing them from a list maintained by each party.9.1.5. Place of arbitrationThe place where the arbitral proceeding will be held may be agreed to by the disputing

parties. If they do not agree otherwise, the arbitration will take place in the territory ofa party that is a party to the New York Convention of 1958. In addition, the ICSID AdditionalFacility Rules or the UNCITRAL Rules are applicable.9.1.6. Governing lawArticle 1131-1 of NAFTA establishes that disputes shall be decided in accordance withthis agreement and by the applicable rules of international law. In the internationalsphere we can take as a reference the Arbitration Rules of the ICSID Convention and secondarilythe decisions of arbitral tribunals. This suggests to us that the national law ofthe member states to the Agreement will not be applicable.362C H A P T E R X X I I9.1.7. AwardThe award issued by the tribunal will be binding only on the disputing parties and onlywith respect to that specific case. The parties must abide by the award without delay.In the event that a party, which is to say the government of a party to NAFTA, does notabide by the award, the investor may request the government of its country to request theFree Trade Commission to establish an arbitral panel and initiate a proceeding betweenthe parties to the agreement. This is a NAFTA mechanism in which the government of thecountry of the investor intervenes to demand compliance with the award, keeping vigilover compliance with the obligations of the agreement.9.2. Free Trade Agreement between the United Mexican Statesand the Republic of ChileThis Agreement entered into force on August 1, 1999 and includes a chapter (Chapter 9)dedicated exclusively to investment matters. Its scope of application is between theinvestors of the State parties, the investments of investors of one party in the territory ofthe other party and all investments in the territory of a party.In this chapter a mechanism is established for the resolution of investment disputesthat ensures both equal treatment among investors of the parties according to the principleof international reciprocity, and due legal process before an impartial tribunal.Furthermore, it contains provisions that regulate most-favored-nation treatment,national treatment, expropriation, etc. Under the Agreement, an investor of a party maysubmit a claim to arbitration that the other party has violated an obligation establishedin the Agreement related to monopolies and enterprises of the State. In this regard, providedsix months have elapsed from the occurrence of the acts that resulted in theclaim, a disputing investor may submit it to arbitration in accordance with: the ICSIDConvention, provided that both the disputing party and the party of the investors aremembers thereof; the ICSID Additional Facility Rules when the disputing party or the

party of the investor, but not both, are party to the ICSID Convention; or the UNCITRALRules of Arbitration.9.3. Agreement to Strengthen the Economic Association betweenthe United Mexican States and JapanThis Agreement was signed on September 17, 2004, and entered into force on April 1,2005, once ratified by the Senate. Its objectives are the following:a) To liberalize and facilitate the trade of goods and services between the parties;b) To increase investment opportunities and strengthen investment protection andinvestment activities of the parties;c) To increase opportunities for suppliers to participate in the public sector acquisitionsof the parties;d) To promote cooperation and coordination for the effective application of the competitionlaws in each of the parties;e) To create effective procedures for the implementation and operation of this Agreementand for the resolution of disputes;f) To establish a framework to promote bilateral cooperation and improvement of thebusiness environment.The scope of application refers to the investors of the other party; the investments ofinvestors of the other party made in the territory of the party and all investments in theterritory of the party.An investor may submit a dispute to arbitration in accordance with:a) The ICSID Convention, provided both the disputing party and the party of theinvestor are parties to that Convention;b) The ICSID Additional Facility Rules with their amendments, provided that the disputingparty or the party of the investor, but not both, are parties to the ICSID Convention;c) The UNCITRAL Rules of Arbitration;d) Any other rules of arbitration agreed on by the disputing parties.363Dispute ResolutionA claim may not be submitted to arbitration if more than three years have elapsed fromthe date on which the investor first had or should have had knowledge of the presumedbreach and knowledge that the investor or enterprise has incurred loss or damage.Unless the disputing parties agree otherwise, the arbitral tribunal will carry out thearbitral proceeding in a country that is party to the New York Convention of 1958.Any arbitral award issued in accordance with the provisions mentioned in the Agreementwill be final and binding on the parties. When a disputing party does not complywith or abide by a final award, the party whose investor was a party in the arbitration

proceeding may request a decision as to whether the failure to comply with or abide bythe terms of the final award is incompatible with the obligations of this Agreement; anda recommendation that the party abide by or comply with the final award.10. Agreements for the Reciprocal Promotionand Protection of Investments364C H A P T E R X X I IAs can be seen from the free trade agreements that Mexico has executed, investmentarbitration has gained much importance in this country. However, this type of arbitrationis not limited to free trade agreements. It has also been extended to all internationalagreements adopted by Mexico with other countries for the reciprocal protection ofinvestment, in which express reference is made to arbitration as a means for dispute resolutionbetween an investor and the State receiving the investment.Among the agreements for the Reciprocal Promotion and Protection of Investments(Acuerdos para la Promoción y Protección Recíproca de las Inversiones, APPRIS, or BilateralTrade Agreements [BITs] in English) signed and ratified by Mexico are those executedwith Spain, Switzerland, Argentina, the Netherlands, Austria, Germany, the Belgian-LuxemburgEconomic Union, France, Finland, Uruguay, Portugal, Denmark, Italy, Sweden,South Korea, the Greek Republic, Cuba, and the Czech Republic, among others.The principal matters addressed in the BITs are definition of investment, promotionand admission, scope of application, treatment of investments, expropriation, transfers,resolution of investor–State and State-State disputes, and final provisions.The agreements generally provide for the submission to arbitration of disputes relatedto a breach of the agreement between a national investor of a State party and the Stateparty that receives the investment. The majority of the BITs follow the same outline, andtherefore a generic description of the dispute resolution procedure to which theinvestors protected by such agreements have direct access will be provided below.The investor of a party may submit on its own behalf an arbitration claim when the otherparty has breached an obligation established in the Agreement, provided the investor or itsinvestment has suffered loss or damage by virtue of the breach or as a consequence thereof.The action to initiate the claim expires after a certain number of years from the date onwhich the investor had knowledge or should have had knowledge of the presumed breach.10.1. Submission to ArbitrationProvided that six months have elapsed from when the acts resulting in the claim tookplace and the disputing investor has given notice 90 days in advance to the contractingparty of its intention to submit the claim to arbitration, the disputing investor may submitthe claim to arbitration in accordance with:

a) The ICSID Convention;b) The ICSID Additional Facility Rules;c) The UNCITRAL Rules of Arbitration;d) The NAFTA Rules of Arbitration.10.2. ArbitratorsThe tribunal will be composed of three arbitrators, unless the disputing parties agree toa different odd number of arbitrators. Each of the disputing parties will appoint an arbitrator,while the third, who will be the presiding arbitrator of the arbitral tribunal, willbe appointed by agreement of the disputing parties.The arbitrators that are appointed in accordance with this Agreement must have experiencein international law and in investment matters.When a tribunal established in accordance with this Agreement is not formed within90 days from the date on which the claim is submitted to arbitration, either because acontracting party does not appoint an arbitrator or the disputing parties cannot reach anagreement on the appointment of the presiding arbitrator of the arbitral tribunal, the SecretaryGeneral of ICSID, at the request of either of the disputing parties, will appoint at itsdiscretion the arbitrator not yet appointed. Nevertheless, in the case of the appointmentof the presiding arbitrator of the tribunal, the Secretary General of the ICSID must ensurethat said presiding arbitrator is not a national of the contracting party or a national of thecontracting party of the disputing investor.365Dispute Resolution10.3. Governing LawAny tribunal established under this Agreement will decide the disputes in accordancewith said Agreement and international law.10.4. Final AwardWhen an award unfavorable to a contracting party is issued, the tribunal may onlyresolve the payment of pecuniary damages and the restitution of the property, in whichcase pecuniary damages may be paid, plus the applicable interest, instead of restitution.10.5. Enforcement of the AwardThe parties must abide by and comply with the award without delay. The disputinginvestor may resort to the enforcement of an arbitral award under the ICSID Conventionor the New York Convention of 1958.

CHAPTER XXIIICourt PrecedentIn Mexico, the judicial branch is responsible for the interpretation and harmonization ofthe laws. Through this interpretation process, the judicial branch establishes court precedent,which is binding if certain requirements are met.Binding court precedent can be formed in one of three ways in Mexico: by confirmation, byunification of interpretations, or by unconstitutionality actions and constitutional disputes.3671. Court Precedent by ConfirmationCourt precedent by confirmation is formed when the contents of judgments on severaldifferent cases are similar. There must be similarity in the interpretation adopted inresolving such judgments in order for this interpretation to become binding and consideredcourt precedent. 1In order to become court precedent by confirmation, essentially three requirementsmust be met: 2a) The case in question must turn on decisions by the Supreme Court of Justice ofthe Nation based on interpretation of the law, ruling in plenary session or in Chambers,or by the Collegiate Circuit Courts in matters of their exclusive jurisdiction;b) The interpretation must be upheld in five judgments, uninterrupted by a contraryjudgment;c) Such judgments must be adopted by a vote of eight in the case of a plenary judgmentor four in the case of a judgment in chambers. The judgment further mustbe adopted unanimously in the case of a judgment of the Collegiate Circuit Courts.__________1Supreme Court of Justice of the Nation, La jurisprudencia: su integración (Court Precedent: its Formation), Mexico,2 nd Ed., 2005, p. 25.2This is seen in Articles 192 and 193 of the Amparo Law.

In order to become binding court precedent by confirmation, the same judicial bodymust uphold an interpretation in five judgments, when in each one the required vote ismet and the interpretation is not interrupted by a contrary one. 32. Court Precedent by Unification of Interpretations368C H A P T E R X X I I IThe formation of court precedent by unification of interpretations arises from the existenceof contradictory court opinions. 4 Its purpose is to maintain the unity of interpretationsof the national judicial order by establishing interpretations that should prevailwhen those held by the Chambers of the Supreme Court of Justice of the Nation or bythe Collegiate Circuit Courts regarding the same legal problem are contradictory.It should be pointed out that the decision that is adopted on the contradictory interpretationswill not affect the specific legal situations of the proceedings in which suchinterpretations have been issued. 5The requirements for the formation of this type of court precedent are the following:a) Report of the existence of contradictory decisions. This denunciation must be formulatedby the Chambers of the Supreme Court of Justice of the Nation, its Ministers,the Collegiate Circuit Courts, the Magistrates of the latter, the parties involvedin proceedings where the contradictory interpretations have been held, or theAttorney General of the Republic;b) Contradiction in the substantive aspects of the rulings. In this regard there is a contradictorydecision when the following circumstances occur: 6• When ruling on legal transactions, essentially equivalent legal questions areexamined and discrepant positions are adopted;• The difference in interpretation exists in the legal arguments, reasoning, orinterpretations of the respective decisions;• The different interpretations result from the examination of the same elements;c) That the legal point on which the contradiction has arisen has not been resolvedin binding court precedent;d) That the report is not obviously invalid;e) That the relative decisions are final and conclusive.The bodies competent to resolve contradictory decisions are both the Plenary and thechambers of the Supreme Court of Justice of the Nation.__________3Supreme Court of Justice of the Nation, op. cit., p. 30.4It should be clear that it is not a motion for review of a decision or a motion for clarification.5Supreme Court of Justice of the Nation, op. cit., p. 31.6Judgment P./J. 26/2001, Federal Judicial Weekly and its Gazette, Ninth Period, Volume XIII, April 2001, p. 76.

3. Court Precedent Arising from Unconstitutionality Actionsand Constitutional DisputesIn relation to the third method of forming court precedent, it should be specified thatthe reasoning contained in the conclusions of law or legal arguments of decisions onconstitutional disputes and unconstitutionality actions approved by eight Justices iscourt precedent. 7Normally, in drafting an authoritative decision arising from these proceedings, the procedureof extracting the interpretation held and approving its text in a session is followed,as is done with respect to court precedent arising from the resolution of amparoproceedings. 83.1. Binding EffectCourt precedent set in a plenary session of the Supreme Court of Justice is binding 369on chambers of the Supreme Court, the Unitary and Collegiate Circuit Courts, theDistrict Courts, the military and local courts, and administrative and labor courts,local or federal. 9 Regarding the Electoral Court, the Organic Law of the Judicial Powerof the Federation constrains it to following court precedent set by plenary sessions ofthe Supreme Court when it involves a direct interpretation of an article of the Constitution.It should be emphasized that the binding nature of court precedent is not dependenton the drafting, control, and dissemination of the decisions constituting precedents. Inthe event a decision constituting precedent that is presumed to have been held by theSupreme Court of Justice of the Nation without being reflected in a decision formallyapproved and published is invoked before a Collegiate Circuit Court, the respectivecourt must verify, through the Bureau of Coordination of Compilation and Systemizationof Decisions, the existence of the legal interpretation.However, the bodies that establish court precedent must comply with Article 195 ofthe Amparo Law with regard to approval of the text and heading of the binding decisions.According to this law, said bodies must also send the court precedent to the area responsiblefor publishing the Federal Judicial Weekly and its Gazette and the judicial bodies thatwere not involved in its formation. 10Court Precedent__________7By analogy, the rulings in the summary constitutional appeals and complaints filed in relation to theseconstitutional means of control must have the same effects.8Supreme Court of Justice of the Nation, op. cit., p. 62.9Which can be seen from Article 192 of the Amparo Law.10Supreme Court of Justice of the Nation, op. cit., pp. 77-79.

The binding effect of court precedent is eliminated when it is interrupted. The interruption,which can be total or partial, presumes the issuance of a new interpretation thatoverturns the prior one.3.2. RetroactivityThe plenary session of the Court has held that court precedent is not governed by aguarantee against retroactivity of the law set forth in Article 14 of the Constitution,assuming that such a guarantee is applicable to laws issued by the Congress and not tocourt precedent that is not considered law.370C H A P T E R X X I I I

Von Wobeser y Sierra, S.C.Guillermo González Camarena 1100, 7º pisoSanta Fe, Centro de CiudadDelegación Álvaro Obregón, C.P. 01210, México D.F.Tel. (52 55) 52 58 10 00www.vonwobeserysierra.com

Legal Guideto Doing Businessin Mexicowas printed in February, 2008by Artes Gráficas Panorama, S.A. de C.V.,Avena 629, colonia Granjas México,C.P. 08400, México, D.F.2 500 copies were printed.

Doing businessin the NetherlandsEdition September 2014

Doing business in the Netherlands 2Contents1. Business introduction to theNetherlands 31.1. Background 31.2. Country and Government 31.3. Location 31.4. Economic overview and export 31.5. Finances 31.6. Right to establish a business 31.7. A most competitive economy 42. Starting business 52.1. General summary of business forms 52.2. Branch or subsidiary 52.3. Private limited liability company (BV) 62.4. Public limited liability company (NV) 82.5. Large NV’s and BV’s:special requirements 82.6. Cooperative (coöperatie) 92.7. Other common forms ofnational business entities 102.7.1. Sole proprietorship (eenmanszaak) 102.7.2. Foundation (stichting) 102.7.3. General/commercial partnership(Vennootschap onder firma, VOF) 102.7.4. Partnership (maatschap) 102.7.5. Limited partnership(Commanditaire vennootschap, CV) 112.8. Dutch business entities formedpursuant to EU Regulations 112.8.1. European Company (SE) 112.8.2. Cross Border Conversion into a B.V.or N.V. 112.8.3. European Cooperative Society (SCE) 112.8.4. European Economic Interest Grouping(EEIG/EESV) 112.9. Management assistance: Licensedtrust company 122.10. Corporate governance 122.11. Compliance Management 122.12. Intellectual property protection 123. Finding an office location 143.1. The Dutch office market 143.2. Town planning 143.3. Lease or buy 143.4. Leasing practises and taxes 154. Personnel 164.1. Employment relationships 164.2. Termination of an employmentagreement 184.3. Working conditions 205. Subsidies 215.1. Innovation subsidies 215.2. Regional subsidies 215.3. Investments 215.4. Finance 225.5. Environment and energy 235.6. Foreign markets 236. Tax legislation 246.1. Corporate income tax 246.2. Income tax 286.3. Dividend withholding tax 306.4. Prevention of double taxation 306.5. Wage tax 306.6. The 30% ruling 336.7. Value Added Tax (VAT) 346.8. Excise and other duties and taxes 357. Helpful addresses 378. Conclusion 38Kennedy Van der Laan– a great innovative law firm 39

Doing business in the Netherlands 31. Business introductionto theNetherlandsKennedy Van der Laan is pleased tooffer you this edition of DoingBusiness in the Netherlands. The purposeof this detailed manual is to guideyou through the investment environment inthe Netherlands. It offers practical informationinto the country and how to set up a business,adopting the ideal legal form, the subsidy schemes,the tax system, labour law and much, much more.1.1 BackgroundThe Dutch United Provinces declared their independencefrom Spain in 1579; during the 17th century,they became a leading seafaring and commercialpower, with settlements and colonies around theworld. After a 20-year French occupation, a Kingdomof the Netherlands was formed in 1815. In 1830Belgium seceded and formed a separate kingdom.The Netherlands remained neutral in World War I,but suffered invasion and occupation by Germany inWorld War II. A modern, industrialized nation, theNetherlands is also a large exporter of agriculturalproducts. The country was a founding member ofNATO and the EEC (now the EU) and participated inthe introduction of the euro in 1999. In October 2010,the former Netherlands Antilles was dissolved andthe three smallest islands - Bonaire, Sint Eustatius,and Saba - became special municipalities in theNetherlands administrative structure. The largerislands of Sint Maarten and Curacao joined theNetherlands and Aruba as constituent countriesforming the Kingdom of the Netherlands.1.2 Country and GovernmentThe Netherlands has a total population of 16.83million inhabitants (August 2014) and is a constitutionalmonarchy. The king is head of the governmentand the Prime Minister, together with the 12 otherMinisters and 9 State Secretaries are responsiblefor the actions of the government. The king does notbear political responsibility and can therefore notbe held politically accountable by the parliament.The Netherlands has 12 provinces 403 municipalities,and 24 water boards, each with their own localauthorities.1.3 LocationMost of the major industries in the Netherlands aresituated in the country’s western regions. The Port ofRotterdam is one of the biggest ports in the world.The railway line, the ‘Betuweroute’, ensures fast andefficient transport from the port to the Europeanhinterland. Utrecht is a central traffic junction andSchiphol, the Dutch airport, is growing at a rapidrate. The Low Countries, as the Netherlands is alsoknown, play an extremely important role in the functioningof the transport artery.1.4 Economic overview and exportThe Dutch economy is the sixth-largest economy inthe euro-zone and is noted for its stable industrialrelations, moderate unemployment and inflation, asizable trade surplus, and an important role as aEuropean transportation hub. Industrial activity ispredominantly in food processing, chemicals, petroleumrefining, and electrical machinery. The country’sperfect location and healthy financial policyhave helped to ensure that the Netherlands hasgrown into an important import and export nation.The country’s most important industrial activitiesinclude oil refineries, chemicals, foodstuff processingand the development of electronic products.Germany, Belgium-Luxembourg, Great Britain,France and the United States are the country’s mainimport partners. All the above-mentioned countries,including Italy, are also the country’s most influentialexport partners.1.5 FinancesThe Euro monetary unit was officially introduced on1 January 2002. The Nederlandsche Bank (DNB) isresponsible for the money flow in the Netherlands.One of the government’s most important objectivesis to keep prices stable and thereby to contain inflation.Dutch banks offer an extensive range of financialservices: some are specialized, while othersoffer an extremely wide range of services. Dutchbanks are reliable: most financial institutions useorganizational structures that prevent the possibilityof entanglement of interests. The general prohibitionon commission also contributes to this from 1April 2014.1.6 Right to establish a businessForeign companies wishing to set up business activitiesin the Netherlands can set up the existing foreignlegal entity in the country without the need toconvert it into a Dutch legal entity. They will, however,be required to deal with both international andDutch law. All foreign companies with establishmentsin the Netherlands must be registered withthe Trade Register (Handelsregister) at theChamber of Commerce (Kamer van Koophandel).

1.7 A most competitive economyThe Netherlands is an attractive base for doing businessand for investment. Its open and internationaloutlook, well-educated work force and strategiclocation are contributors. The attractive fiscal climateand technological infrastructure createfavourable propositions for international business.Doing business in the Netherlands 4

Doing business in the Netherlands 52. StartingbusinessUnder Dutch law, a foreign individualor company may operate in theNetherlands through an incorporatedor unincorporated entity or branch. Dutchcorporate law provides a flexible and liberalframework for the organization of subsidiariesor branches. There are no special restrictions for aforeign entrepreneur to do business in theNetherlands.2.1 General summary of business formsThe business operations can be set up in theNetherlands with or without a legal personality. If alegal entity has legal personality, the entrepreneurcannot be held liable for more than the sum it contributedto the company’s capital.Dutch law distinguishes two types of companies bothof which possess legal personality: the private limitedliability company (besloten vennootschap metbeperkte aansprakelijkheid - BV) and the public limitedliability company (naamloze vennootschap -NV). These forms of legal entities are most commonlyused for doing business in the Netherlands.Other commonly used legal entities in theNetherlands, are the cooperative (coöperatie) andthe foundation (stichting). The foundation is a commonform used within the non-profit and health caresector.Other common business forms are sole proprietorship(eenmanszaak), general partnership (vennootschaponder firma - VOF), (civil) partnership(maatschap) and limited partnership (commanditairevennootschap - CV). None of the latter formspossesses legal personality and, as a consequencethereof, the owner or owners will be fully liable forthe obligations of the entity.All entrepreneurs engaged in commercial businessand all legal entities have to register their businesswith the Trade Register at the Chamber ofCommerce. This section covers the abovementionedlegal entities for doing business in the Netherlandsfrom a legal perspective. After dealing with thedistinction between a subsidiary and a branch, theabove-mentioned entities will be described ingreater detail. This will be followed by a summaryof the status of intellectual property rights in theNetherlands. Finally, this manual will explain theadvantages and disadvantages of doing businessthrough a subsidiary or a branch.2.2 Branch or subsidiaryBranchA branch is not a separate legal entity. A branch is apermanent establishment of a company from whichbusiness operations are carried out. As a result, thecompany that establishes a branch in theNetherlands is liable for claims incurred by actionscarried out by the branch.SubsidiaryA subsidiary is a separate legal entity that maybe established by one or more shareholders. Thesubsidiary is a legal entity that is controlled by the(parent) company. Control of a subsidiary is mostlyachieved through the ownership of more than50% of the shares in the subsidiary by the (parent)company. However, under certain circumstances itis also possible to obtain control by special votingrights or diversity of the other shareholders. Theseshares or rights give the (parent) company thevotes to determine the composition of the boardof the subsidiary and thereby to exercise control.Since a subsidiary has limited liability, a shareholder(the parent company) is generally only liable tothe extent of its capital contribution.Many foreign companies make use of a subsidiaryrather than a branch. The main legal reason to set upa subsidiary, instead of a branch, is limitation of liability.As a shareholder of a subsidiary, the foreigncompany’s liability is basically limited to the extentof its capital contribution; whereas, if the foreigncompany makes use of a branch, it is fully responsiblefor all the obligations and liabilities of thebranch.One major advantage of setting up a branch is that itdoes not generally require the same legal formalitiesrequired for setting up a subsidiary. However, asmentioned above, the simplification and flexibilizationof the Dutch limited liability company law maywell diminish this advantage.Another important aspect to consider with respectto the choice of setting up a branch or a subsidiary inthe Netherlands is the matter of local tax regulations.The choice of setting up a branch or a subsidiarywill be determined based on the circumstancesand relevant factors with respect to the business assuch, and the Dutch tax regulations and tax treaties.

Doing business in the Netherlands 6For more detailed information on tax legislation andparticipations, we refer to section 5.2.3 Private limited liability company (BV)Incorporation processA BV is incorporated by one or more incorporatorspursuant to the execution of a notarial deed of incorporationbefore a Dutch civil-law notary. The notarialdeed of incorporation must be executed in the Dutchlanguage and must at least include the company’sarticles of association and the amount of issuedshare capital.While the BV is in the process of incorporation, businessmay be conducted on its behalf provided that itadds to its name the letters, ‘i.o.’ (for ‘in oprichting’),which means in the process of being incorporated.The persons acting on behalf of the BV i.o. are severallyliable for damages incurred by third partiesuntil the BV (after its incorporation and its registrationwith the Trade Register) has expressly orimplicitly ratified the actions performed on itsbehalf during the process of incorporation. A similarliability arises for the persons responsible if the BVis not incorporated or if the BV fails to fulfil its obligationsunder the ratified actions and the responsiblepersons knew that the BV would be unable to doso. In the event of bankruptcy within 1 year of incorporation,the burden of proof lies with the personsresponsible.Members of the board of directors are also severallyliable to third parties for legal acts performedafter incorporation, but preceding the registration ofthe BV with the Trade Register.Share capitalA BV must have a share capital, divided into a numberof shares of at least one with a par value expressedin Euro, or a currency other than Euro. There are norequirements for a minimum share capital for a BV. Itwill be sufficient if at least one share with votingrights is held by a party other than the BV.Payment for shares can be in cash or in kind.Payments in kind are contributions of property and/or other non-cash items. These payments arerestricted to items that can be objectivelyappraised. If these payments take place upon incorporationof the BV, the incorporators must describethe contributed assets and its value as per a date notlonger than six months prior to incorporation.SharesA BV may only issue registered shares. Besides ordinaryshares, a BV may also issue priority shares, towhich certain (usually voting) rights are allocated inthe articles of association, and preference shares,which entitle the shareholder to fixed dividends thathave preference over any dividends on ordinaryshares. Within a given type of share, the articles ofassociation may also create different classes ofshares (e.g. A, B and C shares) to which certain specificrights are allocated (e.g. upon liquidation).The voting right is linked to the nominal value of theshare. However, it is possible to attach different votingrights to classes of shares (even when the nominalvalues of the various classes are equal), as longas such different voting rights allocation applies toall shareholders resolutions. Moreover, it is possibleto create non-voting shares and shares without anyprofit right. Non-voting shares must give a right toprofit.It is not mandatory to include share transfer restrictionsin the articles of association. If a BV opts toinclude such restrictions in its articles of association,then such provision may perfectly includedetailed rules on how the price of the shares will bedetermined. The articles of association may alsoinclude a lock-up clause prohibiting the transfer ofshares for a specific period. Furthermore, it is possibleto include provisions in the articles of associationimposing additional obligations on all shareholdersor holders of a specific class of designationof shares (e.g. the obligation to extend a loan to theBV, to supply products to it or to offer the shares forsale to the co-shareholders in specific circumstances).Shares in a BV are transferred by a deed of transferexecuted before a Dutch civil-law notary.The board of directors of a BV must keep an up-todateshareholders’ register, which lists the namesand addresses of all shareholders and holders ofdepositary receipts of shares to which so-calledmeeting rights have been allocated, the number,type and designation of shares, the amount paid-upon each share and the particulars of any transfer,pledge or usufruct of the shares.

Doing business in the Netherlands 7Corporate Bodies of a BVThe BV is managed by a board of directors under thesupervision of the general meeting of a BV(“General Meeting”). The General Meeting can, inaddition, resolve to install a supervisory board forthe purpose of supervising the management policyimplemented by the board of directors.General meetingAt least once each financial year, a shareholders’meeting should be held or, alternatively the GeneralMeeting should adopt a written resolution withoutholding a meeting. The General Meeting adoptsshareholders resolutions in principle by an absolutemajority of votes, unless the articles of associationprovide otherwise. The General Meeting may givespecific instructions to the board of directors withrespect to the management of the company, oralternatively only general directions, if the articlesof association contain such a provision.Supervisory boardThe supervisory board’s sole concern is the interestof the BV. Its primary responsibility is to superviseand advise the board of directors. Pursuant to theLarge Company Regime (Structuurregime), thesupervisory board is a mandatory body for a LargeBV.Board of directorsThe board of directors is responsible for managingthe BV. The members of the board of directors areappointed and removed by the shareholders (unlessthe BV is a large BV); if the BV is not a large BV, thearticles of association may grant the board of supervisorydirectors the right to suspend or remove adirector. The articles of association generally statethat each director is solely authorized to representthe company. However, the articles of associationmay provide that the directors are only jointlyauthorized. Such a provision in the articles of associationcan be invoked against third parties.The articles of association may provide that certainacts of the board of directors require the priorapproval of another corporate body such as theshareholders’ meeting or the supervisory board.Such a provision is only internally applicable andcannot be invoked against a third party, exceptwhere the party in question is aware of the provisionand did not act in good faith. In addition, the articlesof association can provide that the managementboard shall comply with specific instructions givenby any corporate body.A member of the board of directors of the companycan be held liable by the BV, as well as by third parties.The entire board of directors can be held liabletowards the BV for mismanagement. An individualmember of the board of directors can be held liablewith respect to specific assigned duties. The shareholderscan discharge the members of the board ofdirectors from their liability to the company byadopting an express resolution barring statutoryrestrictions.Besides the aforementioned liability prior to incorporationand registration, liability towards thirdparties can occur in several situations. For example,in case of the bankruptcy of the BV, the members ofthe board of directors are severally liable for thedeficit if the bankruptcy was caused by negligenceor improper management in the preceding threeyears. Similarly, directors risk to be held liable forthe deficit as a result of an approved distribution, ifwithin one year following such distribution the companywould no longer be able to pay the current andfuture debts. An individual member of the board ofdirectors can exonerate himself by proving that he isnot responsible for the negligence or improper management.As an alternative to the two-tier board structurewhere there is a management board and a separatesupervisory board, Dutch law provides statutoryprovisions on the one-tier board structure, a singleboard comprising both executive and non-executivedirectors. The Dutch Civil Code enables the structuringof a one-tier board structure for NV’s and forBV’s, including companies that are subject to theLarge Companies Regime. In a one-tier board thetasks within the board of directors are dividedbetween executive and non-executive members ofthe board of directors. The executive members willbe responsible for the company’s day-to-day management,the non-executive members have at leastthe statutory task to supervise the managementperformed by all board members. Such board ofdirectors adopts all board resolutions except thoserelated to the supervision on the management, whichresolutions are adopted exclusively by the non-executivedirectors. The general course of affairs ofthe company will be the responsibility of all boardmembers (executive and non-executive). The non-ex-

Doing business in the Netherlands 8ecutive members in a one-tier board are part of theboard of directors and are therefore subject todirector’s liability. Please note that regulationsapplicable to certain business sectors (such as inthe health sector, insurance companies sector andbank sector) may have an effect on the ability toimplement the one-tier board system.2.4 Public limited liability company (NV)In general, everything mentioned above that appliesto the BV also applies to the NV. This section willoutline the most significant differences between theNV and the BV.An NV must have an authorized capital. At least 20%of the authorized capital must be issued and at least25% of the par value of the issued shares must bepaid up. The issued and paid-up capital of an NV mustamount to at least € 45,000.Besides registered shares, an NV may also issuebearer shares. Bearer shares must be fully paid upand are freely transferable. Registered shares haveto be transferred by executing a deed of transferbefore a Dutch civil-law notary. An NV is authorizedto issue share certificates (certificaten).If payment on shares is made in cash upon incorporationof the NV, the incorporators must describe thecontributed assets and an auditor must issue astatement to the effect that the value of the contributionis at least equal to the par value of the sharesissued, and in case of an explicitly stipulated sharepremium contribution, equal to the aggregate shareissue price of the shares issued. The auditor’s statementis to be delivered to the civil-law notaryinvolved prior to incorporation.The articles of association of an NV can stipulatelimitations on the transferability of the shares.Dutch law provides for two possible restrictions,which require the transferor either to:• offer his shares to the other shareholders, theright of first refusal; or• obtain approval for the transfer of shares fromthe corporate body, as specified in the articlesof association.At least once each financial year, a shareholders’meeting should be held.2.5 Large NV’s and BV’s: special requirementsA company is considered a ‘large NV or BV’ (structuurvennootschap),and thus subject to the LargeCompany Regime, as soon as three years haveexpired following a deposit at the Trade Register ofthe Chamber of Commerce of a notice that the companymeets each of the following requirements:• the company’s issued share capital, reservesand the retained earnings according to the balancesheet amount to at least 16 million Euro;• the company, or any other company in which ithas a controlling interest, has appointed aworks council pursuant to a legal obligationthereto; and• the company, alone or together with a company(or companies) in which it has a controllinginterest, normally has at least 100 employeesin the Netherlands.Unless an exemption applies, such a company isrequired to appoint a supervisory board (Raad vanCommissarissen) which is given specific powers,which are not granted to the supervisory board of arelatively ’small’ B.V. Such a supervisory board hasthe following powers:• appointment/dismissal of the managementboard; and• approval of major amendments with respect togovernance, including the proposal to amendthe articles of association, a proposal to dissolvethe company, the issuance of new shares,a proposal to increase the issued share capital.In addition, such a supervisory board is governed bythe following rules:• The supervisory board will be required to drawup a profile indicating its size and composition,taking into account the nature of the company,its activities and the desired expertise and backgroundsof the supervisory board directors. Theprofile must be discussed at the GeneralMeeting and with the works council beforeadoption or amendment.

Doing business in the Netherlands 9• The General Meeting will appoint the membersof the supervisory board on the recommendationof the supervisory board. The GeneralMeeting may, however, reject a recommendation,subject to a requirement for an absolutemajority of the votes cast, which must togetherrepresent at least one third of the issued sharecapital. In such situations, the supervisory boardmay submit a new recommendation, whereasthe General Meeting will not be authorised todo so. The General Meeting will then be asked tovote on the new recommendation.• The works council has the right to make ‘strong’recommendations for up to one third of thetotal number of supervisory board directors.The supervisory board may only object to arecommendation if it expects the candidate toprove unsuitable and unable to fulfil the dutiesof a supervisory board director or if appointmentof the proposed candidate would result inthe supervisory board not being properly constituted.The supervisory board will then consultthe works council and, if agreement cannotbe reached with the works council, ask theEnterprise Section of the Amsterdam Court ofAppeal (Ondernemingskamer) to rule on theobjection. If the Enterprise Section accepts theobjection, the works council will be asked tomake a new recommendation. If the objection isrejected, the supervisory board will appoint thenominated candidate.The General Meeting may enforce the collectivedismissal of the supervisory board by passing a resolutionof no-confidence in the board of directors.This will require an absolute majority of the votescast, which must together represent at least onethird of the issued share capital. The board of directorsand the works council must be granted theoption to advise on the proposed resolution and thereasons for it at least 30 days before the generalmeeting of shareholders. If the works council has theright to express a view on the proposed resolution,this view must be communicated to the supervisoryboard and the General Meeting by the board ofdirectors. The works council may explain its view atthis general meeting of shareholders. If the resolutionis passed by the General Meeting, the supervisoryboard will be dismissed with immediate effect.The board of directors must then request theEnterprise Section of the Amsterdam Court ofAppeal to appoint one or more supervisory boarddirectors for a temporary period. The EnterpriseSection will determine the consequences of theappointment and the date by which a new supervisoryboard must be established. Under certain conditions,companies subject to the structure regimecan be fully or partially exempt from these requirements.A supervisory board of a company under apartially exempt structure regime has powers onlyin approving certain specified decisions/actions ofthe board of directors and in appointing the supervisoryboard.2.6 Cooperative (coöperatie)The cooperative is an association incorporated as acooperative by notarial deed executed before aDutch civil law notary. At the time of incorporationthe cooperative must have at least two incorporatorsand can have one or more members. Thesemembers can be legal entities or natural persons.The name of a cooperative must contain the word“coöperatief” or “coöperatie”.The objective of the cooperative must be to providecertain material needs for its members under agreements,other than insurance agreements, concludedwith them in the business it conducts or causes to beconducted to that end for the benefit of its members.The articles of association of the cooperative maystipulate that such membership agreements may beamended by the cooperative.In general, the members of the cooperative are notliable for the obligations of the cooperative duringits existence. In case of dissolution or bankruptcy ofthe cooperative the members and the members whoceased to be members less than 1 year priorthereto, are liable for a deficit on the basis providedfor in the articles of association of the cooperative. Ifa basis for the liability of each member is not providedfor in the articles of association, all shall beequally liable. A cooperative may, however by itsarticles of association (i) exclude or (ii) limit to amaximum, any liability of its members or formermembers to contribute to a deficit. In the first case itshall place at the end of its name the letters “U.A.”(Uitsluiting van Aansprakelijkheid – exclusion of liability).In the second case it shall place at the end ofits name the letters “B.A.” (BeperkteAansprakelijkheid – limited liability). In all othercases the letters “W.A” (Wettelijke Aansprakelijkheid– statutory liability) shall be placed at the end of its

Doing business in the Netherlands 10name. Most cooperatives choose a system ofexcluded or limited liability. It is also possible tocreate different classes of members who are eachliable to a different extent (or not at all). If the liabilityis not excluded “U.A”, a copy of the list stating themembers must be filed with the Trade Register ofthe Chamber of Commerce. Any changes must befiled within one month after the end of each financialyear.The cooperative has no minimum capital requirementsand the capital does not have to be in Euro.The profits may be distributed to its members pursuantto a statutory provision. The articles of associationof the cooperative must also provide for a provisionregarding the entitlement of any liquidationbalance.The cooperative is increasingly used as a holding andfinancing company. The main reasons are its favourabletax treatment and its corporate flexibility.2.7 Other common forms of national businessentities2.7.1 Sole proprietorship (eenmanszaak)In the case of a sole proprietorship (eenmanszaak),one (natural) person is fully responsible and liablefor the business. A sole proprietorship does not possesslegal capacity and there is no distinctionbetween the business assets and private assets ofthe (natural) person.2.7.2 Foundation (stichting)A foundation is a legal entity under Dutch law withtwo main characteristics:• a foundation does not have any members orshareholders and is therefore governed solelyby its board of directors; and• a foundation is incorporated with the aim ofrealising a specific goal by using capital designatedfor that purpose. The goals or objective ofa foundation are stipulated in its articles ofassociation.A foundation is incorporated by means of the executionof a notarial deed of incorporation, which deed isexecuted before a Dutch civil law notary.Pursuant to mandatory law a foundation may notmake distributions to its incorporators and themembers of its corporate bodies and may only makedistributions to other persons if such distributionsare of an ideal or social nature.The board of directors of the foundation may consistof individuals and legal entities. After incorporation,members are appointed by the board itself, unlessotherwise stated in the articles of association of thefoundation. The foundation is represented by theentire management board or by board membersacting individually.Foundations are often used to create a separationbetween legal ownership and beneficial ownership ofassets.2.7.3 General/commercial partnership(Vennootschap onder firma, VOF)A general partnership can be defined as a publicpartnership that conducts a business instead of aprofession. A VOF and its partners must be registeredin the Trade Register of the Chamber ofCommerce. Each of the partners to the VOF is jointlyliable for all obligations entered into by any partnerfor the benefit of the VOF.2.7.4 Partnership (maatschap)Entrepreneurs in the liberal professions (such asdoctors, lawyers and graphic designers) often set uppartnerships (maatschap).A partnership is an arrangement by means of whichat least two partners, who may be individuals orlegal entities, agree to conduct a joint business. Eachpartner brings money, goods and/or manpower intothe business. Each partner is personally, eitherjointly or severally, liable for all the obligations ofthe partnership. A partnership does not possesslegal personality. Registration with the TradeRegister of the Chamber of Commerce is requiredfor a partnership (maatschap), only if it enters into abusiness.A public partnership (openbare maatschap) participatesin judicial matters under a common name. Thepossessions of a public partnership are legally separatedfrom the possessions of the partners.

Doing business in the Netherlands 112.7.5 Limited partnership (Commanditaire vennootschap,CV)A limited partnership is a special form of the generalpartnership (VOF) which has both active and limited(or silent) partners. A general partner is active as anentrepreneur and is liable, as in the case of the generalpartnership. The silent partner, however, tendsto finance the business and stays in the background.The limited partner is liable only up to the amount ofhis capital contribution. He is not allowed to act as ageneral partner and his name cannot be used in thename of the partnership. However, in the event that alimited partner would promote or otherwise beactively involved in the business he would becomeliable as if he were a general partner.2.8 Dutch business entities formed pursuant to EURegulationsIn addition to the business entities which are incorporatedpursuant to the Dutch Civil Code, theNetherlands being an EU member state, pursuant tovarious EU directives,allow the following businessentities to be incorporated in the Netherlands:2.8.1 European Company (SE)Since 8 October 2004 a European Company(Societas Europaea (SE); Council Regulation (EC)No 2157/2001) can be incorporated in theNetherlands. A holding SE can be set up by two ormore public limited liability companies or privatelimited liability companies of which at least two ofthem (a) is governed by the law of a different EUMember State, or (b) has for at least two years had asubsidiary company situated in another EU MemberState. In the Netherlands an SE has the form of aN.V. A public limited-liability company, formed underthe laws of another EU Member State can be convertedinto an SE registered in the Netherlands, ifsuch company for at least two years has had a subsidiarycompany in the Netherlands. A holding SE canfreely incorporate further SE’s in any EU MemberState. The issued capital of a SE at least amounts to€ 120,000.- The advantage of an SE as opposed to aN.V. was the SE’s ability to transfer its registeredoffice to another EU Member State.2.8.2 Cross Border Conversion into a B.V. or N.V.Pursuant to the judgments of the European Court ofJustice of 13 December 2005 in the Sevic-case, of 16December 2008 in the Cartesio-case, and of 12 July2012 in the Vale-case, pursuant to the right of freedomof establishment another EU Member State isobliged to allow and acknowledge a cross borderconversion of a Dutch N.V. into a company subject tothe laws of that EU Member State. Although in mostEU Member States the cross border conversion hasnot yet been codified, which may complicate thesecure implementation thereof subject to the lawsof the EU Member States involved, a cross borderconversion of a public or private limited liabilitycompany existing under the laws of another EUMember State into a Dutch B.V. or N.V. can in principlebe effectuated. The choice for a cross borderstructuring via an SE instead of an implementationof a cross border conversion would be mainlybecause at present only the SE Regulation providesa clear outline of all requirements of the structuringprocess.2.8.3 European Cooperative Society (SCE)Since 16 August 2006 a European CooperativeSociety (Societas Cooperativa Europaea (SCE);Council Regulation (EC) No 1435/2003) can beincorporated in the Netherlands by among othersfive natural persons or entities of at least two differentEU Member States. As opposed to a Dutch cooperativethe SCE has a capital divided by shares andcan transfer its registered office to another EUMember State.2.8.4 European Economic Interest Grouping(EEIG/EESV)Originally, the Europees EconomischSamenwerkingsverband (EESV) was introduced in1985 by the European Commission (EEG 2137/85) toserve as a cross-border operating company withmembers within the European Community. An EESVincorporated in the Netherlands has legal personality,and may not be focussed on profit-making. Forthe structuring of European business activitiesthrough the Netherlands, since 2004 a SE is a moreobvious business entity choice.2.9 Management assistance: Licensed trustcompanyA trust company is entitled to provide corporatetrust services, such as the administration and managementof a company that conducts business in theNetherlands. In addition, a trust company is allowedto offer domiciliation services to foreign companiesand can take care of (required) administrative services,such as the preparation of annual reports. Incertain instances the trust company is the (sole)director of the company for which it provides the

Doing business in the Netherlands 12services. Such trust services can only be provided bytrust companies, which are licensed by the DutchCentral Bank (DNB). A trust company offers expertguidance to tax beneficial international structuresand opportunities to foreign legal entities and privatepersons for their holding-, finance- or investmentactivities in the Netherlands.2.10 Corporate governanceCorporate Governance is a key topic for the corporatepractice in all industries. As a result of theimplementation of the Dutch Corporate Governancecode (edited by Commisie Tabaksblatt and firstestablished with effect from 1 January 2004 andreplaced by an updated edition by Commissie Frijnswith effect from 1 January 2009) for the first time inthe Netherlands principles of good corporate governanceand best practice provisions were codifiedwhich apply to Dutch companies listed on a stockexchange. Following that example for several businesssectors such as real estate construction, banksand childcare as well as for several not-for-profitsectors such as health care, public housing, educationand the cultural sector, governance codes havebeen composed. In practice, if with respect to yourbusiness sector a governance code applies, the challengeis to comply with any requirements under suchgovernance code while safeguarding your businessinterests.2.11 Compliance ManagementUnder the Dutch Corporate Governance Code allDutch companies listed at the AEX, AMX or AScX areobliged to enforce an internal risk management andcontrol system or alternatively explain the reasonsfor deciding not to. The board of directors of a Dutchentity has in general the obligation to manage thebusiness activities responsibly. In its management itmust ensure that all laws are adhered to, for financialreasons as well as for reputational reasons. Atthis moment, Compliance Management within Dutchentities mainly focus on anti-corruption, anti-trustlaw, money-laundering, data protection, productsafety, employment and occupational safety, as wellas environmental laws.2.12 Intellectual property protectionThe Netherlands are a party to nearly all internationalintellectual property conventions and have,as a member of the European Union, implementedall intellectual property directives and apply theEuropean directives. This means that Dutch intellectualproperty law is largely harmonized and protectsforeign right holders with only rare exception.In this section 2.12 we shall provide a brief overviewof the most important intellectual property legislationavailable in the Netherlands.The Netherlands have a so-called Patents KingdomAct, which applies to the Netherlands territory inEurope (as usual), but also to the formerNetherlands Antilles (Curacao, Aruba and SaintMartin). It offers 20 years protection to new andinventive methods and products. Pursuant toEuropean Regulation a supplementary protectioncertificate is offered for medicinal products. Thepurpose of the certificate is to extent the duration ofpatents to up to the full period of 20 years after registrationof the basic patent to allow pharmaceuticalcompanies to earn back their investments in a substanceor combination of substances presented fortreating or preventing disease in human beings oranimals. The duration of such certificate is decidedon application and does not exceed a 5 years period.Patents can be obtained as a single Dutch patent, oras part of a European patent under the EuropeanPatent Convention. One of the European PatentOffice’s subsidiaries is established in theNetherlands.On national Dutch level new plant varieties are protectedby the Seed and Seedlings Act 2005(Zaaizaad- en Plantgoedwet 2005) for a period of 25years, and for some plant varieties, including potatoes,tulips and strawberries, 30 years upon registrationwith the Council for Plant Varieties. Pursuant toEuropean Regulation 2100/94 on Community plantvariety rights it is also possible to apply for one singleEuropean plant variety right with the CommunityPlant Variety Office.A trade name is the name used by a company, includingbusinesses without legal personality (see section2.1), in the course of trade. Such names are protectedagainst confusingly similar trade names ofthird parties under the Trade Name Act(Handelsnaamwet). Protection is offered automaticallyand registration of trade names is not required.

Doing business in the Netherlands 13Foreign companies doing business in theNetherlands or preparing operations in theNetherlands equally enjoy trade name protection.The Benelux Convention on Intellectual Propertyregulates the uniform provisions regarding the registration,use and protection of trademarks, designsand models in the Netherlands, Belgium andLuxembourg.Trademarks can be names, drawings, stamps, letters,numbers, shapes of goods or packages and all othersigns used to distinguish the goods of one companyfrom those of others. A registered trademark is protectedfor a period of 10 years from the registrationdate and the protection can be extended by a further10 years. Renewal must be requested and all duefees paid. The rightful owner is entitled to claimdamages for infringement of its rights (such as theuse of the trademark by another party).A design or model is the new appearance of a utilityproduct. A registered model or design is protectedfor 5 years from the registration date onwards andthe protection can be extended by 4 periods of 5years each, up to a maximum of 25 years. Renewalwill be effective upon timely settlement of all feesdue. The rightful owner is entitled to claim damagesfor any infringement of its rights (such as the use ofthe model or design by another party).European Regulation 40/94 on the Community trademarkintroduces a system for the award ofCommunity trademarks by the Office forHarmonisation in the Internal Market (OHIM). TheCommunity trademark system of the EuropeanUnion enables the uniform identification of productsand services of enterprises throughout theEuropean Union. Requiring no more than a singleapplication to OHIM, the Community trademark hasa unitary character in the sense that it produces thesame effects throughout the Community. TheCommunity trademark contains provisions concerningthe registration and use of Community trademarksby (legal) persons and the protection of therightful owners of such Community trademarks.3 years from the moment that the design was madepublic in the European Union for the first time, or as aregistered design in which case the applicationneeds to be filed with the OHIM and shall be protectedfor a period of up to 25 years.Like many countries, the Netherlands lack specificlegislation with respect to domain names. There is,however, ample case law offering protection to trademarkand trade name owners (and even individualsnames) in case a third party registers or uses adomain name, which is identical or confusingly similarto the rights invoked by the owner. The Dutch toplevel domain .nl is one of the most popular countrycode top level domains in the world, and the namingauthority SIDN offers efficient online dispute resolutionpursuant a dispute resolution policy regimeadministered by the WIPO. As part of the procedure,SIDN offers free of charge mediation in case the .nldomain name holder files a response, resulting inmany disputed which are resolved in an amicably way.The Copyright Act (Auteurswet) contains provisionsregarding the protection of copyrights. Copyrightdoes not require registration in the Netherlands andapplies (amongst other things) to literature, dramatic,musical and artistic work, sound recordings,films and computer programs. A copyright expires 70years after the author’s death. Closely linked to theCopyright Act is the Neighbouring Rights Act (Wet opde Naburige Rechten) which offers a 50 years protectionto performing artists, producers of phonogramsand broadcasting organisations.Likewise, European Regulation 6/2002 on theCommunity design offers a single right for theEuropean Union with respect to models and designs.Novel models and design can be either protected asunregistered designs, in which case the protection is

Doing business in the Netherlands 143. Finding anoffice location3.1 The Dutch office marketThe office market in the Netherlandsis decentralized, which results in eachcity having a more or less specific officemarket. Amsterdam (approx. 6.6 million sq.m.office stock) focuses on finance and internationaltrade, The Hague (approx. 4.1 million sq.m.) isthe national administration centre where the governmentand public departments are the main users ofthe local office buildings. Rotterdam (approx. 3.4 millionsq.m.) has one of the largest ports in the world, asa result of which the office market has a traditionalfocus on insurance and trade. Utrecht (approx. 2.6 millionsq.m.) is located in the heart of the country with afocus on transport and domestic commercial services.In Eindhoven (approx. 1.4 million sq.m.) andArnhem (approx. 1.1 million sq.m.) occupiers of officespace have strong ties with electronics, chemicals andenergy supply.although this has also changed over the past 10years as a result of sale-and-lease back transactions.Leasing has advantages, such as a positive impact onthe company’s cash flow, flexibility, the possibility ofoff-balance presentation and negotiation on incentiveswith landlords. Lease contracts can be subjectto VAT; which may result in VAT savings in specificsituations. Depreciation is an important considerationwith respect to the ownership of real estate. Since thebeginning of 2007, the tax depreciation on real estateis limited, both for BVs and for IB entrepreneurs (naturalpersons). Depreciation for tax purposes is exclusivelypermitted where and in as far as the book valueof the building exceeds the so-called base value. Thelevel of the base value depends on the intended useof the building.LocationPrime rent (Jan. 2014) Euro/sq.m./yrAmsterdam - Zuidas 370Amsterdam - Central 270Amsterdam - South-East 195Rotterdam 180The Hague 175Utrecht 195Eindhoven 1203.2 Town planningThe Netherlands has applied strict regulations withrespect to the development of offices, retail, industrialand residential schemes since 1950. The municipalsystem of zoning plans determines in detail whatcan and cannot be built. In general, developers areonly granted building permits if their plans fit in withthe zoning plans or if an exemption has been granted.The zoning plans also apply to all redevelopmentprojects. It is therefore not easy to change the use ofthe building without the cooperation of the localauthorities. Municipal approval is mandatory withrespect to zoning plan changes. Procedures forobtaining permits are scheduled according to stricttimetables. It can take several years to obtainapproval for complex building plans in which publicauthorities have a dominant role.3.3 Lease or buyThe general practice in the Netherlands is to leaseoffice space: approx. 65% of all office buildings areowned by investors. Owner-occupier situations aremore common in the industrial real estate market,

Doing business in the Netherlands 153.4 Leasing practises and taxesOffices and industrialTypical lease length Negotiable, but the common practice is 5 years + auto-renewalsfor 5 yearsTypical break options NegotiableFrequency of payment Negotiable, but generally quarterly in advanceAnnual indexLinked to consumer price index(CPI; all households)Rent reviewsTo market prices only if agreed upon (frequency usually 5 years,by expert panel)Service chargeDepending on contractTax (VAT) 21%Tax (others)Property tax, water tax and sewer taxIn all instances:The tenant has security of tenure as the lease automaticallyrenews at expiry, bearing in mind thenotice period. The exception to this is if the landlordwishes to occupy, tear down or redevelop the building.These conditions are rather strict and in realitythe landlord’s options of terminating the lease arelimited.• The tenant pays for internal repairs and utilities.• The tenant is responsible for insurance of contents.• The landlord pays for the external and structuralelements of the building.• The landlord is responsible for building insuranceand non-recoverable service charge items.• The landlord provides property managementservices that are not recoverable through servicecharges.More about taxesThe landlord and the tenant are each partly responsiblefor the property tax levied by the localauthority. Each property is assessed for taxationpurposes, known as “onroerende zaak belasting”(OZB).The local government gives a value for the propertyand that value applies for 1 year. Each yearthe authorities collect the tax. The rate depends onthe local authorities and this is a percentage of thevalue according to the Immovable Property Act.Purchase practises and taxesThe purchaser is responsible for the so-called ‘kosten-koper’,which means that the buyer is liablefor the payment of all additional costs. Those costsinclude transfer tax (6% for offices and industrialbuildings), notary costs (0.2-0.4%), legal costs(negotiable) and some minor administration costs,such as land registration (Kadaster).General building costsOperational Costs 10.0%Maintenance 7.0%Management 1.5%Property taxDepending on the municipalityOthers 1.0%Insurance 0.3%

Doing business in the Netherlands 164. PersonnelFinding and retaining personnelis an essential condition for the existenceand growth of an organization.Companies stand out through the personnelthey employ. Dutch tax legislation (seesection 5) allows numerous options for rewardingpersonnel in fiscally friendly ways.The Dutch legislation includes various provisions tosecure the rights and obligations of both employerand employee in the Dutch employment market. As ageneral rule, the employer and employee shouldbehave according to the standard of good employershipor employeeship respectively. The employer hasa number of specific legal obligations with respect towork and rest times, leave and working conditions.Please note that there will be changes in the Dutchemployment laws based on the Work and SecurityAct, that will enter into force partly on 1 January2015, partly on 1 July 2015 and partly on 1 April 2016.These amendments will also be explained below.4.1 Employment relationshipsAccording to Dutch law, three different general typesof agreements are used to determine the rights andduties of persons performing activities in the courseof a business for another party. The employmentagreement (‘arbeidsovereenkomst’) is the most commonagreement. The assignment agreement (‘overeenkomstvan opdracht’); for example, a freelanceagreement, consultancy agreement or a managementagreement is used often in an attempt to avoidan employment agreement coming into being. A thirdagreement is the contracting agreement (‘aannemingsovereenkomst’).This agreement is concludedbetween parties if the purpose of the activities is toconstruct an item with a physical nature.Essential features of the employment agreementare: the obligation to perform labour in person inreturn for pay, and the authority of the other partyto give instructions as to how the labour is to be performed.Other agreements lack one or more ofthese features. The employment agreement itself isnot subject to rules as to its form (oral agreementsare perfectly valid, although problems as to proofmay arise). However, according to Dutch labour lawthe employer is under the obligation to provide certaininformation in writing to the employee withrespect to the employment agreement. This relatesamong others to place of work, job title, the date theemployment agreement enters into force, remuneration,working hours, terms and conditions relatingto holidays, the applicability of any collective labouragreement, the non-competition clause and the probationaryperiod.Furthermore, Dutch labour law takes the legal presumptionof an employment agreement as a startingpoint if a person has performed labour every week for3 consecutive months, with a minimum of 20 hours amonth. The contracted work in any given month is presumedto amount to the average working period permonth over the 3 preceding months.Governing lawAs a rule, an employment relation is governed bythe law of the country to which it is most closelyconnected (typically: the country where the labouris performed). As a rule, parties to an employmentagreement are free to choose a different law toapply to their relationship. However, according toEuropean legislation, the effect of any choice of lawin international employment agreements is limitedto the extent that the employee will not lose protectionon the basis of mandatory provisions of thelaw of any member state, which would apply if nochoice of law had been made. Mandatory rules arelegal provisions which cannot be contracted out.For example, many provisions of Dutch labour lawregarding the termination of an employment agreementare considered to be mandatory.The parties to an employment agreement are limitedto negotiations of their own terms and conditionsby both Dutch labour law and any applicablecollective labour agreement, since these containmany mandatory rules on terms and conditions ofemployment.Employment law regulationsEmployment relations in the Netherlands aremostly regulated by the Dutch Civil Code (‘BurgerlijkWetboek’). An important principle of the employmentprovisions of the Dutch Civil Code is theprotection of what is known as the weakest party, i.e.the employee. Apart from the Dutch Civil Code, regulationsconcerning labour law can be found in severalother regulations and legislative acts, such asthe Works Council Act and the Workings ConditionsAct. As a result of the unification of Europe, Dutchregulations are increasingly influenced by Europeantreaties and case law of the European Court ofJustice. Furthermore, employment regulations are

Doing business in the Netherlands 17laid down in collective labour agreements.Minimum wageThere is a statutory minimum wage for employeesaged 23 or over. In addition there is a minimum wagefor employees aged between 15 and 22, the level ofwhich varies according to age. These minimum wagesare indexed and may be adjusted twice a year onJanuary 1 and July 1 (as of July 2014, the statutoryminimum wage for employees aged 23 or over is€ 1,495.20 gross per month, excluding 8% holidayallowance).Collective labour agreements (‘CAOs’)As mentioned above, employment agreements arealso influenced by collective labour agreements(‘CAOs’). Collective labour agreements are negotiatedbetween representatives of employers andemployees and are intended to provide consistentemployment conditions within specific branches.Collective labour agreements can be negotiatedfor an entire branch or be limited to a company.Furthermore, the Minister of Social Affairs canimpose the application of a collective labour agreementon the entire industry or sector by declaring acollective labour agreement generally binding. Anyprovision in an individual employment agreement,which restricts the rights of the employee under anapplicable collective labour agreement, is void. Insuch cases the provisions of the collective labouragreement prevail.Trade unionsAlthough the influence of trade unions in theNetherlands is generally waning, trade unions arestill well organised in the manufacturing industryand the semi-public sector or privatised sector.The most important trade unions are the NationalFederation of Christian Trade Unions (‘ChristelijkNationaal Vakverbond’ (CNV)) and The NetherlandsTrade Unions Confederation (‘Federatie NederlandseVakbeweging’ (FNV)). The main employers’ associationis the Confederation of Netherlands Industryand Employers (VNO-NCW).Works councilsAn employer with in general 50 or more employeesis obliged to establish a works council for consultationwith and representation of its employees basedon the Dutch Works Council Act (“Wet op de ondernemingsraden”).The employer is required to give theworks council an opportunity to render advice on anydecision which may in short have important consequencesfor the enterprise as a whole, such as a decisionconcerning transfer of control of the enterpriseor any unit thereof or a substantial reduction orexpansion in the activities of the enterprise. Consentof the works council is required for any decision concerningin short secondary conditions of employmentsuch as pension insurance schemes andarrangements relating to working hours. Theemployer is required to provide the works councilwith all the information it reasonably needs for theperformance of its duties.Employment agreementsAn employment agreement may be agreed for anindefinite or fixed period of time. If an employmentagreement for a fixed period of time is continued, anew agreement will then be deemed to have beenentered into under the same conditions and for thesame period of time (subject to a maximum of 1year) as the former employment agreement.Parties are free to enter into consecutive employmentagreements for a fixed period of time, endingby operation of law, however two restrictions (chainprovision) apply:• The aggregate duration of the consecutiveemployment agreements (with interruptions ofnot more than 3 months) may not exceed.• 36 months; if the aggregate duration is longerthan 36 months (interruptions included), thelast employment agreement shall be deemedto be an employment for an indefinite period oftime.• The number of consecutive employment agreementsmust be less than 4. If the number of consecutiveemployment agreements exceeds 3(while there are no interruptions of more than 3months in between the employment agreements),the fourth employment agreement willbe considered to be an employment agreementfor an indefinite period of time.The Work and Security Act will change the arrangementfor consecutive employment agreements as of 1July 2015. The legislator has reduced the maximumnumber of consecutive employment agreements for adefinite period. As of 1 July 2015 the general rule willbe that an employment agreement for a fixed period of

Doing business in the Netherlands 18time may be entered into for three consecutive times,which is currently the same, during which the totalperiod may not exceed two years, which period is currentlythree years. The fourth consecutive contract willbe considered to have been entered into for an indefiniteperiod. The same will apply if the total duration exceedsthe two-year period. For employment agreements to beconsidered non-consecutive, intervals should be morethan six months, which interval is currently threemonths.In CAOs it is allowed to deviate from the main rule forconsecutive employment agreements. Current legislationdoes not set a limit to this deviation option. Underthe new legislation it is only possible to deviate fromthese rules to a limited extent. The two-year period maybe extended to a maximum period of four years, and themaximum number of contracts may be raised fromthree to six, but only if it concerns temporary agencywork or the CAO shows that the intrinsic nature of thebusiness operation or the type of position or job categoryrequires such an extension or increase.Consequently, the CAO must include and explain whythe statutory consecutive employment agreementsarrangement is deviated from, which will limit theoptions for an extension or increase as well.4.2 Termination of an employment agreementWith respect to termination of an employmentagreement, a distinction must be made between anemployment agreement for a fixed period of timeand an employment agreement for an indefiniteperiod of time. There are several ways for employmentagreements to terminate:Probation periodParties can agree upon a probation period. However,it should be noted that a probation period is subjectto strict rules. A probation period for maximum2 months can only be concluded if parties haveagreed upon an employment contract for a fixedperiod of at least 2 years, or in case of an employmentcontract for an indefinite period of time. Anemployment contract for the limited period of lessthan 2 years and an employment for a specific project,where a termination date is not indicated, mayonly contain a probation period of 1 month. Duringthe probation period both the employer and theemployee can terminate the employment contractdirectly at any time. In order to be valid, the probationperiod has to be expressly agreed upon byparties in writing. Any deviation from the aforementionedrules will result in a void probation period.With the introduction of the Work and Security Act,the option to include a trial period in a temporaryemployment contract lapses as of 1 January 2015.A contract of a maximum of six months may now nolonger include a trial period.Lapse of the agreed periodAn employment agreement for a fixed period oftime will end by operation of law at the end of theagreed period of time without formalities.Summary dismissalThe employment agreement can be terminatedfor urgent cause; for instance, if the employee hascommitted a serious crime, such as, but not limitedto, theft, fraud, etc. Before a summary dismissalcan be given, all circumstances must be taken intoconsideration. Dismissal must be given withoutdelay, only the time necessary for an investigationinto the facts is usually allowed. The grounds forthe dismissal must be conveyed to the employeeat the moment of dismissal. The employment endsimmediately, without notice, and the employee isnot entitled to compensation. Usually, payment ofunemployment benefits is denied. The courts do noteasily accept that sufficient grounds are present todeem a summary dismissal valid. Before decidingon a summary dismissal, therefore always consult alegal advisor.The employee may challenge the dismissal itselfwithin 6 months, stating that he is still employed andis thus entitled to pay. Alternatively, the employeemay acquiesce in the termination of the employment,but claim damages for reasons that thegrounds for the dismissal were not valid. As a riskcontainment measure, it is advisable to file for dissolutionof the employment (see below).Death of the employeeThe employment agreement will terminate by operationof law in case of death of the employee: thefamily of the employee is entitled to be paid approximately1 month’s gross salary.Mutual consentThe employment agreement can be terminated bymutual consent; the entitlement to unemploymentbenefits still exists unless the employee him/herselfhas taken the initiative for termination or he/she has acted in such a way that there is an urgent

Doing business in the Netherlands 19cause for summary dismissal.Dissolution by the CourtThe Court can terminate the employment agreementthrough dissolution. The employer will needa sound reason to have the employment contractdissolved by the Court. Amongst others, restructuringof the company and non-performance of theemployee can serve as reasons. The proceedingswill take approximately 6 to 8 weeks. No noticeperiod is called for; the court sets the terminationdate in its verdict (usually at a date approximately 2weeks after the verdict). The Court can grant a severancepayment to the employee in the case wherethe employment agreement is dissolved. A rule ofthumb for calculating severance (‘Cantonal CourtFormula’) is widely used. It is based on age, years ofservice, salary and circumstances. A rough indicationfor severance due is 1 month’s salary for every yearof service.Furthermore the Cantonal Court Judges may takeinto consideration the employee’s position on the jobmarket, the employer’s financial position and theposition of older employees who are close to theirretirement.No appeal is possible against the decision of theCourt, either to dissolve the employment contractor to grant a severance payment, apart from exceptionalcases in which – in short – the Court has failedto apply the law correctly.NoticeThe employer, who wishes to terminate an employmentagreement for an indefinite period of time,can give notice to the employee observing the noticeperiod – employment agreements for a fixedperiod of time can only end by giving notice if thispossibility is explicitly stated in the employmentagreement. However, in order to be able to do so,the employer must first obtain approval of theUWV (labour office) before serving the notice oftermination, stating the reason(s) for the intendedtermination. The UWV approval procedure will usuallytake about 2 months provided that the reasonsfor termination are clear.After having obtained such approval to terminatethe employment agreement, the notice period maybe shortened by 1 month.The statutory notice period that has to be observedmay vary from 1-4 months, depending of the durationof the employment.An employee whose employment has been properlyterminated (i.e. after consent of the UWV and withdue observance of the applicable notice period) maynevertheless claim damages on the grounds that hehas been unreasonably dismissed (comparable to“unfair dismissal”). There is no general rule for thecalculation of such damages.The Work and Security Act also results in a changeto the dismissal procedure as of 1 July 2015. Therewill be a clearly defined route: dismissal for economicreasons will be via the UWV and dismissal forpersonal reasons is reviewed by the district court. Inall cases the employee has the right to a statutorytransition allowance.In the new situation after an employment contract ofa minimum of two years employees will have theright to a transition allowance intended to be usedfor training and transferring to a different professionor employer. The allowance depends on theduration of the contract and is 1/3 of the monthlysalary per year of service and 1/2 of the monthlysalary for each year of service where the employeewas employed for more than ten years. The maximumallowance is € 75,000 or one annual salary foremployees with an annual salary of over € 75,000.All reasons for dismissal will be included in the newlegislation. The Work and Security Act, furthermore,states for each reason for dismissal a number ofrequirements, which the UWV or the sub districtcourt must test against. If the requirements are notmet, the UWV, in principle, cannot grant any permissionand/or the sub district court cannot dissolveany contract.In contrast to the current situation, the new legislationno longer allows the sub district court to compensatea limited case file with a higher severancepayment. The court may award any additional payment– besides the statutory transition allowance –only in exceptional cases. This payment may underno circumstance be intended to compensate for alimited case file.The new legislation still allows the conclusion oftermination agreements. An employee may alsoassent in writing to the employer’s termination. An

Doing business in the Netherlands 20important difference with the current law is that theemployee may retract or rescind this agreementwithin fourteen days, without stating reasons or havingto go to court. The employer is required to pointout this option to the employee within two days of hiswritten approval. If he fails to do so, the period willbe extended from fourteen days to three weeks.Finally, the new legislation allows lodging an appealagainst any decision of the sub district court. Unlikethe current system, an order dissolving the employmentagreement may be appealed to the court ofappeal and to the Dutch supreme court. This mayresult in considerably longer proceedings and assuch will make it even more attractive to reach asettlement with the employee.4.3 Working conditionsBy comparison with international worker protectionstandards, the Dutch regulations are of a high standard.In view of an action plan of the DutchGovernment (Simplifying Social Affairs andEmployment Regulation), it is expected that theseregulations will be simplified to bring them more inline with the international worker protection standardsand to strengthen the position of theNetherlands on the international labour market.Under Dutch law, the employer is responsible fororganizing work in such a way that it protects thesafety, health and well-being of the employees inaccordance with a statutory set of standards andcriteria. In principle, all employers are highly recommendedto avail themselves of the professionalassistance of a certified occupational health service(‘Arbodienst’) in respect of the implementation of asignificant part of the applicable health and safetymeasures (for example the occupational healthmedical examination). Under certain circumstances,the employer’s own employees may provide thisassistance, providing that they are certified to thisend.Wet arbeid vreemdelingen (Foreign Nationals (Employment)Act)Workers from the European Union, EEA countries(Norway, Iceland and Liechtenstein) and Switzerlanddo not need special permits to work in theNetherlands. Non-qualifying nationals, however, doneed a ‘residence permit for work’ permits to worklegally in the Netherlands.As of 1 January 2014 the Foreign Nationals(Employment) Act is being amended. The employerapplies for the residence permit. There are differenttypes of residence permits, including for regularemployment, as a highly skilled migrant, holder of aEuropean blue card, lecturer, (guest) lecturer,trainee doctor or scientific researcher. If severalpermits are possible, the employer must make achoice. For the highly skilled with no employer aresidence permit for a search year is possible. Thisresidence permit gives the right to find an appointmentas a highly skilled migrant within one year.When applying for the residence permit, the employeracts as sponsor. The sponsor is responsible for theemployee complying with the conditions. A residencepermit for regular employment can be applied for byany employer with a branch or commercial agent inthe Netherlands. Registration of the employer withthe Trade Register of the Chamber of Commerce isrequired.To be admitted as a highly skilled migrant incomerequirements are laid down. To be admitted as atrainee doctor or (guest) lecturer, the employermaking the application must be a sponsor authorisedby the IND (Immigration and NaturalisationService of the Ministry of Security and Justice).Authorisation is carried out by the IND. The authorisationas a sponsor is in a number of cases a conditionfor the application for the residence permit.Employees with a European blue card are employeeswho carry out highly qualified work within theEuropean Union and meet the salary and trainingrequirement. For the scientific researcher admissionto the Dutch labour market is regulated by EUDirective 2005/71/EC.With effect from 2014 the UWV is from now onobliged every year to check a job taken by a foreignemployee (from outside the European Union, EEAcountries or Switzerland) against the labour marketstatus. The recruitment efforts of employers whowish to recruit or continue to employ foreign workersrequired by law issue no more than an employmentpermit for a maximum of one year (up to 2014 amaximum of three years). After five years (up to2014 after three years) labour migrants gain freeaccess to the Dutch labour market. After that a permitmay be refused if an employer has in the pastbeen sentenced for infringing labour legislation.

Doing business in the Netherlands 215. SubsidiesThe Dutch government offers anumber of incentive schemes in varioussectors to support companies intheir business operations. Foreign entrepreneurswho set up companies in theNetherlands and who register their companieswith the Trade Register of the Chamber ofCommerce can also apply for a number of incentiveschemes.The most important subsidy agency in theNetherlands is RVO (previously AgentschapNL),which is based in The Hague. The latter organization isresponsible for the execution of most of the schemesavailable in the Netherlands. In addition, there are alsoa number of important regional and provincialschemes available, as well as a number of internationalschemes offered by the Ministry of ForeignAffairs, the Ministry of Economic Affairs and Brussels.This section will outline a number of the schemesthat are currently available. Obviously this is not anexhaustive list, so we recommend that you contactyour consultant for more detailed information.5.1 Innovation subsidiesTop Sector policyThe Dutch government has defined 9 Top Sectors inwhich the Netherlands is strong worldwide and towhich the government is paying special attention. TheTop Sectors are: AgroFood, Horticulture, High Tech,Energy, Logistics, Creative Industry, Life Sciences,Chemicals and Water. More venture capital and extrafiscal support should ensure more research anddevelopment in companies and institutions that fallwithin the above sectors. To achieve this, each topsector has signed an innovation contract in a PPSarrangement with the Dutch government, setting outthe innovation agenda. In 2014 special programs(MIT-programs) will open for SMEs in each TopSector for feasibility studies, research and development,cooperation arrangements and researchvouchers. If you are active in or with a project in a TopSector, contact your adviser about the current subsidyoptions.WBSO (Wet Bevordering Speur & Ontwikkeling)WBSO stands for the Dutch Research and DevelopmentAct. Technological innovation is extremelyimportant. The competitor never rests. The WBSOwill help you if you wish to renew your technicalprocesses or develop new technical products orsoftware. The WBSO is a tax incentive scheme thatforms part of the compensation of salary and wageexpenditures for research and development work.RDA (Research & Development Allowance)The RDA is for businesses that want to carry out researchand development work. The RDA is intendedto reduce the financial burdens of research and developmentwork. The WBSO provides a tax incentivefor the hours worked or labour costs in the wagetax return. For other costs, such as the purchaseof equipment, the RDA applies. The RDA offers atax benefit, namely an allowance in the income taxor corporate tax return. You are only eligible forthe RDA if you also apply for the WBSO incentivescheme (see also section 5).Innovation boxThe innovation box provides for a special tax regimefor innovation profits to stimulate R&D-activities.This regime is explained under section 5.5.2 Regional subsidiesUnder the European EFRD (European Fund for RegionalDevelopment) programme for 2007-2013,different regions in the Netherlands are conductingtheir own incentive policy. For 2014-2020 a newEFRD programme is underway. Within this new programmethe focus will be on subsidising projects oninnovation and research, digital agenda, SME supportand low-carbon economy. The various regionsin the Netherlands have drafted various incentiveplans under this new programme. The regionalprogrammes are in the process of approval by theEU Commission. The subsidy programmes for 2014-2020 are expected to start in the fall of 2014.5.3 InvestmentsMIA (Milieu Investerings Aftrek) (Environment InvestmentDeduction Scheme)The purpose of the Environment Investment Deductionscheme (MIA) is to stimulate investment inenvironmentally friendly capital equipment. Companiesthat invest in the environment are entitledto additional tax deductions at a percentage of theinvestment cost. The Environment Investment Deductionscheme is only available for capital equipmentlisted on the Environment List 2014 (Milieulijst2014), which is updated on an annual basis.

Doing business in the Netherlands 22EIA (Energie Investerings Aftrek) (Energy InvestmentDeduction Scheme)The purpose of the Energy Investment Deductionscheme (EIA) is to stimulate investment in energy-savingtechnology and sustainable energy, i.e.so-called energy investments. Companies thatinvest in the energy industry are entitled to additionaltax deductions at a percentage of the investmentcost. The energy investment deduction is onlyavailable for capital equipment that complies withthe specified energy performance requirements.The energy performance requirements and thecapital equipment that are subject to the energyinvestment deduction are available in the EnergyList 2014 (Energielijst 2014), which is updated on anannual basis.KleinschaligheidsInvesteringsAftrek (Small-scaleInvestment Deduction)The Small-scale Investment Deduction entitles theentrepreneur to make deductions from investmentsin capital equipment between € 2,300 and € 306,931in 2014. You invest in capital equipment in the year inwhich you buy it and therefore incur a payment obligation.The investment deduction can be applied inthe year in question. If you do not intend to use thecapital equipment in the year in which the investmentis made, then part of the investment deductionis sometimes carried forward to the next year.5.4 FinanceBMKB (Borgstelling MKB Kredieten) (Credit GuaranteeScheme for SMEs) The purpose of the CreditGuarantee Scheme for SMEs (BMKB) is to stimulatecredit provision to small and medium-sizeenterprises (SME or MKB in Dutch). The scheme isdesigned for companies with a maximum of 250 employees(fte) with a year turnover up to € 50 mln ora balance sheet total up to € 43 mln and includesmost professional entrepreneurs. If the entrepreneuris unable to provide the bank with sufficientsecurity or collateral to secure a loan, the bank canappeal to the BMKB for the necessary guarantees.The government will then, under certain conditions,provide the security for part of the credit amount.This reduces the level of the bank’s risk exposureand increases the creditworthiness of the entrepreneur.Because the banks are in a restructuring phase andadditional requirements are being laid down for capitaland liquidity, business finance for starters andother small businesses, fast growers and innovativecompanies is becoming more difficult and long termfinance is under pressure.GO (Garantie Ondernemingsfinanciering)(Corporate Credit Guarantee)With the Corporate Credit Guarantee large andmedium companies can borrow large amounts moreeasily. Financiers who provide capital get a 50%guarantee from the government. The maximum termof the guarantee is 8 years. You are only eligible forthis scheme if your company is established in theNetherlands and if the business activities take placemainly in the Netherlands. You can borrow an amountfrom 1.5 to 150 million Euro.MKB+ (Innovation Fund SME+)The SME+ Innovation Fund enables the businessmanto convert ideas more easily and quickly into profitablenew products, services and processes. The +means that this scheme is also open to companiesbigger than the SME. The SME+ Innovation Fundincludes financial instruments that are available forinnovation and finances rapidly growing innovativeenterprises. The fund comprises three pillars:1. The Innovation CreditThe Innovation Credit is granted directly to enterprises.This encourages development projects(products, processes and services) associated withsubstantial technical and as a result financial risks.Enterprises have no or insufficient access to thecapital market for these projects.2. The SEED Capital schemeThe SEED Capital scheme makes it possible forinvestors to help techno starters and creative startersto convert their technological and creative knowhow into usable products or services.3. Fund-of-FundsFund-of-Funds also improves access to the risk capitalmarket for rapidly growing innovative enterprises.

Doing business in the Netherlands 235.5 Environment and energySDE (Stimulering Duurzame Energieproductie)(Stimulation of Sustainable Energy production)The SDE is an operating subsidy. This means thatproducers receive a subsidy for sustainable energygenerated and not for the purchase of the productioninstallation, as with an investment subsidy. TheSDE is aimed at companies and (non-profit) institutionsthat want to produce sustainable energy. Thecost of sustainable energy is higher than that of greyenergy, so the production of sustainable energy isnot always profitable. The SDE reimburses the differencebetween the cost of grey energy and that ofsustainable energy over a period of 12 or 15 years.This involves a phased opening up of the differenttechnologies. For each phase the subsidy amountincreases per kWh, but the chance that the subsidywill actually be obtained falls. This challengesapplicants to invest for the lowest possible operatingcosts. As of 2014 a SDE+ subsidy excludes the taxbenefit of the EIA (see above).5.6 Foreign marketsPSI (Private Sector Investeringsprogramma)(Private Sector Investment Programme)The purpose of the Private Sector InvestmentProgramme (PSI) is to contribute to the sustainableeconomic development of a number of developingcountries with the use of the knowledge and capitalavailable in Dutch companies and institutions. If youare planning to invest in a developing market, but theassociated risks are excessively high, PSI mightoffer a suitable solution. The scheme could contributeto (partial) compensation of your investmentcosts. The programme applies to selected countriesin Africa, Latin America, Asia and Eastern Europe.Foreign companies from a selected number of countriescan also apply for the PSI.PvW (Partners voor Water) (Partners for Water)Partners for Water is a programme aimed at combiningforces to improve the international positionof the Dutch water sector and hence to help providesolutions for world water problems. The PvW programmewill run up to 2015. The annual budget is9.5 million Euro.

Doing business in the Netherlands 246. Tax legislationThe tax system in any givencountry is invariably anextremely important criterion whenit comes to companies finding a countryof incorporation. The view taken by theDutch government is that the tax systemmay under no circumstances form an impedimentfor companies wishing to incorporate in theNetherlands. In that framework, it is possible toobtain advance certainty regarding the fiscalqualification of international corporate structuresin the form of so-called Advance TaxRulings. In addition, the Netherlands has alsosigned tax treaties with many other countries toprevent the occurrence of double taxation. At thesame time, its vast network of tax treaties offersinstruments for international tax planning.The following are a few of the benefits offered by theDutch tax system:• The Netherlands does not charge withholdingtax on interest and royalties.• In most cases all the profits that the Dutchparent company receives from foreign subsidiariesare exempted from tax in the Netherlands(participation exemption).• The Netherlands offers attractive tax-freecompensation in the form of the 30% rule forsome foreign personnel who are temporarilyemployed in the Netherlands.The Dutch tax system can be divided into taxesbased on income, profit and assets, and cost priceincreasing taxes.6.1 Corporate income taxCorporate income tax is charged to legal entities ofwhich the capital is partially or fully divided intoshares. Examples of such legal entities are theDutch NV and BV. Companies based in theNetherlands are taxed on the basis of the companies’local revenues. The question as to whether acompany is in effect based in the Netherlands (residentcompanies) for tax purposes is assessed on thebasis of the factual circumstances. The relevantcriteria are issues such as where the actual managementis based, the location of the head office and theplace where the annual General Meeting of shareholdersis held. Entities set up under Dutch law aredeemed to be established in the Netherlands. A residentcompany is in principle subject to Dutch corporateincome tax for its profits received worldwide.Non-resident companies may be subject to corporateincome in the Netherlands on Dutch-sourceincome. This is outlined later.Non-resident companiesNon-resident companies may be subject to corporateincome tax in the Netherlands on Dutch-sourceincome. A non-resident company receives Dutchsourceincome in three ways.The first way is if the non-resident company operatesin the Netherlands using a Dutch permanent establishmentor permanent representative. The determinationof taxable profits of a permanent establishment/representativeis similar to the rules applicableto a subsidiary. A second way to receive Dutchsourceincome arises if a non-resident company hasa so-called substantial interest representing atleast 5% of the shares in a Dutch company, unlessthe shares in the Dutch company are held as part ofan active trading business for the investor. In additionthe shares shall not be held mainly to avoid Dutchpersonal income tax or dividend withholding tax.Also non-resident companies could be liable to corporateincome tax on the remuneration for formaldirectorship of companies residing in theNetherlands. As of 1 January 2013 the taxationscope is expanded for fees received for executivemanagement services. Under a tax treaty the taxationright for these remunerations are mostly allocatedto the state of residence of the non-residentcompany.Tax base and ratesCorporate income tax is charged on the taxableprofits earned by the company in any given yearless the deductible losses. The following are theapplicable corporate income tax rates for 2014:Profit from Profit up to and including Rate- € 200,000 20.0%More than € 200,000 25.0%

Doing business in the Netherlands 25If a company incurred a loss in any given year, thatloss can be deducted from the taxable profit of theprevious year or from the taxable profit over 9 subsequentyears. The company profits must be determinedon the basis of sound commercial practiceand on the basis of a consistent operational pattern.This entails, among other things, that as yetunrealized profits do not need to be taken into consideration.Losses, on the other hand, may be takeninto account as soon as possible. The system ofvaluation, depreciation and reservation that hasbeen chosen must be fiscally acceptable and, onceapproved, must be applied consistently. The taxauthorities will not subsequently accept randommovements of assets and liabilities.As a general rule all business expenses are deductiblewhen determining corporate profits. There arehowever a number of restrictions with respect towhat qualifies as business expenses.Valuation of work in progress and orders in progressIn work and/or orders in progress profit taking mayno longer be postponed. Work in progress should bevalued at the part of the agreed payment attributableto the work in progress already carried out. Thesame applies for orders in progress.Arm’s Length PrincipleThe Dutch corporate income tax legislation includesan article that determines that national andforeign allied companies are entitled to charge oneanother commercial prices for mutual transactions.This is however subject to an obligation to keep duedocumentation of all relevant transactions. Thisenables the Dutch tax authorities to determinewhether the transaction between the applicableallied companies are conducted based on marketprices and conditions. It is possible to obtain priorassurance of the fiscal acceptability of the internaltransaction with the use of the so-called ‘AdvancePricing Agreement’.Limited depreciation on buildingsThe annual depreciation is deductible from theannual profits from business operations. As of 1January 2007, the taxpayer is entitled to depreciatethe building until the book value has reached theso-called base value. The base value is determinedwith reference to the WOZ value. The base value isequivalent to the WOZ value (WOZ for ‘Wet waarderingonroerende zaken’ or Real Estate ValuationRegulations). Based on the latter regulations, thevalue of a building for tax purposes is determined,to the greatest extent possible, on the basis of itsvalue in the economic environment. The tax basevalue for owner-occupied buildings is 50% of theWOZ value. The tax base value for buildings used asinvestments is 100% of the WOZ value.Arbitrary depreciationIn the Netherlands the rule is that no more than20% per year of acquisition or production costsmay be depreciated on operating assets, other thanbuildings and goodwill. The minimum depreciationperiod is therefore 5 years. Under certain conditionsgoodwill can be depreciated by a maximum of 10%per year.Research & Development AllowanceWith effect from 2012 a special allowance for researchand development work has been includedin corporation tax: the Research & DevelopmentAllowance (RDA). This allowance aims to make itmore attractive for companies to carry out researchand development (R&D) work. There is already anallowance for wage costs for R&D in the wage tax(S&O Allowance) via the reduced contribution forresearch and development work. The RDA aims toprovide an allowance for non-wage costs and investmentsrelating to R&D. The RDA is taken intoaccount as an extra allowance when determiningthe profit for tax purposes. In 2014 the allowance is60% (2013: 54%) of the costs and expenditure determinedby the Dutch subsidy agency RVO that aredirectly attributable to R&D recognised in an R&Ddeclaration. The allowance becomes effective in theyear of the R&D declaration.Innovatiebox (Innovation box)Companies that have developed intangible assets(an invention or technical application) can deductthe development costs from the company’s annualprofits in the year in which the asset was developed.As soon as a patent has been granted for the intangibleasset, the company can opt to place the benefitsin the so-called innovation box. Plant varietyrights also fall under this. The innovation box alsoapplies to intangible assets for which a patent hasnot been granted but which have arisen from a researchand development project. The taxpayer musthave received an R&D declaration for this fromAgentschapNL.

Doing business in the Netherlands 26The rate for corporation tax for innovative activitiesis 5% (2014). Losses on innovative activities canfrom now on be deducted at the normal corporateincome tax rate. The outsourcing of R&D work is alsopossible if the principal has sufficient activities andknowledge present. With effect from 2011 it is alsopossible to include innovation advantages obtainedbetween the application for a patent and the grantingof a patent in the innovation box. There is no maximumto the profit taxed at the special rate of 5%.As of 2013 the company has the option to declare aninnovation box benefit equal to 25% of the company’stotal profit instead of complex profit allocation tothe qualifying intangible asset(s). The benefit is howeverlimited to the amount of € 25,000. The option isvalid in the investment year and in the following 2years.A number of conditions must however be fulfilled tobe able to qualify for the aforementioned tax benefits:For example, to make use of the innovation boxthe intangible assets must contribute at least 30%to the profit that the company receives from theintangible asset. The innovation box does not applyto brands, logos, TV formats, copyrights on softwareand so on. The choice must be specified in the corporateincome tax declaration.Participation exemptionParticipation exemption or substantial holdingexemption is one of the main pillars of corporateincome tax. The scheme was introduced to preventdouble taxation. Profit distribution between groupcompanies is exempted from tax.A participation refers to a situation where a company(the parent company) is the owner of at least 5% ofthe nominal paid-in capital of a company that isbased either in the Netherlands or abroad (the subsidiary).A cooperative membership qualifies as wellregardless its share in the cooperatives capital.Under the participation exemption, all benefitsderived from the participation are tax exempt. Thebenefits include dividends, revaluations, profits andlosses in the sale of the participation and acquisitionand sales costs. The participation exemption alsoapplies to revaluations of assets and liabilities fromearn-out and profit guarantee arrangements. If thevalue of the participation falls due to lossesincurred, devaluation by the parent company is inprinciple not permitted. Losses arising on liquidationof a participation can under certain conditions bededucted.As a general rule participation exemption does notapply if the parent company or subsidiary is aninvestment institution. It is however possible toappeal for a ‘reduced tax investment participation’.To determine whether the participation exemptionapplies an intent test is used. This means looking atwhether or not the participation is held as an investment.A participation in a company whose balancesheet consists for example of liquid assets, debentures,securities and debts is regarded as an investment.In the latter case the participant is not entitledto participation exemption, but is however entitledto appeal for a participation settlement. It iscommon practice to apply for an Advance TaxRuling on the qualification of the participationunder the participation exemption provision.Because a number of conditions have to be satisfiedin order to apply for the participation exemption,factual and circumstantial changes can affect thetax (exempt) status of a participation. In this case,the capital gains or losses on this participation mustbe partitioned into a taxable and non-taxable part(partitioning doctrine). This doctrine will be codifiedby a bill released by the Dutch government in 2013.In addition, the bill provides for a participation to berevalued at fair market value once the participationtax regime changes. The revaluation result (positiveor negative) is, amongst other qualifying occurrences,added to a separate reserve (partitioningreserve). The reserve must be released upon disposalof the corresponding participation. A partialdisposal triggers a pro rata release. The rules underthis bill should apply retroactively as from 14 June2013. Before its enactment the bill may be subject toamendments due to EU law, the Parent-SubsidiaryDirective in particular.Property exemption for permanent establishmentWith effect from 1 January 2012 a property exemptionhas been introduced for foreign permanentestablishments of companies based in the Netherlands.As a result the profits and losses of a foreignpermanent establishment no longer affect theDutch tax basis. Final losses of foreign permanentestablishments that remain upon cessation (termination)can however still be deducted. The propertyexemption does not apply for profits from so-called

Doing business in the Netherlands 27passive permanent establishments in low-taxationcountries. There is an offset system for these. Basedon the transitional law existing rights and claimsthat were present upon the introduction of the propertyexemption are respected. These are dealt within accordance with the existing system.Fiscal unityIf the parent company owns at least 95% of theshares of a subsidiary, the companies can submit ajoint application for fiscal unity to the tax authorities,whereby the companies will be viewed as a singleentity for corporate income tax purposes. The95% shareholding should represent 95% or moreof the voting rights and at least a 95% entitlementto the subsidiary’s capital. The subsidiary is therebyeffectively absorbed by the parent company. One ofthe most important advantages of fiscal unity andits tax consolidation of companies, is the fact thatthe losses of one company can be set off againstthe profits of another company in the same group.The companies are thereby also entitled to supplygoods and/or services to one another without fiscalconsequences, and they are also entitled to transferassets from one company to another.Fiscal unity is only permissible where all of the companiesconcerned are effectively established in theNetherlands. It is however possible to include in thetax consolidation of the fiscal unity a Dutch permanentestablishment of a non-resident group. In addition,the parent company and the subsidiaries mustalso use the same financial year and be subject tothe same tax regime.Restriction on deduction for interest paid on holdingstaken overAs of 1 January 2012 there is within the fiscal unityregime a restriction on the deduction for interestpaid on a take-over liability. If a Dutch company istaken over with borrowed money, the interest on thetake-over liability can in principle no longer be setoff against the profit of the company taken over. Thetake-over interest can however still be deductedup to an amount of 1 million Euro or in the case ofhealthy financing. This is the case if the take-over liabilityin the year of take-over is not more than 60%of the take-over price. This percentage is then reducedover 7 years, by 5% per year, to 25%. Severalexceptions as well as thresholds may be applicableto this restriction rule.Interest deduction restrictionsOver the years the tax legislator has been increasinglyaiming at discouragement of the (international)financing of Dutch operating activities throughexcessive debt. Effectively the corporate incometax law provides for certain restrictions to the deductionof financing costs.Anti-base erosion regulationThe anti-base erosion rules in Dutch corporationtaxation restricts the deduction of financing costsof intragroup loans if these loans in essence relateto the conversion of equity into financing throughdebt without sound business motives. This comprisesloans relating to inter alia dividend distributions,repayment of formal and informal capital and capitalcontributions. On the other hand, the anti-baseerosion rules also entail the possibility to overrulethis restriction in tax deduction of the relating financingcosts if the taxpaying company can demonstratethat the sound business motive for this debtfinancing or the interest payment is effectivelytaxed at a rate of 10% or more. With effect from 1January 2008 it is to be taken into consideration thatthe existing anti-base erosion regulation has beentightened up further. The Dutch tax authorities mayfrom now on demonstrate that in the case of a grouptransaction no business considerations are involved,even if the recipient pays 10% or more tax abroad.In that case the interest paid within the group is notdeductible. The interest for ordinary business transactionsdoes however remain deductible. Evidence tothe contrary is however possible with the so-calledevidence to the contrary ruling. If the requirementsfor this ruling are met, the deduction of interest isrestored.Restriction on loans for investments in participationsTo restrict the deduction of interest on loans forinvestments in participations qualifying for the participationexemption provision, a new rule has beenintroduced in the corporate income tax act with effectfrom 1 January 2013. The restriction rule takeseffect for the financial (tax) years commencingon or after 1 January 2013. With this new rule thelegislator aims to revoke the deduction of interestinsofar as the financing costs for investment participationloans are deemed excessive and offensive.

Doing business in the Netherlands 28In general the financing costs are considered to benon-deductible for the amount in excess of € 750,000.The non-deductible interest is determined by a mathematicalrule, The amount of the non-deductible interestis under this rule calculated by considering theamount of the historic investment cost of the qualifyinginvestments, the sum of the fiscal equity and theamount of loans taken up by the participating taxpayer.The rule excludes from this restriction loans for anacquisition of a participation as well as a capital contributioninto a participation that relate to anincrease in operating activities of the group to whichthe company belongs in the time frame of 12 monthsbefore or after the participation investment. Thisexclusion claim is to be substantiated.Tax declarationsThe corporate income tax declaration must besubmitted to the tax authorities as a rule within 5months of the end of the company’s financial year.If a firm of accountants submits the return a postponementscheme applies. This means that the returnmay be submitted later in the year.6.2 Income taxIncome tax is a tax levied on the income of naturalentities with domicile in the Netherlands (domestictaxpayers). They are taxed on their full income whereverit is earned in the world. Any natural personwho is not domiciled in the Netherlands, but earnsan income in the Netherlands, is liable to pay incometax on the income (foreign taxpayers). Foreign taxpayerscan also opt to pay domestic taxes. In thelatter instance, the taxpayer is subject to all therules applicable to domestic taxpayers.In principle, income tax is charged on an individualbasis: Married persons, registered partners andunmarried cohabitants (under certain conditions)can however mutually distribute certain joint incometax components.Tax baseIncome tax is charged on all taxable income. Thedifferent components of taxable income are brokendown into three ‘closed’ boxes; each at a specific taxrate.Each source of income can only be entered in onebox. A loss in one of the boxes cannot be deductedfrom a positive income in another box. A loss generatedin Box 2 can be deducted from a positive incomein the same box in the previous year (carry back) orin one of the 9 subsequent years (carry forward).Where a loss in Box 2 cannot be compensated, thetax law offers a contribution in the form of a taxcredit. This means that 25% of the remaining loss isdeducted from the tax burden payable, on conditionthat no substantial interest exists in the current taxyear and the previous year. The tax credit amounts to25% of the remaining loss. A loss in Box 1 can bededucted from a positive income in the same box inthe 3 preceding years or in one of the subsequent 9years. Box 3 does not recognize a negative income.Box 1: Taxable income from work and homeThe income from work and home is the sum of:• The profit from business activities;• The taxable wages;• The taxable result of other work activities (e.g.freelance income or income from assets madeavailable to entrepreneurs or companies);• The taxable periodic benefits and provisions(e.g. alimony and government subsidies);• The taxable income derived from the own home(fixed amount reduced by a deduction equivalentto a specified interest paid on the mortgagebond);• Negative expenditures for income provisions(e.g. repayment of specific annuity premiums);and• Negative personal tax deductions.The following allowances apply to the above-mentionedincome components:• Expenses for income provisions (e.g. premiumspaid for an annuity insurance policy or a disabilityinsurance); and• Personal deductions. This concerns costsrelated to the personal situation of the taxpayerand his family that influence his ability to

Doing business in the Netherlands 29support himself and his dependents (e.g. medicalexpenses, school fees and specific livingexpenses for children).The tax rate in Box 1 is progressive and can accumulateto a maximum of 52%.Profit from business activitiesA natural person who derives income from businessactivities qualifies for tax allowances for entrepreneursunder certain circumstances. The tax allowancesfor entrepreneurs include self-employed allowance,research and development allowance, taxdeductible retirement allowance (FOR Allowance),discontinuation allowance and SME allowance. Inaddition, a starting entrepreneur is also entitled toa start-up allowance.The SME Allowance (MKB-vrijstelling) means thatentrepreneurs will be entitled to an additionalexemption of 14% (2014) of the profits followingdeduction of the above entrepreneur’s allowance(tax allowances).Box 2: Taxable income from substantial interestSubstantial interest applies where the taxpayer, withor without his partner, is a direct or indirect holder ofa minimum of 5% of the issued capital in a companyof which the capital is distributed in shares.The income from substantial interest is the sum of theregular benefits and/or sales benefits reduced bydeductible costs. Regular benefits include dividendpayments and payments on profit-sharing certificates.Sales benefits include the gains or losses on the saleof shares. Examples of deductible costs include thefollowing: consultancy fees and the interest on loanstaken out to finance the purchase of the shares.A non-resident taxpayer is subject to tax for incomefrom substantial interests if the interest is held in acompany residing in the Netherlands. If this companywas resident in the Netherlands for a minimum offive years in the past ten years, the company isregarded to be resident in the Netherlands.The tax rate in Box 2 is 25%. For 2014 only the first €250,000 of taxable Box 2 income rate is subject to arate of 22% and the remaining at the standard rateof 25%.Box 3: Taxable income from savings and investmentsBox 3 charges tax on the taxpayer’s assets. Thisassumes a fixed return on investment of 4% of theyield base. The yield base is the difference betweenthe assets and the liabilities. The yield base is determinedon 1 January of the calendar year. The referencedate of 1 January also applies if a taxpayer doesnot yet owe any inland tax on 1 January or if the inlandtax obligation ends during the calendar year for reasonsother than death.The assets in box 3 include: Savings, a second house orholiday house, properties that are leased to third parties,shares that do not fall under the substantialinterest regime and capital payments paid out on lifeinsurance.Liabilities in box 3 include: Consumer loans andmortgage bonds taken out to finance a second house.Per person, the first € 2,900 (2014) of the averagedebt is not deductible from the assets.Untaxed assetsAll taxpayers are entitled to untaxed assets in Box3 of € 21,139 (2014). The amount is intended to reducethe yield base. Taxpayers of 65 and older areentitled to an extra increase up to a maximum of €27,984 (2014) under certain conditions. A fixed returnof 4% is then calculated on the amount remainingafter deduction of the exemption. The tax rate isthen paid on this return. The tax rate in Box 3 is 30%.Tax allowancesOnce the due tax has been calculated for each box,certain tax allowances are deducted from thoseamounts. All domestic taxpayers are entitled to ageneral tax allowance of € 2,103 (2014). As of 2014the general tax allowance is reduced by 2% of thetaxable income from work and home exceeding €19,645, but with a maximum of € 737. Depending onthe personal situation of the taxpayer and the actualamount of the annual income, the taxpayer mayalso be entitled to specific tax deductions.Advance tax paymentsTax is withheld in advance over the course of the taxyear for income deriving from work activities andfrom dividends. Both wage withholding and dividendtax are advance tax payments on income. The withheldamount may be deducted from the income taxdue.

Doing business in the Netherlands 30Tax declarationThe income tax declaration for any given tax yearmust be submitted to the tax authority in principlebefore 1 April of the next year. If a firm of accountantsproduces the return an extension schemeapplies. This means that the return may also be submittedlater in the year.6.3 Dividend withholding taxCompanies often pay out profits to the shareholdersin the form of dividends. The following are furtherexamples of dividend situations:• Partial repayment of the moneys paid-up onshares by shareholders;• Liquidation payments above the average paid-upequity capital;• Bonus shares from profits;• Constructive dividend. This concerns paymentsmade by a corporation primarily for the benefitof a shareholder as opposed to the businessinterests of the corporation;• Interest payments on qualifying hybrid debt assuch debt is treated as informal equity of theborrowing company.ExemptionNo tax is withheld, among others, in the followingsituations:• Where, in inland relationships, benefits areenjoyed from the shares, profit-sharing certificatesand cash loans of participations to whichthe participation exemption applies;• If a Dutch company pays out dividends to a companyestablished in a member state of theEuropean Union and the company holds at leasta 5% share of the Dutch company.Tax rateThe tax rate for dividends is 15%. The tax is withheldby the company that pays out the dividendsand pays it to the tax authorities. The dividend taxwithheld serves as an advance tax payment onincome and corporate income tax.The Netherlands has signed tax treaties with variousother countries, as a result of which a lower tax ratewill apply in many instances.6.4 Prevention of double taxationResidents of the Netherlands and companies that areregistered in the Netherlands must pay tax on all revenuegenerated worldwide. This could result in any givenincome component being taxed both in the Netherlandsand abroad. To prevent this kind of double taxation, theNetherlands has signed tax treaties with many othercountries. The treaties are largely modelled on theOESO Model Treaty for the prevention of double taxation.If an income tax component is nevertheless double-taxedas income or corporate income tax, thetaxed amount is reduced based on the exemptionmethod. The method entails a reduction of the Dutchtax related to the foreign income. The exemption onthe income tax is calculated per box.Double taxation of dividend payments and interestpayments and royalties is prevented with the use ofthe settlement method. The use of this methodmeans that the Dutch tax is reduced by the amountof tax charged abroad.In certain situations it is also possible to deduct theforeign tax directly from the profits or as costsrelated to income.6.5 Wage taxAs explained earlier in this section wage withholdingtax is an advance tax payment on income tax. Anyonederiving an income from employment in theNetherlands is liable to pay income tax on theincome. In addition, employees in the Netherlands aregenerally covered by social security. The employerwithholds the social security premium and wage taxdue from the wages as a single amount and subsequentlypays this to the tax authorities. The combinedamount is referred to as wage tax. The wage tax is subsequentlysettled against the amount of income taxdue.Dutch tax legislation allows numerous options forrewarding personnel in fiscally friendly ways. Wagetax is calculated on the full value of the remunerationsreceived by the employee based on theemployment contract. The remuneration may takethe form of cash, such as a salary, holiday allow-

Doing business in the Netherlands 31ances, overtime, commissions and payments for athirteenth month. Employees can however alsoreceive remuneration ‘in kind’, such as products fromthe company or holiday trips. The concept ofremuneration also includes various other claims,compensations and provisions.A claim is a right to receive a benefit or provisionafter a period of time or subject to certain predeterminedconditions. One example of the latter is theright to receive retirement benefits. Examples ofprovisions include tools, meals, public transporttickets, etc. ‘Compensation’ normally refers toamounts that the employer pays its employees tocover costs incurred by the employee in thefulfilment of his or her job.Tax rateThe wage tax rates in 2014 are:• On the first € 19,645 of taxable income:a percentage of 36.25% is withheld (5.1% wagetax and 31.15% social security premium);• On the next € 13,718 of taxable income:a percentage of 42% is withheld (10.85% wagetax and 31.15% social security premium);• On the next € 23,168 of taxable income:42% is withheld;• On all additional income: a percentage of52% is withheld.When withholding the wage tax, the employer mustalso take into account the general tax allowanceand the labour allowance. The latter discounts arediscussed above.The employer himself, rather than the employee isliable for certain taxable components of the wage.This concerns the so-called final levy components.Certain forms of compensations ‘in kind’ are eligiblefor final levy payment, such as traffic fines notcharged to the employee and benefits with an economicvalue of a maximum of € 272 on an annualbasis and a maximum of € 136 per benefit (for examplea gift voucher or a bottle of wine). An importantexample of a compulsory final levy component is aredundancy payment for an older employee whichactually qualifies as an early retirement payment.Pseudo final levy on high salariesIn 2013 as a temporary crisis levy the pseudo-levyon high salaries was introduced. Initially it wasonly intended to apply for 2013. The levy has beenextended by one year and also applies for 2014.This final levy (for account of the employer) is 16%and is calculated on the annual salary, where thissalary for the employee is more than € 150,000.Work expenses schemeSince 1 January 2011 a new wage tax scheme hasapplied for compensations and provisions to employees:the work expenses scheme. Through thisscheme an employer may spend in 2014 a maximumof 1.5% (2013: 1.5%) of the total wage for tax purposes(the ‘free scope’) on untaxed compensationsand provisions for employees. In addition certainthings can continue to be paid or given untaxed.These are expenses for which the business characterprevails (specific exemptions). There are alsoexpenses that fall under the scheme, but for whicha zero valuation applies.On the amount above the free scope the employerpays wage tax in the form of a final levy of 80%. Thework expenses scheme has replaced the old rulesfor free compensations and provisions. Employersare not yet obliged to use the work expensesscheme. Up until 2014 it is possible to choose eachyear either the work expenses scheme or the oldrules for free compensations and provisions. From2015 the work expenses scheme will apply for allemployers. For employers not yet choosing thework expenses scheme the following old rules fortax-free compensations and provisions apply.Tax-free compensations and provisionsNot all compensations and provisions are taxablecomponents of the wage. Compensations are taxfreein as far as they are deemed to be issued tocut costs, liabilities and depreciations with respectto the proper fulfilment of the employment contract.Compensations paid by the employer to theemployee, and which are not generally perceivedby society as remuneration and which society considersthe reasonable duty of the employer to payor provide, are also included in the latter category.A ‘free’ compensation is always paid out in the formof cash, while a ‘free’ provision could also be providedin the form of goods and services. The conceptsare considered equivalent to the greatest extentpossible. If something can be provided untaxed,

Doing business in the Netherlands 32then it can generally also be compensated untaxed.Certain forms of compensation and provisions arehowever only exempted up to a certain limit and insome instance standard amounts apply.The following are a number of ‘free’ compensationsand provisions.Travel expensesEmployers are entitled to pay their personneluntaxed compensation of € 0.19 (2014) per kilometrefor home-work travel and other work-relatedkilometres. This is irrespective of the means oftransport used. When using public transport, theemployer is entitled to choose between the completelyuntaxed compensation of the actual cost ofthe public transport and an untaxed compensationof € 0.19 per kilometre. Alternatively, the employermay provide the employee with a car (in caseof any private use of the car, a percentage of thecatalogue price must be added to the employee’staxable income).Coffee and refreshmentsExpenses for refreshments taken during workhours, such as coffee, tea, confectionary and fruitmay be provided untaxed. The employer is entitledto provide the above items free of tax without theneed for documentary proof to the value of € 2.75per week or € 0.55 a day (2014).MealsMeals may be provided untaxed provided that thebusiness character is of more than incidental interest.The value of a meal at a company canteen is setat the fixed amount of € 2.40 (2014) for a coffee,meal or breakfast and € 4.60 (2014) for a cookedmeal.Company productsEmployers are entitled to offer their employeesdiscounts or compensation for purchasing productsproduced or manufactured by the company.This can be done tax-free subject to the followingconditions:• These must be products that are unique to theindustry in which the company operates;• The maximum discount or compensation perproduct must be 20% (2014) of the marketvalue (including VAT) of the product;• The total value of the discount or compensationmay not exceed € 500 (2014) per calendar year.If in any calendar year the employee does notmake use of this facility, any remaining amountsmay be carried forward for a maximum of 2 calendaryears.This may also extend beyond the termination of theemployment contract due to disability or retirement.Study/trainingStudy and/or training expenses incurred by theemployee with a view to obtaining an income canbe compensated free of tax. This includes studyand course fees, the cost of study books and otherstudy materials. The following items are exceptionsto the above and are taxed: compensation for costsrelated to a work room or study space, includingits design and furnishing; compensation for foreigntravel in as far as the compensation exceeds € 0.19per kilometre.RelocationIf an employee is required to relocate for workpurposes, the employer is entitled to compensatethe employee free of tax for the moving costsfor his household goods. In addition the employermay give a tax-free moving expenses allowanceof a maximum of € 7,750 (2014). The condition ishowever that this is a move that is entirely relatedto the employment. This in any case applies if theemployer gives the allowance within 2 years afterthe employee accepts the new employment (orafter transfer) and the employee lives more than25 kilometres from his work and moves, as a resultof which the distance between his new home and hiswork is reduced by at least 60%.Courses, congresses, etc.Employers are entitled to compensate employeesfree of tax for the cost of courses, congresses, seminars,symposiums, excursions, study trips and soforth. This also covers the related travel (maximum€ 0.19 p/km) and accommodation. This must howeverinvolve professional expenses.Representation costsThe cost of receptions, festivities, gifts, promotionalgifts and entertainment, including the associatedtravel (maximum € 0.19 p/km) and accommodationcan also be free of tax compensated. This must howeverinvolve professional expenses.

Doing business in the Netherlands 336.6 The 30% rulingForeign employees who come to work in the Netherlandstemporarily qualify for the 30% ruling undercertain circumstances. The ruling entails that theemployer is entitled to pay the employee a tax-freeremuneration to cover the extra costs of their stayin the Netherlands (extraterritorial costs). Thedisposition is only valid for a maximum period of 8years. The compensation amounts to 30% of the salary,including the compensation, or 30/70 of the salaryexcluding the compensation. The condition is that,based on this salary, the employee is not entitled toprevention of double taxation. If the employer reimbursesmore than the maximum amount, this salaryis subject to wage tax. The employer may deduct afinal levy on this additional amount.Conditions for qualification for the 30% rule1. The employee has a permanent job; and2. The employee has a specific expertise that isscarce or not available at all on the Dutch employmentmarket. This is called the scarcity and expertiserequirement. For this the specific expertise thelegislator introduced a salary norm.An employee is regarded as fulfilling the conditionalspecific expertise if the employee’s remunerationexceeds a defined salary standard. The salary standardis indexed annually. For 2014 the salary standardis fixed at a taxable annual salary of € 36.378(2013: € 35,770) or € 51,968 including the 30%allowance (2013: € 51,100). This salary standard of€ 36,378 (2014) is excluding the final levy componentsand thus excluding the 30% allowance. In mostcases no more specific check is made for scarcity,but this is done if for example all the employees witha particular expertise meet the salary standard.The following factors are then taken into account:• the level of the training followed by theemployee;• the experience of the employee relevant for hisjob;years and have completed their Master’s degreethere is a reduced salary standard of € 27,653 for2014 (2013: € 27,190) or € 39,504 including the 30%allowance.The 30% ruling contains a rule on post-departureremuneration. As a result the 30% rule also applieseffectively until the end of the wage tax period thatfollows the wage tax period in which the employmenthas ended. This rule came into effect retroactivelyfrom 1 January 2012.150 Kilometre limitUnder the 2012 legislation the 30% rule only appliesif the incoming employee can substantiatethat the employee has lived for a minimum period oftwo thirds of 24 months (i.e. 16 months) outside the150 kilometre area from the Dutch border precedingthe start of the employment in the Netherlands.Since the introduction of this kilometre limit as of1 January 2012 it has been found that employeeson a brief assignment abroad (i.e. for 16 months orless) would be excluded from renewal of the 30%ruling after returning to the Netherlands. Therefore,with effect from 1 January 2012 the kilometre limitrule has been redefined in line with the purpose ofthis kilometre limit. According to the new definitionrelief from the 150 kilometre restriction is grantedif the employee stayed outside the 150 kilometrearea on a renewed Dutch assignment for more than16 months (of the 24 months) preceding the lastDutch assignment. In addition it is required that theprevious Dutch assignment did not commence morethan 8 years prior to the start of the renewed Dutchassignment.The 150 kilometre limit is now under discussion. Inthe meantime in the Supreme Court there is a casepending with the question whether Article 45 TFEU(Free movement of workers within the EU) precludesthe application of the 150 kilometre limit as acondition for the 30% rule. The Supreme Court hasasked preliminary questions of the Court of Justiceof the European Union.• the pay level of the present job in theNetherlands in relation to the pay level in theemployee’s country of origin.For scientists and employees who are physicians intraining as specialists there is no salary standard.For employees coming in who are aged under 30

Doing business in the Netherlands 34Extraterritorial costsThe extraterritorial costs consist of the following,among other things:• extra cost of living because of the higher cost ofliving in the Netherlands than in the country oforigin (cost of living allowance);• the cost of an introductory visit to theNetherlands, with or without the family;• the cost of the application for a resident’s permit;• double housing costs (for example hotel costs),because the employee will continue his or herresidence in the country of origin.The following aspects are not covered by the extraterritorialcosts and can therefore not be compensatedor granted untaxed:• the overseas posting allowance, bonuses andcomparable compen sations (foreign servicepremium, expat allowance, overseas allowance);• loss of assets;• the purchase and sale of a house (reimbursementof house purchase expenses, agent’s fee);• the compensation for higher tax rates in theNetherlands (tax equalization).If the employee has children, the employer is entitledto offer the employee tax-free compensationfor school fees at an international school in additionto the 30% rule. Other professional costs can becompensated untaxed based on the normal rulesapplicable to the Wages and Salaries Tax Act (Wetop de loonbelasting).If the extraterritorial costs add up to more than30%, then the actual costs that have reasonablybeen incurred can also be compensated tax-free. Itmust however be possible to demonstrate that thecosts incurred are justifiable.To be able to make use of the 30% rule, theemployer and the employee must jointly submit anapplication to the Foreign Office of the tax authoritiesin Limburg (Belastingdienst/kantoorBuitenland). If the application is approved, the taxauthorities will issue a decision.The decision is valid for a maximum period of 8 years.Should the request be made within 4 months afterthe start of employment as an extraterritorialemployee by the employer, the decision shall beretroactive to the start of employment as an extraterritorialemployee. If the request is made later, thedecision shall apply starting the first day of themonth following the month in which the request ismade. The eight-year period is reduced by previousperiods of stay or employment in the Netherlands.In addition, the employee with the 30% ruling canalso submit an application for registration as a partialforeign taxpayer for tax purposes in theNetherlands. This entails that he will be entered as aforeign taxpayer in Box 2 and 3. In that case, as a foreigntaxpayer the income to be reported is limited toDutch source income and not to its worldwide(investment) income.6.7 Value Added Tax (VAT)The Dutch turnover or value added tax system isbased on the European Directive concerning tax onadded value. Tax is due the Added Value (VAT or‘BTW’ in Dutch). This entails that tax is charged ateach and every stage of the production chain and inthe distribution of goods and services. Businessescharge one another VAT for goods and/or servicesprovided. The company that charges the VAT isrequired to pay the VAT amount to the tax authorities.If a company is charged VAT by another company,it is entitled to deduct the VAT amount fromVAT due on the company’s part. By doing so, the systemensures that the end user is effectively responsiblefor paying the VAT.Foreign companies that perform taxed services inthe Netherlands are in principle also liable to payVAT. Those companies, too, will be required to paythe VAT due in the Netherlands and will thereforealso be able to claim the VAT invoiced to it by Dutchcompanies. The VAT system entails strict invoicingrules. The rules are determined by the mandatoryEU Directive on VAT Invoicing rules and implementedby EU Member States in their national VATLaw.

Doing business in the Netherlands 35ExemptionsNot all goods and services in the Netherlands aresubject to VAT. The following services are VAT exempt:medical services, services provided by educationalinstitutions, most banking services, insurancetransactions, services performed by sports organizationsand property rentals. Companies that provideexempted services are not entitled to chargeVAT for their services. In addition, they are alsonot entitled to claim the VAT charged to them forgoods and services. Companies that perform bothVAT liable and VAT exempt services will assign VATto those specific services on which VAT is due.The VAT system in the internal European marketThe European Union has recognized the free trafficof goods, persons, services and capital in the EU.Performances within the European Community arereferred to as the intra-community supply andacquisition of goods and intra-community services.VAT is charged based on the destination countryprinciple. This means that goods that cross the borderto another EU country are taxed in the destinationcountry. For business to business services(B2B). The rule applies that these services are taxedin the country where the customer is established orhas a permanent establishment.VAT defermentThe Netherlands has implemented a so-called defermentsystem. This system offers cash-flow advantages.This system’s benefit involves payment of VAT to bemoved from the time of import to when the companydeclares taxes, usually monthly. The VAT due for theimport will be recorded in the declaration as payable,while at the same time, amounts will be subtracted aspre-paid taxes. To obtain this deferment, the importermust apply for a license at the tax department under“Article 23.” To obtain this license the company (importer)has to be registered for VAT in the Netherlandsas a domestic entrepreneur or as a foreign entrepreneurwith a permanent establishment for VAT inthe Netherlands. In addition this company (importer)should have regular imports to the Netherlands andthe bookkeeping is subject to meet specific requirements.Tax ratesThe general VAT tax rate is 21%. The Netherlandsalso has a low VAT rate of 6%. Goods and servicesfalling under the low tax rate are specified in Table1 of the Turnover Tax Act (Wet op de omzetbelasting1968). This applies, among other things, tofoodstuffs and medicines. The zero rate is mainlyintended for goods exported to outside the EU andfor goods exported to other EU members states.All companies are bound to submit VAT declarations.If the company also supplies goods or services toelsewhere in the European Union, it is also bound tofill in the ‘Opgaaf Intracommunautaire Prestaties’(Intra-Community Supplies) tax form.6.8 Excise and other duties and taxesExcise dutyThe Netherlands charges excise duties on alcohol-containingbeverages, tobacco, fuel and othermineral oils. Manufacturers, traders and importerspay excise duties to the tax authorities. The ExciseDuty Act (Wet op de accijns) in the Netherlands isfully harmonized with the applicable EU directives.Environmental taxesThe Netherlands charges the following environmentaltaxes:• Tax on mains water• Fuel tax• Energy tax• Waste taxTax on mains waterThe Netherlands charges tax on mains water. Allcompanies and households pay tax on a maximumamount of 300 cubic metres of water per connectionper annum. The rate is € 0.33 m 3 per up to 1 July2014. From 1 July 2014 on the rate is related to theamounts used, starting at € 0.33 and reducing up to€ 0.05) per m 3 .Fuel taxFuel tax is paid by the producers and importers ofcoal. The rate is € 14.27 (2014) per 1,000 kg coal.Energy taxThe purpose of energy tax is to reduce CO 2emissionsand to reduce energy consumption. The energytax is charged to the user of the energy (naturalgas, electricity and certain mineral oils). The ratesare related to the amounts used, whereby the ratesare progressively reduced as consumption increases.

Doing business in the Netherlands 36Waste taxAs of 1 April 2014 the waste tax is being reintroduced.The tax rate is € 17 per 1,000 kg of landfill.Bank taxLegal entities carrying out banking activities insidethe Netherlands are subject to bank taxation. Thebank tax is levied on unsecured debt. The rate is0.044% (2014) for short term debt (term of lessthan 1 year) and 0.022% for longer term debt.Insurance premium taxThe insurance premium tax is levied upon the conclusionof an insurance contract with an insurer. Theinsurance premium tax rate amounts to 21% of thepremium due. Some types of insurance contractsare exempt from this taxation, such as health insurance,unemployment insurance, accident, transport,disability and life insurance. The insurance premiumtax imposed is paid by the designated intermediariesand insurers.

Doing business in the Netherlands 377. HelpfuladdressesRijksdienst voor OndernemendNederland (most important subsidyagency in the Netherlands)P.O. Box 93144 NL-2509 AC Den Haagwww.rvo.nl or phone +31 88 602 50 00Ministerie van Buitenlandse Zaken(Ministry of Foreign Affairs)P.O. Box 20061 NL-2500 EB Den Haagwww.government.nl/ministries/bzor phone +31 70 348 64 86Belastingdienst/kantoor Buitenland (Foreign officeof the Department of Inland Revenue)P.O. Box 2865 NL-6401 DJ Heerlenwww.belastingdienst.nl or phone +31 555 385 385Benelux Office for Intellectual PropertyBordweijklaan 15 NL-2591 XR Den Haagwww.boip.int or phone +31 70 349 12 42CNV (National Federation of Christian Trade Unionsthe Netherlands)P.O. Box 2475 NL-3500 GL Utrechtwww.cnv.nl or phone +31 30 751 11 00CPB (Netherlands Bureau for Economic PolicyAnalysis)P.O. Box 80510 NL- 2508 GM Den Haagwww.cpb.nl or phone +31 70 338 33 80Douane (Customs and Excise Department)P.O. Box 3070 NL-6401 DN Heerlenwww.douane.nl or phone +31 45 574 30 31European Patent Office (EPO)P.O. Box 5818 NL-2280 HV Rijswijkwww.epo.org or phone +31 70 340 45 00FNV (The Netherlands Trade Union Confederation)P.O. Box 8456 NL-1005 AL Amsterdamwww.fnv.nl or phone +31 20 581 63 00IND (Immigratie- en Naturalisatiedienst) (Immigrationand Naturalisation Service)P.O. Box 287 NL-7600 AG Almelowww.ind.nl or phone +31 88 043 04 30Kamer van Koophandel Nederland (Chamber ofCommerce)P.O. Box 29718 NL-2502 LS Den Haagwww.kvk.nl or phone +31 88 585 15 85Ministerie van Economische Zaken(Ministry of Economic Affairs)P.O. Box 20401 NL-2500 EK Den Haagwww.government.nl/ministries/ezor phone +31 70 379 89 11Ministerie van Financiën (Ministry of Finance)P.O. Box 20201 NL-2500 EE Den Haagwww.government.nl/ministries/finor phone +31 70 342 80 00Ministerie van Sociale Zaken en Werkgelegenheid(Ministry of Social Affairs and Employment)Anna van Hannoverstraat 4 NL-2595 BJ Den Haagwww.government.nl/ministries/szwor phone +31 77 333 44 44MKB-Nederland (Dutch agency for Smalland Medium-size Enterprises or SMEs)P.O. Box 93002 NL-2509 AA Den Haagwww.mkb.nl or phone +31 70 349 09 09Netherlands Foreign Investment Agency (NFIA)P.O. Box 93144 NL-2509 AC Den Haagwww.nfia.nl or phone +31 88 602 11 42ACM (Autoriteit Consument en Markt) (Authorityfor Consumers & Markets)P.O. Box 16326 NL-2500 BH Den Haagwww.nma.nl or phone +31 70 722 20 00UWV (Employee Insurance Schemes ImplementingBody)P.O. Box 58285 NL-1040 HG Amsterdamwww.uwv.nl and www.werk.nlor phone +31 88 898 20 01SRA (Umbrella body for accountants)P.O. Box 335 NL-3430 AH Nieuwegeinwww.sra.nl or phone +31 30 656 60 60Ministerie van Binnenlandse Zaken en Koninkrijksrelaties(Ministry of the Interior and Kingdom Relations)P.O. Box 20011 NL-2500 EA Den Haagwww.government.nl/ministries/bzkor phone +31 77 465 67 67

Doing business in the Netherlands 388. ConclusionDoing Business in the Netherlandsis a practical guide to help you todeal effectively and efficiently withthe most important issues that you mightface upon your arrival in the Netherlands.Obviously the information contained in thismanual is not exhaustive, we described only themain points. For additional explanations regardingany of the items mentioned in this brochure or forfurther consultation regarding an intended businessstructuring in the Netherlands by you or yourclient, please contact Jan Schouten, Louis Bouchez,Alfred Meijboom or Eva Knipschild.International Business StructuringJan SchoutenPartner Corporate Transactions, Civil-law notaryTel: +31 20 5506853 Mob: +31 6 53526034E-mail: jan.schouten@kvdl.nlMergers & AcquisitionsLouis BouchezPartner Corporate TransactionsTel: +31 20 5506692 Mob: +31 6 511 72723E-mail: louis.bouchez@kvdl.nlIntellectual PropertyAlfred MeijboomPartner Intellectual PropertyTel: +31 20 5506633 Mob: +31 6 53188187E-mail: alfred.meijboom@kvdl.nlEmploymentEva KnipschildPartner Employment LawTel: +31 20 5506840 Mob: +31 6 22487152E-mail: eva.knipschild@kvdl.nl

Doing business in the Netherlands 39Kennedy Vander Laan– a greatinnovativelaw firmKennedy Van der Laan, chosenmost innovative law firm in theNetherlands, is one of the Netherlandstop independent law firms, full service andbased in Amsterdam. With nearly 100 attorneysand civil law notaries, it is one of the top 20independent law firms in the country. Our businesssavvy lawyers help great innovative business clientsranging from large international and national companiesto young entrepreneurs. We strive to providethe best in legal services and expertise to our clientswhile running our business in a socially responsibleway.During the Chambers Europe Awards Kennedy Vander Laan was rewarded with the Client Service Award2012 for The Netherlands. In the accompanyingreport clients describe Kennedy Van der Laan as:“Excellent, and not only in terms of professionalskills – the lawyers are timely, very, very efficient,and they always have time to speak to me. The teamgives uncomplicated, not too formal, hands-on,practical and fast advice. All round good value formoney.” Our own research shows that 93% of ourclients are satisfied or extremely satisfied and theymention our strong points as being: Reliable,Personal and Informal.Commitment to knowing our client’s business andindustry contextWhether a client operates in one of the industries inwhich we have extensive experience or represents abreakthrough into a new industry, we are committedto investing in learning the industry in which a clientoperates, as well as the specific factors affecting theclient’s business.Attention to the relationshipOur clients want us to manage our relationship withthem in a coordinated and efficient way. When a clientrelies on us to provide a variety of services over time,we make sure that an experienced attorney isresponsible for overseeing all work performed forthe client, for building our knowledge based aboutthe client, its business and legal needs, and for assuringthat the client’s needs and expectations are met.Value for moneyWe are conscious that the amounts we invoice for ourservices must reflect value for money. Our monthlyinvoicing and detailed specification of work performedgives clients the insight they deserve in thework we do for them. We will make specific arrangementson request with respect to cost control andbudgeting for legal services.Quality in every respectDepth and breadth of legal knowledge and strategicinsight, leading to clear and practical advice andrepresentation coupled with time lines and responsiveness.Haarlemmerweg 3331051 LH Amsterdam+31 20 5506 666www.kvdl.nlBart de ManManaging PartnerTel: +31 20 5506841 Mob:+31 6 23979369E-mail: bart.de.man@kvdl.nl

Doing Business in New Zealand

DOING BUSINESS INNEW ZEALANDIntroductionWhat is this Guide for?This guide to Doing Business in NewZealand has been prepared to givepersons with an interest in investingin a New Zealand business or venturean overview of some of the keyconsiderations in making such aninvestment. The information containedin this guide is of a general nature andis not a substitute for the need to obtainsubstantive legal advice before makingan investment. However, it should givepotential investors an idea of the basicconcepts that need to be considered.Who is Anthony Harper?Anthony Harper is recognised as oneof New Zealand’s leading commerciallaw firms, with offices in Auckland andChristchurch. Our legal expertise andinnovative approach to client servicehas rewarded us with longstandingpartnerships with a wide range ofNew Zealand and international clients.With a string of high profile corporatetransactions Anthony Harper has earnedpraise from many sources. The influentialAsia Pacific Legal 500 recommendsAnthony Harper for its banking andfinance, corporate and M & A, propertyand insolvency expertise.For further information or guidance onany of the topics covered in our guide,please contact Paul Hartland paul.hartland@ah.co.nz or David Goulddavid.gould@ah.co.nz.1

ESTABLISHING A BUSINESSBusiness structuresThere are a number of differentstructures which can be used toestablish a business in New Zealand.The most commonly used are:(a) establishing a branch office for anoverseas company; or(b) setting up a (or purchasing anexisting) New Zealand registeredcompany.Limited Partnerships have beenavailable in New Zealand since 2008and they are steadily increasing inpopularity.There will be a number of taxconsiderations which will need to betaken into account when consideringwhich business structure to use, andwhen thinking about carrying ona business or deriving other sourcesof income in New Zealand. If taxableactivities are undertaken both inNew Zealand and abroad, then doubletax agreements (or tax treaties) mayreduce the incidence of double taxationbetween countries.Anthony Harper has close links withspecialist tax advisers who can adviseon any complex taxation issues whichmay arise.Establishing a branch of an overseascompanyIn order for an overseas company tocarry on business in New Zealand, itmust apply to be registered under theCompanies Act 1993 as an “OverseasCompany”. The first step is to reservethe company’s name. This is to ensurethat there is not already a companyin New Zealand with that name, or asubstantially similar name. As part ofthe application process, the overseascompany must notify the Registrar of:(a) its principal place of business inNew Zealand (i.e. its branch office);(b) the full names and residentialaddresses of the directors of theoverseas company; and(c) the full name and address of oneor more persons who are residentor incorporated in New Zealandand is authorised to accept serviceof documents in New Zealand onbehalf of the overseas company.It will also be necessary to providedocuments evidencing the overseascompany’s incorporation, together withits constitutional documents (translatedwhere necessary). There is a specificexception for companies incorporatedin Australia. Where the necessarydocumentation is already registeredwith the equivalent of the Registrarof Companies in Australia, it doesnot need to be provided to the NewZealand Registrar.An overseas company carrying onbusiness in New Zealand must ensureits full company name and its countryof incorporation are stated clearly onall written communications sent by, oron behalf of, the company (e.g. letters,advertising materials, emails) and on alldocuments signed by the company.In terms of ongoing compliance, anoverseas company must not changeits name without first reserving thenew name with the Registrar. Further,if there is a change in the directors,principal place of business, orconstitution of the overseas company,the Registrar must be notified within20 working days. Like all companies2

incorporated in New Zealand, anoverseas company registered in NewZealand must complete an “AnnualReturn” once a year confirming thekey information about the company(e.g. address details and directors ofthe company). An overseas companywill also be required to file financialstatements with the Registrar which willbecome publicly available. Generally,these accounts will need to cover theNew Zealand “branch” operation as wellas the overseas company’s activitiesoutside New Zealand, and will likelyneed to be audited.CompaniesThe process to incorporate a newsubsidiary company in New Zealandis simple and straightforward. Theprocess can be completed “on line” anda new company registered within amatter of hours of lodging the requireddocumentation.To incorporate a company, therequirements are to:(a) reserve the company name;(b) provide a registered office addressand address for service (theseare often the same). If the newcompany does not have a physicalbusiness presence in New Zealand,a solicitor or accountant may bewilling to provide this service for thecompany; and(c) have at least one shareholderand one or more directors. Thedirector must be a person, but theshareholder would usually be theoverseas company. The directordoes not need to be resident in NewZealand (although this may affectthe tax residency of the company).The director(s) and shareholder(s)will each need to sign a consentform for registration.It is not necessary (although it is oftendesirable) to adopt a constitution.This can be done at the same time asincorporation, or at a later date.As with a company registered as an“Overseas Company”, a New Zealandsubsidiary will be required to file anannual return and register it with theCompanies Office.In certain circumstances, it may bepreferable to acquire an existing NZregistered company. This would bedone primarily through the acquisitionof shares in that existing company.There are certain matters which willneed to be considered including:(a) whether Overseas Investment Officeconsent will be needed;(b) whether the approval of theCommerce Commission is needed;and(c) whether the Takeovers Code isrelevant.These matters are considered later inthis guide.Limited partnershipsLimited partnerships in New Zealandare governed by the LimitedPartnerships Act 2008.A limited partnership is a separatelegal entity and is formed byregistration at the Companies Office. Itmust have at least one general partnerand one limited partner (and a personmay not be both a general partner anda limited partner at the same time) butthere is no upper limit on the numberof either class of partner. A generalpartner may become a limited partnerand vice versa.3

Partnership agreementThe Limited Partnerships Act requiresthat the limited partnership has awritten partnership agreement whichprovides for certain specified matters.There is significant flexibility underthe Act for limited partnerships tobe self governed by the terms of thepartnership agreement.Role and liability – general partnersGeneral partners are the agents of thelimited partnership and are responsiblefor the active, day-to-day managementof the limited partnership. They mayinvest in the limited partnership, but arenot required to.A general partner is liable for the debtsand liabilities of the limited partnershipto the extent the limited partnershipcannot pay. Where there is more thanone general partner, each generalpartner is jointly and severally liable. Ageneral partner’s liability is howevertypically managed by using a limitedliability company as a general partner,which has no assets and which does not“trade”.Role and liability – limited partnersLimited partners are passive investors,cannot bind the limited partnership andare restricted from participating in themanagement of the partnership, exceptthat they may undertake certain “safeharbour” activities which are expresslystated not to be active management ofthe partnership.The liability of each limited partner islimited to the amount of that partner’scapital contribution to the limitedpartnership. However, if a limitedpartner participates in the managementof the limited partnership, they canexpose themselves to the same liabilityas a general partner.TerminationThere is no limit as to the duration ofa limited partnership but terminationevents can be built into the partnershipagreement if a set duration is desired. Alimited partnership can be terminatedunder the following circumstances:(a) an event or the expiry of a period oftime when, under the partnershipagreement, the limited partnershipterminates;(b) a resolution is made by the limitedpartnership that the limitedpartnership be terminated;(c) there is either no general or limitedpartner in the limited partnershipfor 10 working days or more; or(d) the limited partnership agreementhas lapsed for 10 working days ormore.When a termination event has occurredthe limited partnership may pass aresolution to appoint a liquidator tothe limited partnership or any partner,creditor or the Registrar may makeapplication to the Court to place thelimited partnership in liquidation.An application can also be made bycertain parties to deregister a limitedpartnership on certain grounds.RegistrationAn application to register a limitedpartnership is made by completing theprescribed form and filing it with theCompanies Office. Once registered,the limited partnership’s name willappear on the Limited PartnershipsRegister. A limited partnership hassimilar administration requirements to acompany. The limited partnership mustsatisfy a solvency test before makingdistributions. Minutes of meetings,partner details, capital accounts andaccounting records must all be kept and4

changes to details of name, address andpartners (including new partners) mustbe notified.Financial statements and an annualreturn must also be prepared. However,the Act does not require that thesebe audited, registered or made public(though other legislation may affect thisposition). It is worth noting that if thegeneral partner is a foreign controlledNew Zealand company or an overseascompany which is considered to becarrying on business in New Zealandby virtue of it being a general partner,this company will be required to fileaudited financial statements, as usual,which may need to include the limitedpartnership.PURCHASE OF ANEW ZEALAND BUSINESSOverseas investment regimeThe acquisition of securities, businessassets or interests in property by anoverseas person is regulated by theOverseas Investment Act 2005 andthe Overseas Investment Regulations2005. The regime is administeredby the Overseas Investment Office(“OIO”). Information on the OIO andits functions can be found at www.linz.govt.nz/overseas-investment.The acquisition by an overseas person (oran associate of an overseas person) of:(a) sensitive land or an interest insensitive land;(b) farm land;(c) significant business assets; or(d) fishing quota,will require consent from the OIObefore the acquisition is given effect.An overseas person is defined as:(a) an individual who is neither aNew Zealand citizen nor ordinarilyresident in New Zealand;(b) a partnership, body corporate ortrust where an overseas personor persons have 25% or moreownership or control (or similarrequirements are met); or(c) a company incorporated outsideNew Zealand, or in which anoverseas person or persons have25% or more of any class of share, orthe power to control 25% or moreof the company’s governing body,or 25% or more of the voting rights,or the right to exercise control over25% or more of voting rights.The acquisition of sensitive land andfarm land will be considered later inthis guide. However, fishing quotaswill not be discussed given the broadand general nature of this guide. If yourequire specialist advice on that topicplease contact us.The acquisition of significant businessassets is:(a) the acquisition of rights or interestsin securities by an overseas person(or an associate of an overseasperson) if as a result of theacquisition the overseas person hasa 25% or more ownership or controlinterest in the relevant companyor an increase in an existing 25%or more ownership or controlinterest in the relevant companyand the value of the securities orconsideration provided, or the valueof the assets of the company or thecompany together with its 25% ormore subsidiaries, exceeds NZ$100million;5

(b)the acquisition of property (includinggoodwill and other intangible assets)if the property is located in NewZealand, used in carrying on businessin New Zealand and the total valueof consideration provided exceedsNZ$100 million.In determining whether to grantconsent, the OIO will test theapplication against the core investorcriteria, which broadly relate to businessacumen, financial commitment andcharacter. We can provide furtherdetails on the consent criteria ifnecessary.The OIO advises that, while thereis no statutory timeframe withinwhich an application for consentmust be decided, the OIO aims tomake a decision on high quality,straightforward applications, whereno third party consultation is requiredor “special land” is involved, within30 to 50 working days of the date ofregistration of the application. “Specialland” is land which includes foreshore,lakebed or riverbed.Commerce Act/Competition issuesFundamental testThe Commerce Act 1986 prohibitsproposed mergers and acquisitions ofbusiness assets or shares where suchtransactions would, or would be likelyto, have the effect of substantiallylessening competition in a market.No person may acquire assets of abusiness or shares if, as a result of theacquisition, that person or anotherperson would be, or would be likely tobe, in a dominant position in a marketin New Zealand.However, if a clearance or authorisationis given by the Commerce Commissionfor the acquisition of assets of a businessor shares, then no action may betaken against the acquisition by theCommission or any other party whilethat clearance or authorisation is in force.Clearances and authorisationsA clearance may be granted in respectof an acquisition where the Commissionis satisfied that the acquisition will not,or will not be likely to, have the effect ofsubstantially lessening competition in amarket. A party seeking clearance mustcomplete the standard application formand provide this to the Commission,which will then commence aninvestigative process, gatheringrelevant information. The CommerceAct prescribes a 10 working day periodfrom receipt of the application forreaching a decision, however this maybe extended if the parties agree. TheCommission may only grant a clearancewhen it is satisfied, on the balance ofprobabilities, that the acquisition wouldnot result in a lessening of competition.Parties have a right to appeal to theHigh Court if a decision is made not togrant clearance.An authorisation may be granted wherea proposed acquisition will or will belikely to result in a substantial lesseningof competition, if the Commissionfinds that the public benefit directlyrelated to the acquisition outweighsany detriment. The process for grantingan authorisation is much the same asthat for a clearance, however once theCommission has received the applicationform and completed its investigation,it will then issue a draft determination.This sets out its initial view and invitessubmissions from interested parties.This will usually be followed by aconference where interested partiesmay present to the Commission, beforefurther analysis and determination iscarried out. The Act provides for a 60working day timeframe from receipt of6

the application for reaching a decision,unless a longer period is agreed. As withclearances, there is a right of appealwhere authorisation is declined.The benefits resulting from anacquisition need not be solely economicand may, for example, be social orenvironmental. Product innovation,improved export earnings andinternational competitiveness andthe avoidance of corporate failure areexamples of benefits which the courtshave recognised in the past.PURCHASING LAND INNEW ZEALANDTitles systemNew Zealand uses the Torrens landregistration system, under whichmost parcels of land are recordedon a separate Computer Register(previously known as a certificate oftitle). The Computer Register recordsthe dimensions and location of theland, the owner and any other interestsaffecting the land such as mortgages,charges and easements.Computer Registers are recorded on anelectronic register, enabling real timesearching and registration of dealingswith land.The Torrens system enables a buyerand their solicitor to rely on a singletitle document, instead of a successionof title deeds. The Computer Registeris guaranteed by the Government tobe true and correct as at the time ofviewing and a buyer may rely on thedetails contained within it.Once a property is purchased and thename of the buyer is recorded on theComputer Register, valid ownershipexists. This cannot be challenged by anassertion that a defect in a prior deedrenders the current title void.The three most common types ofestate in New Zealand are fee simpleestates, cross leases and unit titles. Anestate in fee simple is practically theequivalent of full ownership of the landand provides the owner with the largestnumber of rights that are enforceableby law. Cross leases are most commonlyfound in the large cities of New Zealand.These were an historical device forproviding separate titles to two or moreowners on one parcel of land, withoutrequiring a legal subdivision of theland. A cross lease structure involvesshared ownership of the fee simpleestate, subject to long term (normally999 years) leases of parts of that landto the respective registered ‘owners’.Unit (strata) titles are common in largerblocks of flats or apartments, and formulti-storey buildings where there issome form of co-operation betweenthe property owners. Each owner hasa separate title to the particular unitthey own. The common areas in suchbuilding, as well as external structures,are maintained and managed by a bodycorporate. Unit owners contribute aspecified amount to the body corporateto cover maintenance, insurance andadministration costs.How land is bought and sold inNew ZealandA real estate agent is usually thefirst point of contact for a purchaserwhen looking to buy a property inNew Zealand. The real estate agentacts for the vendor in the marketingof the property, and assists with thepreparation of a contract when apurchaser is found.Sales by auction or tender arecommon for sales of farm land. They7

have become increasingly popularfor vendors of residential propertiesin recent years, due to high buyerdemand and increasing property prices.However, most properties in NewZealand are still sold by negotiationbetween a vendor and a purchaser,instead of by way of auction or tender.The form of the contractMost contracts for the purchase ofland in New Zealand are based upona standard form contract approved bythe Real Estate Institute of New Zealandand the Auckland District Law Society.This provides both parties with greatercertainty, and serves to reduce legalcosts.Unlike the practice in the UnitedKingdom and many other countries,the contract is entered into from theoutset. However, it is often conditionalon various matters being satisfied bythe purchaser, and sometimes by thevendor.Before becoming committed to aproperty purchase, a buyer should besatisfied with the following matters:(a) the ability to finance the purchase;(b) that there are no legal impedimentsrevealed from the title to the property,including easements and restrictivecovenants which may affect the use ofthe property;(c) that the records held by the localauthority for the property do notreveal any problems;(d) that all necessary consents relevantto the purchase are obtained,particularly OIO consent, if that isrequired; and(e) if there is a lease on the property, thatthe terms of the lease are satisfactory.In certain circumstances, advicefrom other professionals/consultants may be appropriate.For instance:(f) a builder’s report may be requiredto ensure that existing buildingsare sound;(g) a geotechnical report may berequired to ensure that anyearthquake activity has notdestabilised the ground;(h) if the property is being purchasedfor development, the purchaser maywant to undertake due diligenceinvolving reports from planners,architects, geotechnical engineers,surveyors and other professionals;(i) a report from a farm consultantmay be appropriate for ruralpurchases; and(j) an environmental assessmentmay be appropriate in somecircumstances (although this isgenerally of less concern in ‘cleanand green’ NZ).In the case of auction sales, a purchaserwill need to be satisfied with all mattersbefore the date of the auction, becausea successful bidder will be boundto purchase the property from thefall of the hammer. Similarly, beforesubmitting a tender, a purchaser shouldbe satisfied in respect of these matters,although if OIO consent is required, thetender should be conditional on suchconsent being obtained.Where the property is purchased fromthe vendor pursuant to a negotiatedcontract, an offer can be submitted thatis conditional on the purchaser or itssolicitor being satisfied with particularmatters within a specified timeframe.This gives a purchaser the certainty ofknowing that if no issues are found,then they will be able to confirm the8

conditions as being satisfied, withoutanother buyer taking the property.Under such a conditional contract,if necessary consents cannot beobtained, or if a problem is revealedby the Computer Register (title) or aLand Information Memorandum (“LIM”)report (produced by the local authority)or other investigations, then thepurchaser can cancel the contract.The extent to which a vendor will agreeupon a conditional contract may dependon the number of people interestedin the particular property, althoughgeneral practice in New Zealand is thatmost contracts will be subject to thepurchaser’s solicitors being satisfied asto the title to the property and mattersdisclosed by a LIM.It is common for the purchaser to paya deposit to the real estate agent,which is usually around 5-10% of thepurchase price. This is commonly paidon signing, or when the agreementbecomes unconditional – if a depositis paid at the time of signing, butconditions are not satisfied, then thedeposit is normally refunded to thepurchaser in full.It is recommended that all foreignbuyers should obtain legal advice asto whether OIO approval is requiredbefore entering into any contract. Ifthere is no opportunity to take legaladvice then the contract should bemade subject to the buyer obtainingOIO approval.Sensitive land and the overseasinvestment regimeAs noted above, the acquisition ofinterests in property by an overseasperson is regulated.The regime is administered by theOverseas Investment Office (“OIO”).Information on the OIO and itsfunctions can be found at www.linz.govt.nz/overseas-investment.The policy of the Government isto encourage foreign investment.However, some types of land aredeemed by the Overseas InvestmentAct to be ‘sensitive land’, and apurchase by an overseas buyer ofsuch land requires OIO consent to beobtained pursuant to the OverseasInvestment Regulations.Consent applications are usuallysuccessful. However, the consentrequirements are becomingincreasingly stringent, and it isimportant that legal advice isobtained when considering a consentapplication. It is worth notingthough that for many residential andcommercial purchases, consent won’tbe required.Consent is required for an overseasperson to purchase sensitive land,either directly or through the purchaseof shares in a land owning company.An overseas investment in sensitiveland is the acquisition by an overseasperson, or an associate of an overseasperson, of:(a) an interest in land, if the land issensitive and the interest acquiredis a freehold estate (fee simple) ora lease for a term of three years ormore (including rights of renewal); or(b) rights or interests in securities ofa company, if that company ownsor controls (directly or indirectly)an interest in land above and,as a result of the acquisition theoverseas person or the associate(either alone or together with itsassociates) has a 25% or moreownership or control interest inthat company, the overseas person9

or the associate (either alone ortogether with its associates) has anincrease in an existing 25% or moreownership or control interest in thecompany or the company becomesan overseas person.Broadly, land is sensitive if it is aparticular type and exceeds the areathreshold prescribed for that type.For example, sensitive land includesland that:(a) exceeds 5 hectares and is not in anurban area;(b) is situated on particular islands;(c) includes the foreshore or seabed,or is greater than 0.2 hectares andadjoins the foreshore;(d) exceeds 0.4 hectares and includesthe bed of a lake, any land whichis held for conservation purposes,is provided as a reserve, a publicpark, for recreation purposes or asa private open space, is subject to aheritage order or is an historic placeor exceeds 0.4 hectares and adjoinssimilar types of land as above.Non-urban land includes farmland, which is defined as land usedexclusively or principally for agricultural,horticultural, or pastoral purposes,or for the keeping of bees, poultry,or livestock. Farm land must first beoffered to the New Zealand public foracquisition (and be available on theopen market for at least 20 workingdays) before OIO consent may begranted.The requirement that farm land beoffered on the open market does notprevent that land from being the subjectof the sale to an overseas buyer. Nothingin the Regulations requires a vendor toaccept an offer from the open market,but the procedure must be compliedwith before consent can be granted.As noted earlier, while there isno statutory timeframe withinwhich an application for consentmust be decided, the OIO aims tomake a decision on high quality,straightforward applications, whereno third party consultation is requiredor “special land” is involved, within30 to 50 working days of the date ofregistration of the application. “Specialland” is land which includes foreshore,lakebed or riverbed.In determining whether to grantconsent, the OIO will test theapplication against the coreinvestor criteria, which broadlyrelate to business acumen, financialcommitment and character. Where theapplication involves sensitive land, theOIO is required to consider the benefitof the transaction to New Zealand,which involves an analysis of certainenvironmental and economic factors.We can provide further details on theconsent criteria if necessary.CAPITAL MARKETSSecurities ActThe Securities Act 1978 (and theregulations made under that Act)governs the offer of securities to thepublic in New Zealand. The general ruleis that securities may only be offeredto members of the public if the issuerof the securities has first put in place aregistered prospectus and investmentstatement containing prescribedinformation about the securities beingoffered. If the offer of the securitiesis in New Zealand the restrictionsapply regardless of where the actualallotment of securities takes place orwhether the offeror is a New Zealandresident.10

A security means any interest or rightto participate in any capital, assets,earnings, royalties, or other property ofany person, and includes:(a) an equity security (an interest inor right to share in, or in the sharecapital of, a company);(b) a debt security (an interest in, orright to be paid, money which isdeposited with or lent to anotherperson);(c) a unit in a unit trust;(d) an interest in a superannuationscheme;(e) a life insurance policy;(f) a participatory security (a securityoffered by a partnership thatinvites investment from membersof the public).An “offer” includes an invitation, andany proposal or invitation to make anoffer. Therefore any communicationwhich relates to, or is connected with, aproposed investment in securities mustbe carefully considered as the provisionsof the Securities Act may be triggered.Determining who is, and who is not, a“member of the public” can, in somecases, be a difficult task. Legal adviceshould always be sought if therecould be an offer of securities to thepublic. The definition of “the public”includes “any section of the publichowever selected”. A person is notexcluded from being a member of thepublic simply because he or she is anemployee, client or shareholder of thecompany issuing the securities.If a company offers securities to thepublic without a registered prospectusand investment statement being inplace, the allotment of those securitiesmay be void. In that case, the issuermay have to repay the monies paid bysubscribers for securities, together withinterest. The Act also carries criminalpenalties in some cases. Directors canbe personally liable for the repayment.There are exemptions from therequirements under the Act to put aregistered prospectus and investmentstatement in place before offeringsecurities to the public. The mainexemptions are:(a) relatives and close businessassociates of the issuer or thedirectors of the issuing company;(b) individuals whose principal businessis the investment of money or whohabitually invest money in thecourse of their business;(c) where the required subscriptionprice is a minimum of NZ$500,000;(d) persons certified as “wealthy” (netassets of at least NZ$2 million or anannual gross income of NZ$200,000or more in the two precedingfinancial years); and(e) persons certified as experienced ininvesting money or in the industry orbusiness to which the security relates.There are also a number of specificexemptions, and some designedspecifically for the offer of securities inNew Zealand by overseas companiesto avoid dual compliance by an issuerwho is already required to comply withsimilar or tighter controls overseas.If a security can be formally listed, theonly recognised exchange is operatedby NZX Limited. There is also anunregulated trading platform called“Unlisted” which is an internet-basedsecurities trading service that providesa low cost, easy way for small tomedium sized companies to trade theirshares.11

NZXNZX Limited (“NZX”) operates the onlyregistered securities exchange in NewZealand. There are three main marketsforming the exchange:(a) NZSX (New Zealand Stock Market)– this is the main market for equitysecurities;(b) NZAX (New Zealand AlternativeMarket) – this is a lower cost, moreflexible market for small to medium,fast-growing businesses; and(c) NZDX (New Zealand Debt Market)– for corporate and governmentbonds and fixed income securities.It is possible for an overseas companyto have a “dual primary listing” onboth an NZX market and an overseasexchange. A company with a fulllisting on certain overseas exchangescan also register an “overseas listing”on an NZX market meaning that it willnot have to comply in full with the NZXListing Rules.There are listing rules for each of thethree markets described above whichcan be found on the NZX website(https://www.nzx.com/marketsupervision).Financial market regulationThe New Zealand capital marketshave recently seen the introductionof a new financial markets regulator,the Financial Markets Authority(“FMA”). The FMA is responsible formonitoring the capital markets in NewZealand and ensures compliance withfinancial markets legislation relating tosecurities, financial reporting, and theprovision of financial advice.The FMA is also responsible forenforcing the insider trading, marketmanipulation and other dealingmisconduct provisions of the SecuritiesMarkets Act 1988. The “insider trading”rules prohibit individuals and entitieswith price-sensitive information aboutthe securities of a listed company(where that information is notgenerally available to the public) fromtrading in those securities. There arealso provisions to prohibit false ormisleading statements by individualsand entities about trading in thesecurities of a listed issuer.Takeovers CodeThe Takeovers Code is designed toprotect minority shareholders wherethere is a substantial change in controlof a Code company. The Code appliesto all companies listed on the NZX andto unlisted companies with 50 or moreshareholders.The “Fundamental Rule” contained in theCode is that a person (and its associatedparties) must not acquire 20% or more ofthe voting securities in a Code company(or increase their control if they alreadyhold 20% or more). In order to avoida breach of the Fundamental Rule, it isnecessary to comply with one of thefollowing exceptions:(a) a full or partial takeover offerto acquire shares from allshareholders in the Code company(a full offer being an offer topurchase all shares held, and apartial offer being an offer toacquire a specified percentage ofshares from each shareholder);(b) an acquisition or allotment ofsecurities which is approved byan ordinary resolution of theshareholders of the Code companywho are not involved in theproposed acquisition or allotment;12

(c) the “creep” exception, which allowsa person holding between 50% and90% of the voting securities on issueto increase their voting percentageby up to 5% in any 12 month period;(d) through “compulsory acquisition”where a person already holds 90%of the voting securities in the Codecompany (in this case the majorityholder can force the remainingshareholders to sell their shares to it,and the minority shareholders canalso force the majority shareholderto buy them out); or(e) where an exemption is granted bythe Takeovers Panel.Financial services regulation(financial service providers andfinancial advisers)The Financial Advisers Act 2008provides a regulatory regime forfinancial advisers and brokers.That Act sets minimum standardsof professionalism, competencyand conduct. The Financial ServiceProviders (Registration and DisputeResolution) Act 2008 requires that allpersons carrying on the business ofproviding a financial service must beregistered on the Financial ServiceProviders Register and must belongto a dispute resolution scheme if theyadvise retail clients.The Financial Advisers Act providesfor a number of different categoriesof financial adviser. The rights andobligations of each category varydepending on the type of advice givenand products offered. The Act requiresfinancial advisers and brokers to take anappropriate degree of care in providingservices to investors and prohibitscertain conduct.The Financial Advisers Act also:(a) stipulates a required level ofdisclosure by financial advisers andbrokers to retail clients to ensurethat clients can make informeddecisions about whether to usea particular financial adviser orbroker and, in the case of anadviser, whether to follow thatadviser’s advice;(b) imposes competency requirementson certain financial advisers whodeal with retail clients to ensurethat financial advisers have theexperience and expertise necessaryto identify the right financialproduct for a client’s needs and riskprofile; and(c) ensures that financial advisers areheld accountable for the servicesthat they provide to retail clientsand that conflicts of interest aremanaged appropriately.All persons who are “in the businessof providing a financial service”are required to be registered on asearchable online database, and wheresuch financial service is provided to“retail clients”, to be a member of anapproved dispute resolution scheme.The purpose of this database is toenable members of the public to accessinformation about the name andaddress of a financial service providerand the name of the dispute resolutionscheme (if applicable) the providerbelongs to.A “Financial Service” includes (amongother matters):(a) a financial adviser service (givingfinancial advice or investmentplanning in the ordinary course ofbusiness);13

(b) keeping, investing, administering,or managing money, securities, orinvestment portfolios on behalf ofother persons;(c) being a registered bank;(d) providing credit under a creditcontract;(e) giving financial guarantees;(f) participating in an offer of securitiesto the public either of as an issuerof the securities or as the promoter(including as a trustee, unittrustee, superannuation trustee ormanager);(g) operating a money or value transferservice or foreign exchange;(h) acting as an insurer; or(i) entering into derivative transactionsor futures contracts.Being “in the business of providing afinancial service” means carrying ona business of providing or offering toprovide a financial service (whetheror not the business is the provider’sonly business or principal business).There are a number of exceptions towhether a person will be regarded asbeing “in the business of providinga financial service”. The exemptionsinclude certain professions such aslawyers, conveyancers, charteredaccountants and real estate agentswho are providing a service in theordinary course of their business,certain government departments andnot-for-profit entities offering freefinancial services.There are significant penalties if anyperson who is in the business ofproviding a financial service is notregistered. A fine of up to $300,000may be imposed for failure to register. Adirector who knowingly fails to preventthe offence also commits an offence.Before a financial service provider canapply for registration, it must join anapproved dispute resolution scheme ifit provides financial services to “retailclients”. A retail client is any personwho receives a financial service who isnot a “wholesale client”. A wholesaleclient is one who, for example, receivesa financial service as a part of their ownbusiness of providing a financial service,persons whose principal business is theinvestment of money, large companiesor certain Crown entities.For each scheme there is an annualmembership fee payable and if acomplaint is made, further fees will beincurred, usually dependent on thelevel to which the complaint escalates.Once a financial service provider hasjoined a dispute resolution scheme,it can register online. The Registrarof Financial Service Providers willcarry out a criminal records check oneach of the individuals named in theapplication for registration (the director,controlling owner and senior manager).This will take two to five working daysand, provided the checks are clear,registration will then be complete.A financial service provider has anobligation to update its details annuallyand to notify the Registrar if theybecome disqualified from providingfinancial services.14

EMPLOYMENTEmployment relationshipEstablishing and maintaining goodfaith relationships is the basis ofemployment law in New Zealand,for both collective and individualarrangements. It is also a requirementof the Employment Relations Act 2000which is the key piece of legislation inthis area.Types of employment agreementsEvery employee in New Zealand musthave a written contract called anemployment agreement. This can beeither an individual agreement or acollective agreement.There are some provisions that must beincluded in employment agreementsby law, and there are also a numberof minimum conditions that must bemet regardless of whether they areincluded in employment agreements.Employment law also provides aframework for negotiating additionalentitlements.Collective employmentagreements/unionsEmployers can enter into collectiveemployment agreements with unionsrepresenting a group of two or moreemployees. Unions are regulatedsocieties in New Zealand and arecurrently the only party allowed toenter into collective agreements withemployees. Employees have the rightto decide whether or not to join aunion, and it is unlawful for an employer(or anyone else) to put unreasonablepressure on an employee to join or notjoin a union.Once employees have joined a union,employers must, if asked, enter intobargaining for a collective agreementwith that union. Bargaining can covera range of issues, but it will normallyinclude the coverage of the agreement,either by the work performed or theworkers involved, and the term of theagreement.Individual employment agreementsIndividual employment agreementscontain an employee’s terms andconditions which are agreed betweenthe parties, provided they are notinconsistent with legislation, asmentioned above.Fixed term agreementsFixed term agreements are usedwhen an employer has a genuinereason based on reasonable groundsto offer a fixed term. This mustbe explained at the start of theemployment relationship. The termsmust be recorded in the employmentagreement and set out how theemployment will end and why. Thiscould be, for example, as a result ofthe completion of seasonal work or aparticular project. Such workers havethe same rights as other employees,except that their jobs will finish at theend of the fixed term.Part-time/casual employeesPart-time employees (who simply workfewer hours than full-time employees)are regarded as permanent employeesand have the same rights as full-timeemployees on that basis.Casual employees, on the other hand,work intermittently on an “as andwhen” required basis. Although casualemployees also generally derive thesame rights as permanent employees,the way in which annual holidays, sickand bereavement leave are applied canvary for these employees.15

Leave entitlementsNew Zealand law provides for aminimum statutory leave entitlementof four weeks’ holiday, 11 publicholidays, five days’ sick leave andthree days’ bereavement leave eachyear. There is no long service leaveavailable as a matter of right in NewZealand. If an employer wishesto offer more than the minimumstatutory entitlements, this shouldbe incorporated into an employee’semployment agreement as necessary.Employees may be eligible for paidand unpaid parental leave if theymeet certain criteria. The paidleave is funded by the Government,not employers. In most instances,employers must keep jobs open foremployees on parental leave.Employees may also be entitled toother types of leave, for exampleif they’ve been injured in a workaccident (see Accident CompensationCorporation below) or are training inthe armed forces.Trial period and probationary periodEmployers can make an offer ofemployment that includes either atrial period or a probationary period.Although of similar application, theseclauses have a slightly different effect.A trial period gives an employer theability to assess the suitability of anemployee for a period of 90 days. Theemployer can then choose to terminatethe employee’s employment beforeor at the end of the 90 day period,without the risk of an employeebringing a personal grievance againstthe employer for unjustified dismissal.However, an employee can raise apersonal grievance on other grounds(as opposed to unjustified dismissal),such as discrimination, harassment orunjustified action by the employer.A probationary period allows anemployer to assess the suitabilityof an employee for a particular rolebut places greater obligations onan employer in terms of satisfyingemployment requirements shouldthere be any issues with performance.However, unlike a trial period,probationary periods can be for longerthan 90 days.Employees on both trial periods andprobationary periods are entitled to allother minimum employment rights.Ending the employment relationshipThere are several ways in whichemployment relationships can beended, including retirement orresignation, dismissal and redundancy.There is no set age to retire fromwork in New Zealand, and employerscannot require employees to retire justbecause of their age. Employees mayhand in their resignation at any time,provided they give reasonable noticein accordance with their employmentagreement.There must be a good reason for adismissal and the dismissal must becarried out fairly, which will dependon the circumstances. Any relevantprovisions in the employmentagreement must be followed.An employer must have a genuinework-related reason for a redundancy.The employer cannot use redundancyas a way of dismissing an employeefor reasons relating to the employeepersonally (such as their performance).The employer must provide informationto employees when they areconsidering changes that will affecttheir jobs. Generally, there is no right16

to redundancy compensation unlessemployers and employees or, whererelevant, their union have agreed to it.Employment problems/personalgrievancesEvery collective and individualemployment agreement must containa clear explanation of the processesfor resolving employment relationshipproblems. A problem includes anythingthat may harm an employmentrelationship, including relationshipsbetween an employer and employees,as well as among employees.Some of these problems may be thebasis of a “personal grievance” whichrequires specific treatment underNew Zealand legislation. Personalgrievances can be brought againstan employer for a number of reasonssuch as actions giving rise to anunjustified dismissal, or if an employerhas acted unjustifiably in the event of aredundancy. An employee must raisea personal grievance within 90 days ofthe action complained of.The employer and employee have theoption of trying to resolve the problemthrough mediation before applying tothe Employment Relations Authorityfor determination (a judicial-basedforum in New Zealand), followed by theEmployment Court (the next level ofjudicial determination).Transfer of employeeson sale of businessEmployers have some specific legalobligations where a business is soldor transferred, or work is contractedout. Most employers must follow theprocedures set out in the compulsory“employee protection” clause containedin the employment agreement toprotect employees in these types ofsituations.Employers who employ staffperforming certain catering, cleaning,caretaking, laundry and orderly workhave special obligations that providecontinuity of employment protection toemployees during restructuring.Other obligationsEmployers in New Zealand also haveother obligations in respect of theiremployees, including those set outbelow.KiwiSaver - KiwiSaver is a voluntarywork-based savings initiative to helpNew Zealanders with their long-termsaving for retirement. There are variousobligations imposed on an employerfor managing the scheme includingproviding employees with requiredinformation, making deductions fromtheir remuneration and making therequired contributions should anemployee choose to join the scheme.Failure to comply with these obligationscan lead to penalties.Health and safety - Employers areobliged to provide safe workplaceswith proper training, supervision andequipment, to everyone who has accessto the workplace. This duty includesactively monitoring the workplace toidentify, assess and manage hazardsappropriately. Employees must takereasonable care to keep themselvessafe, and to avoid causing harm to otherpeople by the way they do their work.PAYE (Pay As You Earn) - PAYE is thesystem set up by the Income Taxlegislation for taxing the income ofemployees. It must be deducted frommost payments made to employees,and paid to the Inland Revenue17

Department. It applies to all wages,salaries, and extra payments (forexample, bonuses and lump sums).Wages and records - Generally, theadult minimum wage must be paidto employees aged 16 years andover. Minimum pay rates are usuallyreviewed each year by the NewZealand Government. Employerscan’t pay employees differently ifthe only difference is whether theyare male or female. There are legalrequirements for paying wages andkeeping wage, time, holiday and leaverecords in New Zealand.ACC (Accident CompensationCorporation) - ACC is a “no fault”scheme which covers any accidentthat occurs in New Zealand, includingworkplace accidents. Put simply, ACCis an “insurance” that addresses anycompensation and income lost as aresult of an accident, whatever thecause. Employers are legally requiredto pay annual levies for all employeesemployed by it based on the natureof the profession and the number ofemployees. Employees also pay ACCpremiums which are deducted alongwith PAYE. When an employee isinjured in the workplace, the employeris obliged to pay the first five daysthe employee is absent. If it is not aworkplace accident, then the employeris not obliged to do so.Independent contractorsFor completeness, we also make noteof another type of relationship thatexists separately from the employmentrelationship, that of an independentcontractor relationship arising betweena principal and contractor. Contractorsare commonly engaged under anindependent contractor agreementor a “contract for services” and do notderive the same rights and benefits asemployees do under the applicablelegislation in New Zealand.Normally it is relatively straightforwardas to whether a person is engagedunder an employment agreement oran independent contractor agreement.However, the types of agreementsentered into between the partiesare not necessarily conclusive of thenature of the relationship betweenthem. They can be challenged by eitherparty by making an application to theEmployment Relations Authority or theEmployment Court which will examinethe situation using a number of tests inorder to determine the real nature ofthe relationship.ONGOING OPERATIONALMATTERSFair Trading ActThe Fair Trading Act 1986 isadministered by the CommerceCommission and covers conductrelating to the promotion and sale ofgoods and services. Broadly, it prohibitsconduct in trade which is misleadingor deceptive, the provision of falseinformation and unfair trade practices.It also provides for the disclosure ofcertain consumer information andpromotes product safety.The Fair Trading Act does not compelbusinesses to provide information onits goods or services to consumers inall circumstances, but it ensures thatany information that is provided toconsumers is accurate and prohibits thewithholding of important informationso consumers can be confident thatinformation they receive when makingdecisions is reliable and accurate.18

Consumer Guarantees ActThe Consumer Guarantees Act 1993sets minimum guarantees about goodsand services ordinarily purchased forpersonal or household use, from sellersin trade.Guarantees in relation to goods includethat they will be of acceptable quality,comply with description/sample, andbe reasonably fit for any particularpurpose the consumer makes knownand for any particular purpose for whichthe supplier represents they are or willbe fit.Guarantees in relation to servicesinclude that they will be performedwith reasonable care and skill, fit for thepurpose supplied for and completedwithin a reasonable time.Sellers cannot contract out of theirobligations under the ConsumerGuarantees Act except in relation togoods or services which are purchasedfor the purposes of a business. TheAct sets out various remedies forconsumers against suppliers andmanufacturers when the guaranteesare not complied with.Credit Contracts and ConsumerFinance ActAnother area of law designed to protectNew Zealand consumers is the CreditContracts and Consumer Finance Act2003. This Act requires a creditor whoenters a “consumer credit contract” toprovide a written disclosure statement toconsumers containing certain specifiedinformation about the terms of thecontract.The Act also allows consumers to havethe terms of a credit contract varied for“hardship” reasons and gives power tothe courts to examine and, if appropriate,vary the terms of an “oppressive” contract.A credit contract is defined as a contractunder which credit is or may be provided.Credit is provided where someone isgiven the right to defer payment ofa debt, or incur a debt and defer itspayment. A credit contract also includesthe right to defer payment for thepurchase of property, goods or services(for example, a hire purchase agreement).The Act also places restrictions on theway the creditor can apply interest on thecontract and sets out rules and guidelinesfor fees, payments, extended warrantiesand cancellations.Penalties include statutory damages,fines of up to $30,000, and prohibitionfrom providing consumer credit. TheCommerce Commission is responsible forthe enforcement of the Act.Commerce Act (anti-competitivepractices and pricing controls)Anti-competitive practicesThe purpose of the Commerce Act 1986is to promote competition in markets.Therefore that Act prohibits agreementswhich substantially lessen competitionin a market, such as agreements to fixprices, carve out market conduct orabuse a dominant market position.Co-ordinated conduct prohibited bythe Commerce Act includes:(a) agreements that substantiallyreduce competition in a market;(b) agreements that exclude or restrictdealings with a competitor; and(c) agreements that fix, maintain orcontrol prices (cartels).Unilateral conduct prohibited by theCommerce Act includes:(a) a business or individual taking19

advantage of their dominant marketposition for an anti-competitivepurpose; and(b) a business or individual specifyinga minimum price for the sale of itsgoods by another.In assessing whether competition hasbeen substantially lessened, the Courtswill consider whether other marketparticipants can compete effectively(for example by setting their ownprices, standards of quality and outputvolumes) and how hard it is for newcompetitors to enter the market.The Commerce Commission caninvestigate complaints regardinganti-competitive practices. There area number of actions it may take whereit believes the Act has been breached,including issuing warnings or bringinga prosecution in the High Court.It is possible for a business to apply foran authorisation from the Commissionto prevent any further action beingtaken, where it can show that althoughin breach of the Act, the conduct bringsbenefits which outweigh the potentialharm arising from a loss of competition.This process can however be lengthyand complex.Pricing controlsThe Act prohibits price fixingagreements between competitorswhich set the price of goods or servicesor interfere with how a price is reached.Price fixing agreements are also knownas cartels. A cartel comes into existencewhen businesses agree to act togetherfor an anti-competitive purpose,rather than competing with eachother. Price fixing affects competitionby making goods and services moreexpensive, lessening choices availableto consumers and often reducinginnovation, quality and investment.The Act specifically prohibitsany contract, arrangement orunderstanding between parties whoare in competition with one anotherwhich has the purpose, effect orlikely effect of fixing, controlling ormaintaining the price of goods orservices.Types of prohibited agreementsinclude:(a) price fixing: agreements whichset a minimum price, eliminate orreduce discounts, adopt a formulato calculate price, or increase ormaintain prices;(b) bid rigging: agreements betweencompetitors as to who should win abid. The effect of such agreementsis that consumers are unawarethat these bidders are not actuallycompeting with each other to offerthe lowest price;(c) market sharing: where competitorsagree to divide up markets betweenthemselves (for example allocatinggeographical regions, products orcustomers to each other); and(d) output restrictions: wherecompetitors agree to limit orlessen the output of certaingoods or services so as to limitproduction, and then maintainingor increasing prices.Some exceptions to price fixingarrangements apply under theAct, including where two or morebusinesses are in a joint venture orthere is a partnership arrangementbetween individuals.20

Creditor protection: PersonalProperty Securities Act and securityinterestsThe Personal Property Securities Act1999 sets out a regime for creatingand enforcing security interests inpersonal property. Personal propertyis essentially all property otherthan land (and a few other specificexceptions). A security interest underthe Personal Property Securities Actis an interest in personal property,created or provided by a transactionthat, in substance, secures payment orperformance of an obligation, withoutregard to the form of the transactionand without regard to the person whohas title to the collateral.In order to protect a secured party’spriority to personal property, thesecurity interest must “attach” to thepersonal property and a secured partymust “perfect” the security interest inthe personal property.Attachment occurs when the debtorenters into a valid security agreement.In order to be valid, the securityagreement must:(a) be signed or agreed to in writing bythe debtor;(b) contain a description of the personalproperty to be secured so that it isreasonably capable of identification;and(c) create the security interest or chargeover the personal property.Generally, perfection of the securityinterest occurs when the secured partyregisters a financing statement on thePersonal Property Securities Register(“PPSR”). The PPSR is an online registercontrolled by the Registrar of PersonalProperty Securities.The Act sets out priority rules andenforcement options for securedparties. Priority is determined by orderof perfection, although there are anumber of specific priority rules whichmodify this general rule.Intellectual propertyThe Intellectual Property Office ofNew Zealand is responsible for theregistration and administration oftrade marks, patents, designs and plantvariety rights.New Zealand is a signatory to severalinternational treaties and conventionsin relation to intellectual property,including the Patent Co-operationTreaty, the Paris Convention, the BerneConvention, and the Agreement onTrade-Related Aspects of IntellectualProperty Rights (TRIPS).Trade MarksRegistration of a trade mark underthe Trade Marks Act 2002 confersthe exclusive right to use the mark inrelation to the registered goods andservices. New Zealand uses the NiceClassification System so trade markscan be registered in one or more of the45 classes of goods and services underthat system.The register is publicly available andregistration lasts for a term of 10years (from the date of application orconvention priority date) and can berenewed every 10 years.PatentsA patent granted under the Patents Act1953 grants the registered proprietor ofan invention the exclusive right to useand license the invention during the termof the patent (a monopoly). Patents aregranted for a maximum term of 20 years,provided renewal fees are paid.21

To be eligible for registration ofa patent, an invention must beindustrially applicable, contain a “nonobvious”inventive step and be new ornovel. It is essential that the inventionis not disclosed prior to filing.DesignsA design means features of shape,configuration, pattern, or ornamentapplied to an article by any industrialprocess or means, which appeal to andare judged solely by the eye and whichare not solely functional or a methodor principle of construction. To beregistrable under the Designs Act 1953,a design must be new and originaland must not have been published inNew Zealand before the filing date.The term of a design registration is 15years maximum (provided renewal feesare paid at five and 10 years from theapplication date).CopyrightCopyright is not registrable in NewZealand. Copyright protectionautomatically exists in any originalwork which is, among other works, aliterary, dramatic, musical, or artisticwork, a sound recording, film orcommunication work. Owners of suchoriginal works are granted rights underthe Copyright Act 1994, such as theright to make copies, adaptations, issuecopies to the public and perform/play/show the work in public.The term of copyright is generally 50years from when the work was madein the case of sound recordings andfilms and 50 years from the death of theauthor in the case of literary, dramatic,musical and artistic works.Goods and Services TaxGoods and Services Tax (GST) is aconsumption tax which is charged onthe supply of most goods and servicesin New Zealand at a rate of 15%.Businesses are responsible for chargingGST where appropriate and collectingit on behalf of the government. GST onbusiness purchases and expenses maybe claimed back. It is important to seektax advice on GST registration and GSTrecords and returns.THE NEW ZEALAND LEGALSYSTEMGovernmentThe New Zealand system ofgovernment is derived from the Englishone and comes from two main sources,the common law and statute law.The common law is a body of law madeup from judicial decisions made in theUnited Kingdom and in New Zealand.Additionally, other decisions madein jurisdictions such as the UnitedKingdom, Australia, United States andCanada are sometimes relevant andoften used to assist the Courts to makedecisions in novel or emerging areasof law. Statute law is the law made byNew Zealand’s Parliament.An integral feature of the New Zealandsystem is the separation of poweramong three different branches ofGovernment. The division of powerseeks to ensure that no one branchcan act unconstitutionally. The threebranches are the legislature, theExecutive and the Judiciary.The role of the legislature is tomake law. The legislature consistsof New Zealand’s Parliament whichhas developed from the British22

parliamentary system known as theWestminster system of governmentand is the highest law making body inNew Zealand. Parliament consists oftwo parts. The first is the head of stateof New Zealand (Queen Elizabeth II)who is represented by the Governor-General. The Governor-General isappointed by the Queen, on the PrimeMinister’s recommendation, for a termof five years. The Governor-Generalexercises the Queen’s royal powers andhis or her main constitutional functionis to invite the leader of the majoritypolitical party to form a government.The Governor-General is required byconstitutional convention to followthe advice of government ministers.This means that the Governor-Generaldoes what the Government adviseshim or her to do. (Although there aresome situations where the Governor-General may be required to exerciseindependent judgment, this has nothappened for a long time.) The secondis the New Zealand Parliament. It hasone chamber, called the House ofRepresentatives. The House consistsof 120 members of parliament (MPs)who are elected to the House for athree year term. New Zealanders aged18 and over elect the MPs by voting inelections every three years. The House’sresponsibilities include to debate andpass legislation, provide a Government,supply money and represent the viewsof the people of New Zealand.The role of the Executive is to initiateand administer law. The Executive ismade up of the Prime Minister, theCabinet (which consists of ministerswho are members of the governingparty or parties in Parliament and ispresided over by the Prime Minister)and the public sector.The role of the Judiciary is to apply thelaw. The independence of the Judiciaryis an important principle of the NewZealand constitution. As a result,freedom from political interference isan essential feature of the Judiciary’sposition within the New Zealand legalsystem. It is the judge’s role to apply thelaw to every case that comes before theCourt. Judges, however, also developlaw by deciding what legislation passedby Parliament means by interpreting it.Judges are appointed by the Governor-General. All judges are lawyers with atleast seven years’ experience, and usuallyhave many more.New Zealand’s ConstitutionNew Zealand does not have a singlewritten constitution. The Constitution,which is the foundation of our legalsystem, is drawn from a number ofimportant statutes, judicial decisionsand customary rules known asconstitutional conventions.The Rule of LawThe Rule of Law also forms a significantpart of the New Zealand Constitution.The principles of the Rule of Lawencompass ideas such as:(a) the powers exercised by MPsand officials are based on legalauthority;(b) minimum standards of justice existto which the law must conform;(c) the law should have safeguardsagainst the abuse of widediscretionary powers;(d) unfair discrimination should not beallowed by the law; and(e) a person should not be deprivedof his or her liberty, status or othersubstantial interest without theopportunity of a fair hearing beforean impartial Court or Tribunal.23

The Treaty of WaitangiThe Treaty of Waitangi was signed in1840, as an agreement between theBritish Crown and a large numberof Maori. Today the Treaty is widelyaccepted to be a constitutionaldocument, which establishes andguides relationships between theCrown, New Zealand and Maori.The Court systemNew Zealand has a hierarchical Courtsystem which has jurisdiction to hearboth criminal and civil claims. NewZealand also has a specialist familycourt, environment court, employmentcourt, youth court and Maori land court.The New Zealand processes closelyresemble those of England andAustralia. With a small number ofexemptions, civil cases are determinedby a judge sitting alone and not witha jury. However, juries are common inserious criminal trials.In addition, parties are able to resolvetheir disputes by arbitration withoutinterference of the Courts, pursuantto the Arbitration Act 1996. TheAct is based on the Model Law onInternational Commercial Arbitration(UNCITRAL) and gives effect tovarious international protocols andconventions. New Zealand is also asignatory to the New York conventionon the recognition and enforcement offoreign arbitral awards. Arbitral awardsfrom other state parties are recognisedand enforceable in New Zealand.ENVIRONMENT AND RESOURCEMANAGEMENTThe Resource Management ActThe principal piece of environmentallegislation in New Zealand is theResource Management Act 1991. TheAct has a broad purpose, being thesustainable management of naturaland physical resources. Sustainablemanagement is defined in section5(2) of the Act as managing the use,development, and protection of naturaland physical resources in a way, orat a rate, which enables people andcommunities to provide for their social,economic, and cultural well being andfor their health and safety while:(a) sustaining the potential of naturaland physical resources (excludingminerals) to meet the reasonablyforeseeable needs of futuregenerations;(b) safeguarding the life-supportingcapacity of air, water, soil, andecosystems; and(c) avoiding, remedying, or mitigatingany adverse effects of activities onthe environment.(d) In practice, sustainablemanagement is achieved through,first, a hierarchy of planningdocuments and, secondly, throughthe mechanism of the resourceconsent process.Planning DocumentsPlanning documents include, in order ofhierarchical importance:(a) national Policy Statements;(b) regional Policy Statements;(c) regional Plans; and(d) district Plans.24

The Act incorporates a fixed processfor the development of these planninginstruments, with a particular focus onenabling wide rights of consultationand community participation.Resource consentsRegional and District Plans groupactivities into the categories ofpermitted, controlled, restricteddiscretionary, discretionary, noncomplyingand prohibited. Resourceconsents are required for controlled,restricted discretionary, discretionaryand non-complying activities. Resourceconsents cannot be granted forprohibited activities. Each resourceconsent application must include anassessment of effects of the proposalon the environment, the natureand complexity of which will varydepending on the scale of a particularproject. In making decisions onapplications for resource consents,the consent authority tends to focuson an evaluation of the ‘actual andpotential effects’ on the environmentof allowing the activity and whetheror not granting consent would beconsistent with the policy provisions ofany relevant planning instrument.A particular feature of the Act isdevolved decision making, wherebythe New Zealand Government hasconsistently taken the philosophicalapproach that decisions onenvironmental management are bestmade by those directly impacted.In certain circumstances where, forexample, large infrastructure projectsof national significance are proposed,Central Government can interveneand direct that a decision be madeeither via a call-in process, or by theEnvironmental Protection Authority.Over the term of its existence,the Act has undergone a numberof refinements largely aimed atstreamlining the developmentof planning documents and theconsenting process. Despite its flaws,it continues to be a robust piece oflegislation and one that is likely toremain largely unchanged in theforeseeable future.Climate change and the EmissionsTrading SchemeNew Zealand has committed toreducing its green house gas emissionsto 1990 levels under the KyotoProtocol during the first commitmentperiod from 2008 until 2012. TheEmissions Trading Scheme (“ETS”) isNew Zealand’s method for achievingthis. From 2013 onwards there is nointernational agreement on targetsfor reducing emissions althoughthe indication from the current NewZealand Government is that the ETS willcontinue.Participants in the ETS must monitor,report on and account for greenhousegas emissions they produce. Themethod for “accounting” is an obligationto purchase and surrender “units”(NZUs or other Kyoto units purchasedoverseas), in proportion to the levelsof emissions produced (one unit = onetonne of carbon dioxide released intothe atmosphere).The cost of purchasing units is anincentive to the emissions producer toadopt less polluting techniques andtechnologies. These costs can, in largepart, be passed onto consumers.In many cases “participation” in theETS will be mandatory. However, unitscan also be “produced” by engaging inpractices which ‘capture’ carbon25

(e.g. growing trees). Participation in theETS due to ‘emissions removal’ activitiesis voluntary and allows participantsto potentially sell the units they havegenerated for a profit.Units are held in an account in theparticipant’s name via an onlineregistry and all transfers in and out ofa participant’s account are recorded.A security interest may be registeredon the PPSR against a participant’sETS account.Units are tradeable on the commercialmarket domestically as well asinternationally (subject to certainrequirements). The price of carbon(i.e. the average price of a unit) willtherefore be determined by supplyand demand.The Climate Change Response Act2002 contains significant penalties forfailure to comply (including criminalconviction and potential imprisonment).The offences are strict liability andtherefore it is important to be awareof ETS obligations if you are engagingin an industry where participationis mandatory, to ensure you do notinadvertently breach that Act.The New Zealand ETS (unlike schemesin some other jurisdictions) is designedto cover “all sectors, all gases”. Entryinto the ETS for each sector isstaggered:26

SectorVoluntaryReportingMandatoryReportingFull Obligations(surrender units)Forestry 1 January 2008Liquid fossil fuels 1 January 2010 1 January 2010Stationary energy 1 January 2010 1 January 2010Industrial processes 1 January 2010 1 January 2010Synthetic gases 1 January 2011 1 January 2012 1 January 2013Waste 1 January 2011 1 January 2012 1 January 2013Agriculture 1 January 2011 1 January 2012 1 January 2015SourcesMinistry of Justice:www.justice.govt.nzAuckland District Law Society:www.adls.org.nzIntellectual PropertyOffice of New Zealand:www.iponz.govt.nzCommerce Commission:www.comcom.govt.nzCompanies Office:www.companies.govt.nz27

www.anthonyharper.co.nz

www.spnglegal.comDOINGBUSINESSINNIGERIADoing Business in NigeriaAn Investor’s Guide- 2013Page 1 of 36

www.spnglegal.comCONTENTSPage1. Foreword 32. Sterling Partnership 43. About Nigeria 54. Forming a Company 65. Taxation 136. Financial Report 177. Labour and Employment 208. International Trade 239. Competition Rules 2510. Intellectual Property Protection 2611. Investment Protection 32Doing Business in NigeriaAn Investor’s Guide- 2013Page 2 of 36

www.spnglegal.comFOREWORDIn the wake of the current recession, individuals, companies and nations alike are regrouping anddiversifying their business interests. International cooperation, changing legislation and open borders aswell as the democratization of a number of African states have created a buzz and flurry of activities indifferent sectors of the African economy. Nigeria with its vast natural resources, a growing population,huge infrastructure gaps and innumerable opportunities in agriculture, manufacturing, energy,telecommunications, aviation and transport among others is a haven of opportunity. The government andpeople of Nigeria are not only aware, interested, willing to explore these opportunities together with theinternational community, but have and are still taking measures to create a conducive climate and are nowwelcoming investment and collaboration in the diversification of all sectors of the Nigerian economy.It is with a view to assisting investors in this regard that Sterling Partnership put this Guide together. ThisGuide provides a broad overview of the Nigerian business regime. It highlights the rudimentary steps tostarting a business in Nigeria, the general practices regulating different sectors of the economy and howthese affect businesses in Nigeria and a practical approach to running a business in Nigeria.This Guide is by no means an exhaustive discussion on how to build and run a business in Nigeria but isan essential first step in appreciating the business climate. It is advised that every investor procures theservices of other professionals in the sector of their proposed or operating business.Our Contact Address:Sterling Partnership, Legal Practitioners17A Wumego Crescent, Off Christ AvenueAdmiralty WayLekki Phase 1LagosTel: +234(01)874 4576+234(01)874 4577+234(01)873 9658www.spnglegal.comDoing Business in NigeriaAn Investor’s Guide- 2013Page 3 of 36

www.spnglegal.comSTERLING PARTNERSHIPSterling Partnership is a dynamic and energetic commercial law practice with a professional approach tobusiness and personal legal affairs. Sterling Partnership is devoted to providing exceptional solutions tobusinesses in Nigeria and Africa.Sterling Partnership is made up of multi-skilled lawyers with a clear understanding of the economic,political and legal issues in complex and dynamic areas. Members of our team have at various timesplayed significant roles acting for both public and private sector clients; providing advice and solutions ona wide range of issues arising out of their commercial transactions.Our practice areas include:Tax Capital Market Corporate Law Transporta3on Telecommunica3on and Communica3on Sterling Partnership Dispute Resolu3on Energy Real Estate and Developpment Labour and Employment Hospitality Doing Business in NigeriaAn Investor’s Guide- 2013Page 4 of 36

www.spnglegal.com_____________________________________________________________________________________ ABOUT NIGERIAThe Federal Republic of Nigeria, is a federal constitutional republic comprising 36 states and its FederalCapital Territory, Abuja. The country is located in West Africa and is reported to have a total area of923,768 km 2 (356,669 sq mi) with a population of about 150million persons. Nigeria shares land borders with the Republic ofBenin in the west, Chad and Cameroon in the east, and Niger inthe north.Nigeria has an abundant supply of natural resources includingnatural gas, petroleum, tin, iron ore, coal, limestone, niobium, lead, zinc, and arable land. Nigeria is ratedas the 12 th largest producer of oil in the world by the CIA Factbook data and the 8th largest exporter ofpetroleum products in the world. Similarly, Nigeria’s liquefied natural gas reserves are three times assubstantial as the crude oil reserves. These resources make her a productive haven for investment in awide range of industries.Nigeria’s economy is classified as a mixed economy emerging market with a, well-developed financial,legal, communications, transport sectors and stock exchange (the Nigerian Stock Exchange). Nigeria hasone of the fastest growing telecommunications markets in the world, major emerging market operators(like MTN, Etisalat, Airtel and Globacom) basing their largest and most profitable centers in the country.Nigeria also has a manufacturing industry which includes leather and textiles (centered in Kano,Abeokuta, Onitsha, and Lagos), car manufacturing (for the French car manufacturer Peugeot as well asfor the English truck manufacturer Bedford, now a subsidiary of General Motors), t-shirts, plastics andprocessed food.The official language of Nigeria is English._____________________________________________________________________________________Doing Business in NigeriaAn Investor’s Guide- 2013Page 5 of 36

www.spnglegal.com_____________________________________________________________________________________ OUTLINEFORMING A COMPANY IN NIGERIA1. Forms of Business Entities recognised in Nigeria;2. Incorporation of Business Entities and the Time Frame;3. Listing on the Nigerian Stock Exchange.FORMS OF BUSINESS ENTITIES RECOGNIZED IN NIGERIAThe primary legislation that governs business activities in Nigeria is the Companies and Allied MattersAct, CAP C20, Laws of the Federation ofUnlimited Limited Liability Liability Nigeria, 2004 (CAMA). Company registrationCompany Company (private or (private or public) processes in Nigeria are national and the samepublic) registration processes apply to all parts of thecountry.Company Limited by Guarantee Incorporated Trustees Other laws may apply depending on the field ornature of the business and persons participatingin the business.Partnership/Firms Foreign Company (branch or subsidiary of a foreign company) Business activities in Nigeria may be undertakenusing any of the structures depicted in the diagram and described below:Business En33es Sole Proprietorship Representa3ve office • Limited Liability Company: This is a company where the liability of its members is limited tothe amount if any, unpaid on the shares they hold respectively. It may be either a private companyor a public company.• Unlimited Liability Company: This is a business entity in which there is no limit to the liabilityof its members. It may be either a private or public company.• Company Limited by Guarantee: This company is one in which the liability of its members islimited to the amount that members undertake to contribute in the event of its being wound up. Ithas no share capital and cannot be incorporated with the objective of making profits fordistribution to its members. It may be a private or a public company._____________________________________________________________________________________Doing Business in NigeriaAn Investor’s Guide- 2013Page 6 of 36

www.spnglegal.com_____________________________________________________________________________________ • Incorporated Trustees: This is a not-for-profit business structure wherein Trustees areappointed by anybody, association or community of persons bound together by a commonreligion, culture, nationality or kinship for the promotion of a common cause. An incorporatedtrustee must be set up for the advancement of a religious, educational, literary, scientific, social,developmental, cultural, sporting or charitable purpose and must be lawful.• Sole Proprietorship: This is a business owned by one individual and is registered as a BusinessName.• Partnership: This has the same format as a sole proprietorship but has a minimum of twopersons who come together to do business. This type of business is also registered as a BusinessName.• Foreign Subsidiary: Foreign Companies are required to register a local company in order to dobusiness in Nigeria except those exempt from registration. They include companies invited by orwith the approval of the Federal Government of Nigeria to execute specified individual project(s),foreign government owned companies engaged solely in export promotion activities etc.Exemptions are usually granted for a fixed period.• Representative Office: Foreign companies can set up representative offices but they cannotengage in business or conclude contracts. They only serve as promotional or liaison offices butmust be registered in Nigeria.All business entities must be registered with the Corporate Affairs Commission (CAC), (the statutorybody responsible for the registration and regulation of business entities in Nigeria) located in the FederalCapital Territory, Abuja.ESTIMATED TIMELINES FOR INCORPORATION OF COMPANIESS/N STEP STATUTORY REQUIREMENT ESTIMATEDTIME FRAME1. AvailabilityA statutory form application would be• 24 - 48 HoursCheck/Reservationofsubmitted to the Commission to reserve a• NB: Reservedname.proposed company name and ensure thebusinessname_____________________________________________________________________________________Doing Business in NigeriaAn Investor’s Guide- 2013Page 7 of 36

www.spnglegal.com_____________________________________________________________________________________ proposed name is not already in use. lapses after 60days.Subsequently anapplicationforre-issuance maybe made.2. Prepare the requisiteincorporationdocuments forregistering the companywith the CorporateAffairs Commission.3. Processing ofApplication at the CAC4. Register with theFederal Board of InlandRevenue Department ofthe Ministry of Financefor income tax andVAT.These include;• The Memorandum of Association;• A statement of the authorized sharecapital/shareholders of the company,with evidence of stamp duty on theshares allotted.• Stamp duty (as assessed)• A statement showing the list andparticulars of the initial directors (theremust be at least two (2) directors).• A notice of address of the proposedcompany.• Statutory fees apply for obtainingforms and processing registration.Submission of the application in the requiredformCopies of the company’s incorporationdocuments are submitted alongside;• The letter appointing a tax adviser forthe company;• Tax advisers name and address;• Date the company commencedbusiness;Time frame dependson availability ofinformation.1 – 4 Weeks24 Hrs._____________________________________________________________________________________Doing Business in NigeriaAn Investor’s Guide- 2013Page 8 of 36

www.spnglegal.com_____________________________________________________________________________________ • Names, addresses and mobile numbersof major promoters, principal officersand the chairman of the company.NB: This procedure does not attract anystatutory costs.Registration of Business NamesA Business Name is usually associated with sole proprietorships or partnerships. An individual, firm (ofpartners) or corporation may register a Business Name at the CAC. Business names must be registeredwhere the name consists of an addition to a person’s name. For example, Andrew Philips does not requireregistration but Andrew Philips & Co requires registration.Requirements for the registration of Business NamesThe process for registration of Business Names essentially involves the submission of duly completedforms, which would contain information on the proposed business and the details of the individuals orcorporations forming the business. The information would include (but may not be limited to thefollowing):• The proposed name;• General nature of the business;• Full address of the principal place of business;• Where the registration to be effected is that of a firm; the present forenames and surnames,nationality, age, sex, occupation and usual address of each of the individuals who are the intendedpartners or in the case of a corporation which is an intended partner, the corporate name andregistered address of the corporation;• The proposed date of commencement of business;• Certificate of professional qualification where the business is of a professional nature;• Passport photographs of the individuals;_____________________________________________________________________________________Doing Business in NigeriaAn Investor’s Guide- 2013Page 9 of 36

www.spnglegal.com_____________________________________________________________________________________ • In the case of a non-Nigerian, evidence of the individual’s immigration status.Foreign Investors doing business in NigeriaForeigners are allowed to freely invest and participate in the operation of any business except those on thenegative list including the production of arms, ammunition, production of and dealing in narcotic drugsand psychotropic substances, production of military and para-military wears and accoutrement includingthose of the Police, Customs, Immigration and Prison Services, and such other items as the FederalExecutive Council may, from time to time determine.Approvals/Registrations required for foreign participationIn addition to the above incorporation, foreign companies (or companies with foreign interest) that intendto do business in Nigeria may be required to carry out other registrations or secure other approvals as acondition for doing business in Nigeria. Some of the approvals are mandatory while some others arerequired only where the Company would employ expatriates.a. Registration with the Nigerian Investment Promotion Commission (NIPC): It is a statutoryrequirement that any company in which there is foreign participation must be registered with theNIPC.b. Business Permit: Every enterprise with foreign participation must obtain a business permit inorder to conduct business in Nigeria. Note: only companies that have a minimum share capital ofTen Million Naira (N10, 000,000. 00) are eligible to apply.c. Expatriate Quota: Any company that intends to employ expatriates must obtain an expatriatequota position for each expatriate employed.d. Residence Permit: Expatriate employees who intend to reside in Nigeria must obtain a residentpermite. Certificate of Capital Importation (CCI): CCI’s are Central Bank of Nigeria (CBN) certificatesissued by banks for importation of cash (foreign currency Inflow) for investment as Equity orLoan, and also for importation of machinery and equipment for investment as Equity or Loan.The Certificate is obtained from the Nigerian bank through which the payment is transferred intoNigeria and is primarily aimed at providing statutory evidence of capital inflow/investment into aNigerian Company._____________________________________________________________________________________Doing Business in NigeriaAn Investor’s Guide- 2013Page 10 of 36

www.spnglegal.com_____________________________________________________________________________________ f. Approval for Transfer of Technology and other Agreements: The National Office forTechnology Acquisition and Promotion Act provides that any agreement under which a foreigneris to provide foreign technology, management, or assistance, to a Nigerian company must beapproved by the National Office for Technology Acquisition and Promotion (“NOTAP”).g. Registration with the Department of Petroleum Resources: Companies that wish to engage inpetroleum operations in Nigeria are required to register with the Department of PetroleumResources (“DPR”). The DPR issues Permits, upon application, in respect of oil exploration andproduction activities, as well as oil service activities.Other approvalsOther approvals that may be required include:• National Agency for Food and Drugs Administration and Control (NAFDAC): for foodand drugs manufacturing.• Nigerian Communications Commissions (NCC): for activities in the telecommunicationsindustry.• Nigerian Electricity Regulatory Commission (NERC): for the electricity power sector.• National Tourism Development Commission (NTDC): for the tourism industry.• Standards Organisation of Nigeria: for general manufacturing of productsLISTING ON THE NIGERIAN STOCK EXCHANGECompanies desiring to be admitted to the official list of the Nigerian Stock Exchange (NSE) must complywith the Exchange’s rules governing listing, as well as the relevant provisions of the Companies andAllied Matters Act 2004, the Investment and Securities Act and other relevant statutory requirements.Listing of securities on the stock exchange may be carried out through an Offer for subscription, Offer forsale, placing, Rights offer/issue, Capitalisation Issue, a tender, conversion, an introduction, options or anyother method the NSE Council may prescribe.Requirements for listing on the Nigerian Stock ExchangeThe general requirements for listing are not exhaustive and the NSE Council may from time to time vary,add or subtract from the requirements as considered necessary subject to the approval of the Securitiesand Exchange Commission_____________________________________________________________________________________Doing Business in NigeriaAn Investor’s Guide- 2013Page 11 of 36

www.spnglegal.com_____________________________________________________________________________________ Some of the general requirements are as follows:a. Application for Listing will only be entertained if sponsored by a Dealing Member of theExchange.b. The company must be a public company, which will issue or has issued an invitation to the publicto subscribe for its shares or has satisfied the NSE Council that the public is sufficiently interestedin the company’s shares to warrant Listing.c. Have a minimum of three (3) years’ operating track record, for companies whose securities arenot already listed on the exchange and two (2) years if already listed;d. All securities for which listing is sought shall first be registered with the Securities and ExchangeCommission.e. There must be no restriction on the transfer of shares of the company.f. The Council shall not grant an initial listing where the last audited accounts of a company is morethan 9 months old._____________________________________________________________________________________Doing Business in NigeriaAn Investor’s Guide- 2013Page 12 of 36

www.spnglegal.com_____________________________________________________________________________________ TAXATIONOUTLINE1. Tax StructureCompany Tax 2. Tax RegistrationPersonal Income Tax Petroluem Profit Tax 3. Major Taxes4. Tax Incentives5. Tax TreatiesValue Added Tax Major Taxes Informa3on Technology Tax TAX STRUCTURECustom and Excise Duty Capital Gains Tax Taxation in Nigeria has been structured towardsWithholding Tax Stamp Du3es encouraging private sector involvement in the country’seconomy. It is mainly levied by the federal and stategovernments,although the local government is also legally mandated to collect certain levies and dues. The FederalBoard of Inland Revenue (FBIR) administers federal taxes through its operational arm called theFederal Inland Revenue Service (FIRS). States taxes are administered by the Inland Revenue Boardof respective states, while the various councils administer local government taxes.NB: Individuals including employees, partnerships and unincorporated trusts are liable to PersonalIncome Tax. Every employer is required to file a return of all emoluments paid to his employees at thestate Inland Revenue Board.TAX REGISTRATIONRegistration at the Federal Board of Inland RevenueApplicants are required by the Federal Inland Revenue Service (FIRS) to;a. Complete tax registration forms for corporate income tax registration as well as VAT;b. Submit an application letter to the tax authority for a tax clearance certificate; andc. Register at the integrated tax office for income tax purposes._____________________________________________________________________________________Doing Business in NigeriaAn Investor’s Guide- 2013Page 13 of 36

www.spnglegal.com_____________________________________________________________________________________ Registration at the State Tax OfficeAll employers shall register with the relevant state tax authority for income tax. Once the application isfiled with a copy of the certificate of incorporation attached, a reference file is opened for the company.TAX INCENTIVESThe following are some of the tax incentives available to investors in Nigeria:Pioneer StatusThis incentive is issued by the Nigerian Investment Promotion Commission (NIPC). The benefit of apioneer status certificate is that the company is exempted from paying tax for a specified number of years.The exemption is for 5 years if the company is in an urban area while it is 7 years for companies in ruralareas.Agricultural Sector• Companies engaged in agricultural trade or businesses are not liable for minimum tax.• Non – restriction of the capital allowance claimable by the companies to 66% of assessable profit.• Tax exemption of the interest earned from agricultural loans, provided the moratorium is not lessthan 18 months and the rate of interest is not more than the base lending rate at the time of theloan.Oil & Gas SectorThe following fiscal incentives have been approved by the government in the gas production phase:• Tax rate under Petroleum Profit Tax (PPT) Act to be at the same rate as company tax which iscurrently at 30%;• Capital allowance at the rate of 20% per annum in the first 4 years, 19% in the 5th year and theremaining 1% in the books;• Investment tax credit at the current rate of 5%;• Royalty at the rate of 7% on shore and 5% offshore.Solid MineralsCompanies engaged in the mining of solid minerals are entitled to enjoy tax – free holiday for the first 3to 5 years of operation. They are also entitled to claim initial and annual allowance as follows:• Initial allowance 30%_____________________________________________________________________________________Doing Business in NigeriaAn Investor’s Guide- 2013Page 14 of 36

www.spnglegal.com_____________________________________________________________________________________ • Annual allowance 20%Export and Mining Enterprise• A wholly export oriented company established outside an export processing zone (EPZ) isexempted from companies income tax for its first 3 years, provided the export proceeds constituteat least 75% of its turnover and its repatriates at least 75% of the export earning to Nigeria.• Plant, machinery, equipment and accessories imported exclusively for mining operations inNigeria are exempted from customs and imports duties.• A new company engaged in the mining of solid minerals will enjoy a tax holiday of 3 years.• Free Trade Zones (FTZs) and EPZs are designated from time to time and enterprises operating insuch designated zones enjoy tax exemption and considerably relaxed exchange control measures.Telecommunications• Rebate and tax relief are provided for the local manufacture of telecommunications equipmentand provision of telecommunication services.Abolition of Excise DutyAll excise duties were abolished by the federal government effective 1 January 1998 but excise dutieswere re – introduced from 1 January 1999 on the following products:• Spirit and other spirit – based alcohol• Cigarette, cigars, cheroots and cigarillos• Other manufactured tobacco and tobacco –manufactured substitutesHoteliers and Tourism25% of income derived from tourism by hotels in convertible currencies is tax-exempt. This exemptiononly applies where such income is put in a reserve fund to be utilized within 5 years for expansion or theconstruction of new hotels, conference centres and new facilities deemed useful for the development oftourism.Research and Development• 120% tax deductible expenses for research and development carried out in Nigeria_____________________________________________________________________________________Doing Business in NigeriaAn Investor’s Guide- 2013Page 15 of 36

www.spnglegal.com_____________________________________________________________________________________ • 140% for research and development on local raw materialsInfrastructure• 20% of the cost of providing basic infrastructure (roads, water, and electricity) in communitieswhere they do not exist is tax deductible once and for all.Re – Investment AllowanceThis incentive is given to manufacturing companies that incur capital expenditure for the followingpurposes:• Approved expansion of production capacity• Modernisation of production facilities• Diversification into related productsInvestment in Economically Disadvantaged Areas• 100% tax holiday for 7 years• 5% depreciation allowance over and above the initial capital depreciationTAX TREATIESNigeria has executed double tax treaty agreement (DTA) with some countries that could impact the taxliability of a foreign investor. Some of the countries with which Nigeria has DTAs include the UnitedKingdom, France, Belgium, China, the Netherlands, Pakistan, the Philippines, Romania, South Africa,Canada and Italy (Italy is with respect to shipping and air transport). Please note that this list is by nomeans exhaustive as new ones are being negotiated_____________________________________________________________________________________Doing Business in NigeriaAn Investor’s Guide- 2013Page 16 of 36

www.spnglegal.com_____________________________________________________________________________________ OUTLINE1. Financial Reporting System2. Company Financial Books and Recordsa. Accounting Recordsb. Financial Statementsc. Annual Returns3. Auditing Company Financial RecordsFINANCIAL REPORTING SYSTEMFINANCIAL REPORTING/AUDITINGNigeria has adopted the International Financial Reporting Standards (IFRS), a global accounting standard,which took effect from January 1, 2012. While public entities are expected to have implemented thispolicy by January 1, 2013, small and medium sized entities are expected to implement same by January 1,2014.The Financial Reporting Council of Nigeria (FRCN) established under Act No.6 of 2011 is the FederalGovernment agency under the supervision of the Federal Ministry of Trade and Investment charged withthe primary responsibility of developing and publishing accounting and financial reporting standards to beobserved in the preparation of financial statements of public entities in Nigeria; and for related matters.COMPANY FINANCIAL BOOKS AND RECORDSAll corporate entities in Nigeria are required to maintain a certain minimum of financial records for thebenefit of transparency in corporate governance and the assurance that the entity is a going concern. TheCorporate Affairs Commission (the ‘CAC’) is the autonomous body charged with the responsibility toregulate the formation and management of companies in Nigeria. The records required by the Companiesand Allied Matters Act (CAMA) include;1. Accounting RecordsEvery company in Nigeria is expected to keep and maintain Accounting Records. Accounting recordsinclude all documentation to prove ownership of assets creation of liabilities and evidence of monetaryand non monetary transactions of a company. These records should be sufficient to explain the financialstatus of the company at any time. Accounting records form the basis of relevant information and data_____________________________________________________________________________________Doing Business in NigeriaAn Investor’s Guide- 2013Page 17 of 36

www.spnglegal.com_____________________________________________________________________________________ used in preparing the Financial Statements and audited account of the company. It is a mandatoryrequirement to maintain the Accounting Records of a company for a period of six (6) years from the dateof the making after which the company may destroy it.2. Financial StatementsDirectors of every company are required to prepare a financial statement of the company for eachfinancial year. It is the major Accounting Records of a company and should include:a. statement of the accounting policy of the company (not necessary for a private company);b. the balance sheet as at the last day of the year;c. a profit and loss account , or, in the case of a company not trading for profit, an income andexpenditure account for the year;d. notes on the account;e. the auditor’s report;f. the directors report;g. a statement of the source and application of fund (not necessary for a private company);h. a value-added statement for the year (not necessary for a private company);i. a five year financial summary (not necessary for a private company), andj. in the case of a holding company, the group financial statements.This record is to be compiled in compliance with the International Financial Reporting Standards (IFRS)and should be made available to the members of the company not less than twenty-one days before thedate of the general meeting of the company at which the financial statement would be laid.3. Annual ReturnsEvery company is under an obligation to make and deliver to the Commission an Annual Return inprescribed form. Information to be provided on this statutory form include; the authorised share capital ofthe company, the total number of share units in the company, number of issued shares, particulars of thecompany’s indebtedness (if any), company’s turnover, net assets, etc. Basically, such information thatsummarises the company’s financial status at a glance is what is provided in the Annual Returns. Thisinformation assists the Commission in their assessment of whether the company is still a going concern.Annual Returns should be filed eighteen months post incorporation/registration or within forty-two (42)days after the annual general meeting for each year._____________________________________________________________________________________Doing Business in NigeriaAn Investor’s Guide- 2013Page 18 of 36

www.spnglegal.com_____________________________________________________________________________________ In the case of a foreign company exempted from the obligation to be incorporated in Nigeria, Annualreport to be filed should disclose the following:a. Place/country of registration;b. Date of registration and certificate number;c. Principal place of business in place/country of registration;d. Share capital of the company (if any);e. Principal place of business in Nigeria;f. Date of exemption;g. Description of business in Nigeria;h. Expected date of completion of business in Nigeria;i. Name and address of each director, partner or other principal officers of the company since dateof exemption and any changes therein.AUDITING COMPANY FINANCIAL RECORDSIt is statutorily required of every company to appoint an external auditor for every financial year. Themain duty of the auditor is to examine the financial records of a company and make a report to themembers of the company on these. The auditor’s report is made available to the members of the companyat the general meeting of the company during the tenure of the auditor.In the case of a public company, the auditor’s report is also made to the audit committee of the company.The Auditors report further serves as a reference material for reviewing the company’s system ofaccounting, reporting policies and internal control to ensure they are in accordance with legalrequirements and ethical practices and such further functions as stipulated by statute._____________________________________________________________________________________Doing Business in NigeriaAn Investor’s Guide- 2013Page 19 of 36

www.spnglegal.com_____________________________________________________________________________________ LABOUR AND EMPLOYMENTOUTLINE1. Governing Statutes2. Eligibility3. Holidays4. Social SecurityGOVERNING STATUTESThe Labour Act 1 sets minimum employment conditions mainly for manual and clerical workers.Employers may enter into contracts with these categories of workers but cannot contract outsidethe minimum standards set by the law.Other applicable laws are below:1. Factories Act , Cap F1 (LFN ) 2004;2. Pension Reform Act , Cap P4 (LFN) 2004;3. Trade Union Act, Cap T14 LFN 2004 as amended by the Trade Unions (Ammendment)Act 2005;4. Trade Disputes Act, 1976, Cap T81 LFN 2004;5. National Directorate of Employment Act 1989, Cap N28 LFN 2004;6. Wages Boards and Industrial Councils Acts 1974, Cap W1 LFN 2004;7. National Minimum Wage Act 1981, Cap N61 LFN 2004 as amended by NationalMinimum Wage (Ammendment) Act 2011;8. Employee Compensation Act 2010.ELIGIBILITYAny person may employ or be employed in Nigeria except; (i) children (where the employment is not oneof apprenticeship); (ii) foreigners (where immigration formalities have not been complied with); and (ii)women in underground mines or at night for manual work.1 Cap L1 Laws of the Federation of Nigeria (LFN ) 2004_____________________________________________________________________________________Doing Business in NigeriaAn Investor’s Guide- 2013Page 20 of 36

www.spnglegal.com_____________________________________________________________________________________ Employment of Expatriate StaffThe employer must first secure an expatriate quota from the Immigrations Department. Businesses with acapitalization of 15 million naira and above have automatic quota of 2 expatriate employees whilebusinesses with a 30 million naira capitalization and above have automatic quota of four (4) expatriateemployees. A Work Permit is also granted to the expatriate employee in order for him/her to be able to fillthe expatriate quota position.Procedure for application for Expatriate QuotaCompleted immigration forms should be submitted to the Immigrations Department with accompanyingdocuments such as:• Certified True Copies of Incorporation Documentation of the employing business;• Evidence of non-availability of expertise in Nigeria;• Training programme incorporating management succession schedule for Nigerian employees;• Job title designations of expatriate quota positions required and the academic and workingexperience required for the occupants of such positions;• Tax Clearance.Usually, the expatriate employee will be issued a Subject to Regularisation Visa to enter the country at theNigerian High Commission/Embassy in the country where he has been domiciled for at least six (6)months. The application for this visa must be accompanied by:• Valid passport with minimum of 6 months validity;• Letter of Employment;• Expatriate Quota Approval;• Credentials of the Applicant;• Duly Completed FORM IMM 22;• Curriculum Vitae or Resume;• For Chief Executive Officers (C.E.O) of corporate organizations, there is need for extract of theminutes of the Board’s Resolution.Upon entry into Nigeria, an application is required to be made to the Director of Immigrations for aCombined Expatriate Residence Permit and Aliens Card (CERPAC) for the expatriate employee. Withthis, there is no need to apply for a separate work permit._____________________________________________________________________________________Doing Business in NigeriaAn Investor’s Guide- 2013Page 21 of 36

www.spnglegal.com_____________________________________________________________________________________ HOLIDAYSClerical and manual workers are entitled to a minimum of 6 working days leave per annum. Apprenticesand persons under 16 are entitled to a minimum of 12 working days. Holidays for other classes ofemployees are entirely subject to contract. Women are entitled to maternity leave with pay six weeksbefore childbirth and six weeks afterwards.SOCIAL SECURITYPensionsAll employers (who have more than five employees) and employees must contribute a minimum statutorypercentage of the employee’s monthly emoluments (comprising basic salary, housing allowance andtransport allowance) into the Retirement Savings Account (RSA) of the employee. The employee isbarred from making any withdrawal from the RSA until he/she has attained the age of 50. Thecontributions would be managed and administered by Professional Fund Administrators and held incustody by licensed Pension Fund Custodians. At retirement, the amount in the employee’s RetirementSavings Account would be the total contributions plus income and capital gain earned on thecontributions made.Life Insurance Policy must also be taken on their behalf by their employers for an insured amount of notless than three (3) times their annual total emolument.Pensions for invalidityEvery employer must make a contribution of a minimum of 1% of its total monthly payroll in the first 2years to the National Social Insurance Trust Fund (NSITF) to cover injuries, disease, disability or deathat the work place.The scheme is designed to relieve the employer of the heavy burden of solely taking care of the injuredworker. Compensation is paid to the injured employee regardless of who is at fault.Health InsuranceAn employer who has a minimum of ten (10) employees may together with his employees makecontributions under the National Health Insurance Scheme (NHIS)._____________________________________________________________________________________Doing Business in NigeriaAn Investor’s Guide- 2013Page 22 of 36

www.spnglegal.com_____________________________________________________________________________________ INTERNATIONAL TRADEOUTLINE1. Import and export: Regulatory Agency/ Role2. IncentivesIMPORT AND EXPORTRegulatory Agency/ RoleImportation and exportation of goods into Nigeria is a highly regulated sector of the Nigerian economy.The central agency in charge of monitoring the traffic of goods to and from the Nigerian boarder is theNigeria Customs Service (NCS). The Customs and Excise Management Act (CEMA) Cap C45, Laws ofthe Federation of Nigeria, 2004 vests legal authority in the NCS to act on behalf of the FederalGovernment of Nigeria in all customs matter. In this regard the NCS performs inter-agency functions onbehalf of other government agencies, namely;a. The National Agency for Food and Drugs Administration and Control (NAFDAC) – prevents theillegal importation of food, food products, drugs and chemicals into the country,b. National Drug Law Enforcement Agency (NDLEA)- prevents the importation and exportation ofhard drugs,c. Nigeria Police Force (NPF)- prevents illegal importation or exportation of firearms andammunition,d. Standards Organisation of Nigeria (SON) - ensures that all export products are certified as beingup to standards as stipulated by SON.INCENTIVESIn the process of encouraging trade and commerce across the nation’s borders; the Nigerian governmenthas in place several incentives in to encourage indigenous and foreign investors to the Nigerian market.Established across the country are export processing zones and export processing factories strategicallydesigned by the Federal Government of Nigeria to create a business-friendly environment for the investor._____________________________________________________________________________________Doing Business in NigeriaAn Investor’s Guide- 2013Page 23 of 36

www.spnglegal.com_____________________________________________________________________________________ Locating in any Free Zone in Nigeria automatically confers upon the investor certain advantages, benefitsand incentives which include;• Exemption of application of Nigerian taxes, levies, duties and foreign exchange regulations in theFree Zone;• Repatriation of foreign capital investment in the Free Zone is permitted at any time with thecapital appreciation of the investment;• Profits and dividends earned by foreign investors in the Free Zone may be remitted overseas atany time;• No import or export licenses are required;• Up to 100% foreign ownership of the business in the Free Zone is permitted;• Companies operating in the Free Zone may employ foreign management and other qualifiedpersonnel.A wide range of industries may operate within the Free Zone. These include: electrical and electronicproducts, textile and garment products, leather products, cosmetics, rubber, petroleum, oil and gaslogistics, pharmaceutical kits, medical kits, etc._____________________________________________________________________________________Doing Business in NigeriaAn Investor’s Guide- 2013Page 24 of 36

www.spnglegal.com_____________________________________________________________________________________ COMPETITION RULES/CONSUMER PROTECTIONOUTLINE1. Governing Statutes2. Regulated Sectors;a. The Securities Marketb. Communicationc. Electricityd. AviationGOVERNING STATUTESNigeria does not yet have a single competition law. However, sector specific laws to regulate competitionand protect consumers exist. These sectors are:1. The Securities Market: This is regulated by the Securities and Exchange Commission under theInvestments and Securities Act 2007. The Commission is vested with wide powers to regulatecompetition in the market as it relates to mergers, acquisitions, take-over and any other forms ofbusiness combinations, including partnerships.2. Communication: This is regulated by the Nigerian Communications Commission (“NCC”). It isempowered by the Nigerian Communications Commission Act 2003 which vests it with exclusivecompetence to determine, pronounce upon, administer, monitor and enforce compliance of allpersons with competition laws and regulations, whether of a general or specific nature, as itrelates to the Nigerian communications market.3. Power: The Electricity Power Reform Act Cap E7, Laws of the Federation of Nigeria 2004makes provisions for the development of healthy competition in the sector with the creation of theNigerian Electricity Regulatory Commission (the “NERC”).4. Aviation: The Civil Aviation Act 2006 Cap C13, Laws of the Federation 2004, creates a bodyknown as the Nigerian Civil Aviation Authority. The Body is vested with the authority toinvestigate and determine upon its own initiative or upon receipt of a complaint by any air carrier,air travel agent, consumer of air transport service or other allied aviation service provider,whether any of the aforementioned has been or is being engaged in unfair or deceptive practicesor unfair methods of competition and order a defaulter to desist from such practices._____________________________________________________________________________________Doing Business in NigeriaAn Investor’s Guide- 2013Page 25 of 36

www.spnglegal.com_____________________________________________________________________________________ INTELLECTUAL PROPERTY PROTECTIONOUTLINE1. Copyrightsa. Governing Law/Regulatory Agencyb. Eligibility for Copyright Protectionc. Procedure for Registrationd. Duration of Copyright Protection2. Trademarka. Governing Law/Regulatory Agencyb. Eligibility for Registrationc. Procedure and Requirements for Registration3. Patenta. Governing Law/Regulatory Agencyb. Conditions for Patentabilityc. Procedure for applicationd. life Span of Patente. Rights Covered Under PatentCOPYRIGHTSGoverning Legislations/Regulatory AgencyNigeria is part of the global race for the protection of IP rights. Copyright law and practice is governed inNigeria by a number of legislations. The principal legislation governing Copyright in Nigeria is theCopyright Act, CAP C28 Laws of the Federation, 2004. The Act is regulated by the Nigerian CopyrightCommission and a Licensing Panel.There are also several treaties and international agreements on Copyright to which Nigeria is a party orsignatory such as:§ The Berne Convention 1886;§ The Universal Copyright Convention 1952;§ Rome Convention 1961;_____________________________________________________________________________________Doing Business in NigeriaAn Investor’s Guide- 2013Page 26 of 36

www.spnglegal.com_____________________________________________________________________________________ §§Trade Related Aspects Of Intellectual Property Rights [Trips]; andThe World Intellectual Property Organization (Wipo)Eligibility for Copyright ProtectionLiterary work, musical work, artistic works, cinematograph film, sound recordings, and televisionbroadcast are eligible for copyright protection in Nigeria. Protection may also be given to performers inrespect of live performance and expression of Folklore. Every work eligible for copyright protection musthave the following features:a. Originality,b. Fixation of work,c. The author or one of the authors must be a citizen of Nigeria or a non-Nigerian who is domicile inNigeria or a body corporate incorporated by or under the laws of Nigeria,d. Other than a broadcast, must be one that was first publish in Nigeria; or in the case of a soundrecording, is made in Nigeria,e. The work is made by or under the direction or control of the Government, a State authority andprescribed international body,f. The author is a citizen or body corporate domicile in a country that is a party to an obligation in atreaty or other international agreement to which Nigeria is a party.Procedure for RegistrationUnder copyrights, no registration is required. This is because Nigeria does not operate a centralisedsystem of registration of copy rights. However:• All work entitled to protection are ipso facto, vested with protection (e.g. literary works, Artisticworks, Musical works, films, sound recording, etc.)• The Commission is empowered to maintain an effective data bank on authors and their works.• Copyright Notification is not a mandatory registration process, and therefore does not confer anyright on a work other than the protection granted under the Copyright Act.• Therefore, publishers, printers, producers and manufacturers of works are required to keep aregister of all works produced by them showing the following:1. The name of the author;_____________________________________________________________________________________Doing Business in NigeriaAn Investor’s Guide- 2013Page 27 of 36

www.spnglegal.com_____________________________________________________________________________________ 2. The title;3. The year of production;4. The quantity of the work produced.Duration of Copyright ProtectionDuration depends on the nature of work involved.1. For Literary, musical or artistic works other than photographs, copyright in the work will expireseventy years after the end of the year in which the author dies. If the Author is a corporate bodyor Government copyright will expire seventy years after the end of the year in which the workwas first published.2. For Cinematograph films and photographs the copyright will expire fifty years after the end of theyear in which the recording was first made.3. Sound Recording is fifty years after the end of the year in which the recording was first made.4. Broadcast, copyright will expire fifty years after the end of the year in which the broadcast firsttook place.TRADE MARKSGoverning Legislations/Regulatory AgencyThe Trade Marks Act (TMA) 1965 Cap T13 LFN 2004 and Trade Marks Regulations of 1967 are theprimary legislations governing Trademark administration in Nigeria. Nigeria is also a party to the MadridAgreement on International Registration of Trademarks and the Nice Agreement on the InternationalClassification of Goods and Services also has specific laws governing trademark administration and theenforcement of it accruing rights in Nigeria.The Trademarks, Patents and Designs Registry under the Commercial Law Department of the FederalMinistry of Industry, Trade and Investment (MITI), is the relevant trademark authority in Nigeria.Eligibility for RegistrationA device, brand, heading, label, ticket, name, signature, word, letter, numeral, or any combination thereofall constitute marks which may be registered. Any person claiming to be the proprietor of a trade markused or proposed to be used can apply for the registration of a trademark. Deceptive or scandalous mattersor designs likely to cause confusion, chemical substance and geographical names in their ordinary_____________________________________________________________________________________Doing Business in NigeriaAn Investor’s Guide- 2013Page 28 of 36

www.spnglegal.com_____________________________________________________________________________________ signification are not eligible for registration in Nigeria as trademarks. Once registered, the trademark isassignable and transmissible either in connection with the goodwill of a business or not.Procedure and Requirements for RegistrationSTEP 1 Prepare applica3on on relevant staturory form and payment of prescribed fees STEP 2 • Acknowledgement form is issued • Registrar conducts search of the trademark register STEP 3 • Acceptance or refusal form is issued by the registrar • Acceptance is published in trademark journal and invi3ng objec3on(s) • issuance of cer3ficate where no objec3on is raised Who can apply?Application for trademark registration can be filed directly by the applicant or through his local agent. Anapplicant must provide an address for service within Nigeria where he chooses to file the applicationdirectly.Grounds for refusalA trademark may be refused registration on the grounds that:§ it is not distinctive, that it is deceptive or scandalous, contrary to law or morality or in any waydisentitled to protection;§ that it contains some prohibited words and/symbols such as the names of chemical substances,Coat of Arms, the words “patent”, “patented”, “registered”, “registered design”, “copyright”, “tocounterfeit this is a forgery”, or words to the like effect and so on.Duration and RenewalThe initial registration is valid for 7 years and may be renewed for a period of fourteen years from thedate of expiration of the original registration or of the last renewal of registration. Application for renewal_____________________________________________________________________________________Doing Business in NigeriaAn Investor’s Guide- 2013Page 29 of 36

www.spnglegal.com_____________________________________________________________________________________ may be filed at anytime not more than three months before the expiration of the registration to theRegistrar of Trademarks.PATENTThe right to a patent is granted for an invention to an individual (the Patentee) for a limited period of amonopoly right in respect of that invention.Governing Legislation/Regulatory AgencyGrant of patents in Nigeria is regulated by the Patents and Designs Act (PDA) Cap P2 of Laws of theFederation of Nigeria 2004. The Trademarks, Patents and Designs Registry under the Commercial LawDepartment of the Federal Ministry of Industry, Trade and Investment (MITI), is also the relevant patentauthority.Conditions for patentabilityTwo conditions are primarily set for patentability. They are;§ that there is an invention or inventive step,§ and such invention is capable of industrial application.However, plants or animal varieties, or essentially biological processes for the production of plants oranimals, inventions the publication of which will be contrary to public order and morality, principles of ascientific nature are not patentable.Procedure for applicationSTEP 1 Formal applica3on is made to the registrar STEP 2 Registrar shall grant patent where sa3sified with the applica3on STEP 3 Grant is registered in the register and published in theFederal GazeXe _____________________________________________________________________________________Doing Business in NigeriaAn Investor’s Guide- 2013Page 30 of 36

www.spnglegal.com_____________________________________________________________________________________ Life Span of Patent• Under the Act, a patent may be granted either for a product or for a process. Whichever the casemay be, subject to regular payment of the annual fees due, patents shall be valid for twenty yearsfrom the date of the filing of the relevant patent application.Rights Conferred by PatentUnder the PDA, the grant of a patent confers on the patentee the right to preclude all other persons fromdoing any of the following acts:a. where the patent has been granted in respect of a product, the act of making, importing, selling orusing the product, or stocking it for the purpose of sale or use; andb. where the patent has been granted in respect of a process, the act of applying the process or doing,in respect of a product obtained directly by means of the process, any of the acts mentioned inparagraph (a) of this subsection.Like trademark, a registered patent is assignable and transmissible either in connection with the goodwillof a business or not.The Patentee, whose patent has been infringed, can make claims for remedies such as damages, injunctionand accounts. The Federal High Court has the exclusive jurisdiction for entertaining action brought underthe Patents and Designs Act._____________________________________________________________________________________Doing Business in NigeriaAn Investor’s Guide- 2013Page 31 of 36

www.spnglegal.com_____________________________________________________________________________________ INVESTMENT PROMOTION AND PROTECTIONOUTLINE1. Investment Promotiona. Regulatory Statute/Agencyb. Investment Incentives and Guarantees2. Investment Protection – Legal Frameworka. NIPC Actb. Bilateral Investment Treaties3. Dispute resolutionREGULATORY STATUTE/AGENCYIn order to encourage investments in Nigeria, the Federal Government has established a body known asthe Nigerian Investment Promotion Commission (the “Commission”) under the Nigerian InvestmentPromotion Commission Act, Cap N117, Laws of the Federation of Nigeria 2004 (“NIPC Act”). TheCommission is empowered to encourage, promote, and coordinate investments in Nigeria and provideservices for the grant of business entry permits, licenses, authorizations and incentives in a One-Stop-Shop environment.The One Stop Investment Centre (OSIC) commenced operations officially on the 20 th March, 2006 andprovides investors a coordinated, streamlined and efficient access to the registries of all relevantgovernment agencies and ministries in one location. This is aimed at simplifying the procedural steps forobtaining business approvals and shortens delivery time of the services required by investors.INVESTMENT INCENTIVES AND GUARANTEESA foreign investor engaged in any legitimate enterprise is guaranteed some incentives including thefollowing:1. Unconditional transferability of funds through an authorised dealer in free convertible currency ofdividends or profits (net of taxes) attributable to the investment;2. Payments in respect of loan servicing where a foreign loan has been obtained;_____________________________________________________________________________________Doing Business in NigeriaAn Investor’s Guide- 2013Page 32 of 36

www.spnglegal.com_____________________________________________________________________________________ 3. And remittance of proceeds (net of all taxes) and other obligations in the event of a sale orliquidation of the enterprise or any interest attributable to the investment; and4. Assistance and guidance by the Commission, or for the purpose of promoting identified strategicor major investments, specific incentive packages for the promotion of the investment as theCommission may specify.INVESTMENT PROTECTION – LEGAL FRAMEWORKNIPC ActThe NIPC Act provides, that no enterprise shall be nationalized or expropriated by any government of thefederation and no person who owns, wholly or in part, the capital of any enterprise shall be compelled bylaw to surrender his interest in the capital to any other person unless such acquisition is in the nationalinterest, or for a public purpose.In the event that any acquisition in the national interest or for a public purpose, this must be carried out:1. Under a law that provides for the payment of fair and adequate compensation to the investor; and2. A right of access to the courts for the determination of the investor’s interest or right and theamount of compensation to which he is entitled.Any such compensation payable shall be paid without undue delay, and authorisation for its repatriationin convertible currency shall where applicable, be issued.Bilateral Investment TreatiesThe risks faced by foreign investors are not necessarily limited to those inherent in the particular businessventure, but often extend largely to those relating to interference from local governments, import andexport restrictions, political unrest and in some instances, even war. The object of BITs is to protectinvestments by providing an efficient framework for resolving disputes on the basis of international law.Although BITs differ because they are concluded on the basis of negotiations with states, the standardrecurring provisions relate to protection of investments by ensuring that there is:1. Fair and Equitable treatment;2. Full protection and security;3. No arbitrary or discriminatory measures impairing the investment;_____________________________________________________________________________________Doing Business in NigeriaAn Investor’s Guide- 2013Page 33 of 36

www.spnglegal.com_____________________________________________________________________________________ 4. National treatment and most favoured nation treatment;5. Free transfer of funds relating to investments;6. No expropriation without compensation; and7. Compliance with specific investment undertakings.Nigeria has bilateral treaties with:1. Germany;2. South Korea;3. Netherlands;4. Turkey;5. United Kingdom;6. Egypt;7. Spain;8. Finland;9. Switzerland; and10. France.DISPUTE RESOLUTIONThe Nigerian Government has committed under the NIPC Act to make all efforts through mutualdiscussion to reach an amicable settlement of any disputes that may arise between investors in anenterprise and any Government of the Federation. The Act provides that where there is a dispute betweenthe Federal Government and an investor, relating to the investment, and the parties cannot agree to themethod of dispute settlement to be adopted, the International Center for Settlement of InvestmentDisputes (ICSID) Rules will apply.In the event that the parties are unable to amicably settle the dispute, the parties may:1. Submit at the option of the aggrieved party to arbitration, in the case of a foreign investor, withinthe framework of any bilateral or multilateral agreement on investment protection to which theFederal Government and the country of which the investor is a national; or_____________________________________________________________________________________Doing Business in NigeriaAn Investor’s Guide- 2013Page 34 of 36

www.spnglegal.com_____________________________________________________________________________________ 2. In accordance with any other national or international dispute resolution mechanism for thesettlement of investment disputes agreed to by the parties.In addition, there is no restriction or hindrance to the right of an investor to approach the Nigerian courtsfor the resolution of any investment disputes. However, the courts in keeping with common lawprinciples will often not interfere with any contract terms reached by parties relating to the operation ofthe investment and the method of dispute resolution._____________________________________________________________________________________Doing Business in NigeriaAn Investor’s Guide- 2013Page 35 of 36

www.spnglegal.com_____________________________________________________________________________________ DISCLAIMERThis document is for information purposes ONLY and should not be construed as legal advice. While due care hasbeen taken in the compilation of this information and every attempt made to present up-to-date and accurateinformation, we cannot guarantee that inaccuracies will not occur. Sterling Partnership will not be held responsiblefor any claim, loss, damage or inconvenience caused as a result of any information within these pages. You must notrely on the information contained in this document as an alternative to legal advice from your attorney or otherprofessional legal services provider. Any information contained in this document is not confidential and does notcreate a lawyer-client, advisory, or fiduciary, relationship. If you have any specific questions about any legal matteryou should consult your attorney or other professional legal services provider. You should never delay seeking legaladvice, disregard legal advice, or commence or discontinue any legal action because of information provided in thiscompilation._____________________________________________________________________________________Doing Business in NigeriaAn Investor’s Guide- 2013Page 36 of 36

INVESTING IN PARAGUAY

INVESTING IN PARAGUAYCONTENTSA. AREAS OF INTEREST1. Introduction2. Economic Sectors for Investment in Paraguay3. Privatization of State Enterprises4. Telecommunications5. Water Supply and Sewage6. Energy7. Natural Resources8. International Waterway “Hidrovía Paraguay-Paraná”9. Free Trade Zones10. Maquila Operations11. Leasing12. Real estate13. Competition Act14. E-commerce15. Public-private alliancesB. FISCAL AND LEGAL INCENTIVES1. Equal Policies for National and Foreign Investments2. Investment Act3. Investment Promotion Act4. Investment Guarantees5. Banking and Insurance6. Stock Markets7. Trust and Fiduciary Relationships8. Migration Act9. Labor Legislation10. Representation, Agency and Distribution Act11. Pharmaceutical and Health Products12. Intellectual Property Protection13. Acknowledgment and Enforcement of Foreign Judgments14. Arbitration15. MERCOSUR Preliminary MeasuresC. MERCOSUR1. General Principles2. Instruments for meeting MERCOSUR’s objectives3. Benefits for Paraguay in joining the MERCOSURD. ESTABLISHING A COMPANY IN PARAGUAY11. Branches or Representatives of Foreign Companies2. Limited Liability CorporationsBerkemeyer Attorneys and Counselors | Asunción - Paraguay

3. Corporations4. Hague ApostilleE. SOURCES2Berkemeyer Attorneys and Counselors | Asunción - Paraguay

INVESTING IN PARAGUAYAAREAS OF INTEREST1. INTRODUCTIONParaguay is located in the heart of South America with no maritime coast. Historically the economy hasbeen characterized by the predominance of agriculture and cattle production. Today it has positioneditself as the eight leading exporter of meat and the fifth ranking nation as an exporter of soybeans. Inaddition, Paraguay also always stood out as the main exporter of energy in South America and was oneof the principal net exporter world-wide clean energy with two international hydroelectric dams.However, over the years a moderately diversified economy has been developed, achieving in 2010, thelargest economic expansion in Latin America. The industrial sector's growth is mainly consequence offoreign direct investment by multinational companies in the production of edible oils. In addition,important advances have occurred in the mining sector with the discovery of deposits of titanium,uranium and gold.As a member of MERCOSUR (Common Market of the Southern Cone), the trading block formed in 1991by Brazil, Argentina, and Uruguay. It is also a member of the World Trade Organization (WTO) since1997.Regarding foreign trade, the country has an open economy with principal trading partners such asBrazil, Argentina, China, the United States and Russia. There are no restrictions, discriminations orlimitations for foreigners in any sector, and investment law sets forth equal policies for local andforeign investors in all sectors. The private investment laws also grant fiscal exemptions, as well asadministrative and legal incentives with special regimes to foreign and local investors.So, Paraguay’s economic system is based on free trade, making a free currency exchange system, freeimport and export, and free transfer of capital have been introduced. There are no restrictions orlimitations for foreigners in any sector, and its investment legislation set forth equal policies for localand foreign investors in all sectors.Regarding economic activity, national legislation limits the Government´s intervention inentrepreneurial activities and grants private initiative a more important role in investment andeconomic growth. The private investment legislation, which grants fiscal exemptions andadministrative and legal facilities to foreign and local investors, has established these grounds.Law also grants private initiative a more important role in investment and economic growth withrecent legislature such as Public-Private Partnership (PPP) and Competition Law. For instance, the goalof the Public-Private Partnership law is to establish standards and mechanisms to promoteBerkemeyer Attorneys and Counselors | Asunción - Paraguay3

partnerships between the public and private sectors for investment in public infrastructure and theprovision of services, as well as in the production of goods. The law establishes a clear framework forpublic-private partnership contracts, and regulates private initiatives and regulates the use of trusts forthe purposes specified in the law. Contracts may include management of infrastructure and services,which include road projects, rail, port, airport, waterway dredging and maintenance of the rivers whichsurround Paraguay, social infrastructure, electrical equipment and urban development.In sum, currently Paraguay has a growing and diversifying economy with abundant natural resourcesand excellent human capital, which is always been accompanied by an open trade principle andpromotion of a legal framework to protect investors. The upcoming years promise to be an excellentyear for Paraguayans and those who are betting on the country.2. ECONOMIC SECTORS FOR INVESTMENT IN PARAGUAYParaguay offers important options for private investment in the telecommunications sector. Thesector was opened to private investors in 1995 and has experienced growth beyond expectations eversince, particularly in mobile phone services. The sector is set to further experience a major change asthe State telecommunications company is passed on to the private sector.Water supply and sewage services in sectors of the countryside have been opened to privateinvestment, having set up the appropriate legal framework and created the regulating agency in late2000.As a country rich in energy generated by two main sources, the bi-national hydroelectric dams builttogether with Brazil and Argentina, Paraguay also constitutes a convenient location for energysensitiveindustries.Industries focused on local market supply and export activities are seen as other options, among whichare cast metals, textiles, vegetable oils, dairy products, leather and hides, beef and timber products,cold storage facilities and transportation.Paraguay’s main products are: cotton, soybean, sugarcane, meat, timber, vegetable oils, corn, rice,tobacco, manioc (cassava), fruits and vegetables, among others.Overall, the main investment attractions in Paraguay could be listed as follows: abundance of natural resources abundant electrical energy, environmentally clean and renewable; mainly young population that is trainable; stable macroeconomic and a fiscal policy with the lowest tax burden in the region; ample advantage and benefits for foreign and domestic investments;4Berkemeyer Attorneys and Counselors | Asunción - Paraguay

quick return on investment with fast growing economy;it is among the world's top exporters of soybean and beef, with high productivity and capacityfor expansion;strategic location in the heart of South America with free access to MERCOSUR;center of the Paraguay-Parana Waterway with free navigation throughout the year for riversea trade;good levels of quality of life and safety.Paraguay's advantages for investors include open business environment and a geographical locationconductive to business. It offers macroeconomic stability by providing a healthy environment forinvestors, including low inflation, financial stability and legal incentives for investment discussedfurther below.One of the key areas to invest in projects involving the improvement of infrastructure. As mentionedbefore, Paraguay has developed a diversified economic growth in the primary and industrial sector.Nevertheless, the country lacks of the proper road, rail, port, airport connectivity; waterway dredgingand maintenance of the rivers; social infrastructure; electrical equipment and urban development.Considering this situation, the government has recently passed the Public-Private Partnership Law inorder to promote projects in this area with favorable conditions to the private sector.Another current key area is the real estate market, a renovated business with world class hotels andapartment buildings as flag ship.3. PRIVATIZATION OF STATE ENTERPRISESEnactment of Act 1615/2000, addressing government reform and privatization of State companies,opened the way for a series of privatizations and extensive structural reforms in Governmentadministration. Earlier privatizations enabled the transition of steel, alcohol and fleet companies to theprivate sector, as well as the State airline.4. TELECOMMUNICATIONSThe sector must rely on foreign investment to level the average impact of other countries of theregion. The expansion of mobile phone services has overtaken the number of fixed lines, while othervalue-added services have also experienced outstanding growth.5Berkemeyer Attorneys and Counselors | Asunción - Paraguay

The National Telecommunication Commission – CONATEL – created by Act 642/1995 is the regulatingagency for telecommunication services. It may be said that the sector is open to competition, exceptfor fixed lines and international carrier services, which remains under State monopoly.CONATEL processes all concession, license and permit applications and it is in charge of developing,implementing and enforcing the regulatory policy, analyzing and proposing tariff regimes, approvingtechnical standards, assessing conformity of equipment, monitoring quality of service, and preventinganti-competitive practices among other duties. Telecommunication services are classified into twobasic services, broadcasting and value-added services. Basic services may be rendered under aconcession granted by the State, which must be approved by Congress. Broadcasting and value-addedservices may be rendered under a license or permit. Concessions are granted for a period of 20 yearsand may be renewed in accordance with the terms and conditions of the contract. Broadcastinglicenses are granted for a period of 10 years, and may be renewed for an additional period. All otherservices may be licensed for a period of five years and are renewable upon Licensee’s request.5. WATER SUPPLY AND SEWAGEAct 1614/2000 established the framework for water supply and sewage services and created theregulatory agency – the Regulating Entity for Sanitary Services – ERSSAN. ERSSAN is in charge ofdeveloping regulatory standards for suppliers and users, preventing anti-competitive practices,supervising investment and tariffs and, in general, enforcing applicable legislation. Concessions may begranted for up to 30 years, whereas permits for a maximum of 2000 individual connections may begranted for a 10-year-term.The sector must rely on foreign investment for expansion in order to level the average impact of othercountries in the region.6. ELECTRICITYParaguay has abundant hydroelectric energy provided by the Acaray (national), Itaipú (binational) andYacyretá (binational) power stations, with countrywide supply networks.Reforms are being proposed to unbundle the sector and allow private investment in hydroelectricityand thermal power.67. NATURAL RESOURCESBerkemeyer Attorneys and Counselors | Asunción - Paraguay

Paraguay has substantial natural resources mainly for forestry, agriculture and cattle raising, as well aspotential reserves of natural gas and non-ferric minerals.Abundant fresh water sources and rainfall provide a wide range of investment opportunities related tothe industrialization of timber, agricultural products and food production.Reforestation is encouraged through tax incentives.The economic, political and legal framework for investment in the hydrocarbon sector in Paraguaymoment is outstanding. The government decided to give a strong boost to oil and gas exploration,which, added to the growth of the Gross Domestic Product (GDP) and the results of geological studies,predict excellent prospects for the activities of this nascent industry, with potential incalculable.As for the chances of finding oil, the expectations based upon the work of the private companieswithin areas that belong to the same basins from which oil is extracted since several years ago on theArgentine side, are encouraging.Paraguay shares five sedimentary basins with neighboring countries, in four of which there isproduction of hydrocarbons. Experts say that the prospects for finding hydrocarbons in Paraguay arehigh. However, it is recognized that at the country level exploration is still in its infancy because of 25exploratory blocks in only two activities are carried out, so that there is a great task to develop yet.The studies and oil exploration works made recently showed that serious work began in this area inParaguay, so exploratory projects will come into its decisive phase in 2014 with the drilling of wells.There is no technical reason why this country lacks such resources, but obviously, perforations must bemade to make contact with the potential reservoir.General Hydrocarbon Act 779 of 1995, provides significant tax advantages to investors, and expresslystipulates as follows: "With the exception of fees, prospecting and exploration are exempt from anytax, state and municipal taxes, including permit applications and exploration concessions, and therespective contracts".Only during the exploitation period, paraguayan Act provides the following tax system, low impactcompared to other countries:a) An initial fee of USD 0.30 per hectare;b) An annual operating fee per hectare:i. From 1st to 5th year : USD 0.20ii. From 6th to 10th year : USD 0.60iii. From 11th to 15th year : USD 1.60iv. From 16th to 20th year : USD 2.00For royalties, the grantee shall pay to the Paraguayan Government on the gross production of crude oil:a) From one hundred (100) barrels until 5000 (five thousand) barrels, 10% (ten percent);7Berkemeyer Attorneys and Counselors | Asunción - Paraguay

) Since 5001 (five thousand one) barrels per day, up to 50000 (fifty thousand) barrels 12%(twelve percent) and,c) Since 50001 (fifty thousand one) barrels onwards 14% (fourteen percent).8. INTERNATIONAL WATERWAY “HIDROVÍA PARAGUAY-PARANÁ”MERCOSUR member countries (Argentina, Brazil, Paraguay and Uruguay) and Bolivia have designed anambitious multi-lateral project known as the “Hidrovía Paraguay-Paraná” (hereinafter called the“waterway”), an international waterway seeking rivers Paraguay and Paraná to be permanentlynavigable along 3.500 km from Puerto Cáceres (Brazil) to Puerto Nueva Palmira (Uruguay). Paraguay’sgeographical location, the Waterway, other projects such as the Paraná-Tieté Hidrovia (Paraná-TietéWaterway) in Brazil, the Bioceanic Corridor connecting the Atlantic and Pacific Oceans, will significantlyfacilitate communication between countries of the region and shall turn Paraguay into an importantalternative as center of production, supply and rendering of services within the framework of the RiverIntegration Plan between MERCOSUR member countries and Bolivia9. FREE TRADE ZONESAct 523/1995 that rules free trade zones has the purpose of encouraging investments, employment,exports and international trade. Export transactions in a free trade zone are exempt from all national,departmental and municipal taxes. Significant fiscal incentives are guaranteed to Licensees and Usersto facilitate establishment and operation in free trade zones.Concessions are executed through a joint agreement signed by the Paraguayan Government to buildand operate a specific area as a free-trade zone. Concessions shall be granted for a term of thirty (30)years, unless the licensee applies for a shorter period of time, counted as from the date of the grantingof the agreement. The term may be extended for an equal term in accordance with the Acts ruling freetrade zones at the time of the extension, provided that the licensee has duly met its legal andcontractual obligations.10. MAQUILA OPERATIONSAct 1064/1997 created the framework to facilitate the establishment of assembly plants or maquilafactories that could profit from the country’s lower industrial and labor costs compared to othercountries of the region. The Act provided further incentive to export-oriented investment, and further8Berkemeyer Attorneys and Counselors | Asunción - Paraguay

strengthened a legal framework, which has long given foreign investors unrestricted access in allsectors of the Paraguayan economy.The legal scope embraces both the assembly of products and the performance of services. TheNational Council administers the program for the Maquila Export Industry and the Program Unit, aone-stop-shop that handles the reception and processing of all applications and approvals.Materials and equipment for processing are imported under the drawback system that suspends taxand tariffs payment until the final product is re-exported. The Customs Authority demands a guaranteein order to clear goods imported under the drawback system. It is possible to obtain a bond from aninsurance company in order to fulfill this requirement. Processed materials must be re-exported withina maximum term of six months. Machinery and equipment may remain in the country during saidterm, at the end of which they must be re-exported without incurring in tax payment. MERCOSURregulations of origin are applicable to trade with Brazil, Argentina and Uruguay, whereas WTOregulations of origin apply to trade with all other countries.The Act practically eliminates income tax and, instead, establishes a 1% tax to be levied on the valueadded within the country. The tax is effectively assessed on the value invoiced by the exportingcompany.Paraguay offers good opportunities for maquila operations given its low labor cost, abundant energysupply, and a central geographical location with easy access by road or river to the largest SouthAmerican markets.11. LEASINGLeasing or Financial Lease Act 1295/1998 introduced a commercial and financial alternative into theParaguayan market. The Act focuses on two main objectives: to offer legal security to both the lessorand the lessee and provide tax incentives making the operation attractive for all parties.Leasing companies that wish to operate in Paraguay must constitute a stock corporation and includethe following legal denomination after its trade name: “Sociedad Anónima de ArrendamientoFinanciera” or “Sociedad Anónima de Leasing Financiero.” Registered stocks must represent capitaland the corporate purpose must be limited to the performance of financial and commercial leasingoperations subject to legal terms.12. REAL ESTATE9In the period between 2013, 2014 and 2015, the Capital city will see the emergence of more than600,000 m2 in luxury buildings.Berkemeyer Attorneys and Counselors | Asunción - Paraguay

Right now, the boom of economic sustainability has attracted 18 companies, members of theParaguayan Chamber of Real Estate Developers (CAPADEI, in Spanish), which are running severalmajor projects whose investments now exceed USD 500 millions.Corporate and commercial buildings and residential units are the main attractions.These figures only relate to the square meters by 18 firms that are part of the Paraguayan Chamber ofReal Estate Developers (CAPADEI).The enterprises have the security of a solid law, property matters guarantor of private property,constitutional support; well as administrative procedures tend to progressive simplification of proceduresrelated to building permits.The main references, including the World Trade Center (WTC) resulted in the generation of 39,500industrial sources.CAPADEI has gone beyond the capital city and it has gestated the idea to form committees in somecountry areas where industrial projects, commercial complexes and apartments are rising rigorously toquantify the investments made in the country.The odds are in favor of keeping this increasing rate as more high estate plans, including the SheratonWTC and Ciudad del Este, more shoppings at the country borders and industrial developments inChaco'i and Acceso Sur.On July 10, the presentation of the first official report of Asuncion property will be held in conjunctionwith the Municipality.CAPADEI also points to the generation of housing products aimed at the middle class and theseproducts will be presented within 3 months.13. COMPETITION ACTAct 4956/2013, defends and promotes free market competition, expressly prohibiting anti-competitiveacts. Competition Act was consolidated and strengthen with the enactment of Decree 1490 of April 14,2014, opening an attractive and substantial national and international business world panorama.The application of the Act refers to all acts, practices or agreements held by individuals orcorporations, domestic or foreign, with legal residence in the country or abroad, whether public orprivate, or any entities develop economic activities, or nonprofit and produce effect on competition, inall or part of the country, except the limitations established by law , duly justified by reasons of generalinterest, excluding the central government entities and decentralized bodies exercising Statemonopoly.The competition presupposes the freedom to buy, sell and efficient market access and nondiscriminatoryconditions, without restrictions other than those arising from the Act; it was precisely,the Merchant Law of 1983, which allowed the holding of competition covenants, as follows: Thecompetition restricting covenant shall be valid if it is restricted to a particular area and activity and notmore than five years, provided it is not intended to harm others . If the restricting covenant had beenstipulated for a longer period, it will only last for five years.The prices of goods and services will be determined and offered freely.Berkemeyer Attorneys and Counselors | Asunción - Paraguay10

Simple market conquest resulting from the natural process of the greater efficiency of the subjectsincluded in the scope of this Act in relation to its competitors, does not constitute a restriction ofcompetition. It was the Merchant Law who established the figure of sole supplier, as follows: If any besole provider of a service or is obligated to supply to all stakeholders on equal terms and price product.To verify the existence of agreements, decisions or concerted practices or consciously parallel,whether written or oral, formal or informal aimed to produce, prevent, restrict or distort competitionin all or part of the national market , the burden of proof is on the CONACOM , but once proven theexistence of an infringement, the burden of proof on the existence of profits in economic efficiencythat outweigh their negative effects on the market will fall on the natural or legal person who alleged.14. E-COMMERCESince a company reported last year, two million transactions worth USD 1.3 billion dollars, the CentralBank of Paraguay (BCP) emphasized a project aims to regulate the cash withdrawals and purchasetransactions that are managed through mobile phones and establish guidelines for the electronicmedia payments entities (EMPES), in this case the telephone companies, that perform these serviceswith increasing acceptance by the public.Mobile companies performing non-bank wire transfers and payments using mobile phones as tools,shall be subject to the control and supervision of the Superintendency of Banks (SIB), which willbecome the regulatory body of the entities identified as EMPES.The BCP endowed the electronic money with the necessary security, by issuing Resolution N° 6,approved by the Board of BCP as Act 18 of March 13, 2014. Electronic money transactions are:conversion and reconversion; payments and non-bank wire transfers.As a way to facilitate the inclusion of more people into the banking system through remotemanagement and minimum requirements, the limit of 40 minimum wages for transactions is not a reallimitation to people to make non-bank wire transfers bigger, but from that number the customer mustrequest a savings account through a financial institution from its own cell, without going to a bank tocomplete the formalities.The legislation seeks, among other things, increase the levels of financial inclusion and brakingoperations to finance LD/ FT/ FP (money laundering, terrorist financing and financing of proliferationof weapons of mass destruction).15. PUBLIC-PRIVATE ALLIANCES11Berkemeyer Attorneys and Counselors | Asunción - Paraguay

The PPP Act 5102/2013 seeks to establish standards and mechanisms to promote, through innovativepublic-private participation, investments in public infrastructure as well as in the production of goodsand provision of services that are themselves the subject of agencies, entities, public companies andcompanies in which the Government is party. For the first time, the Government assumes the role of aresponsible modern State, leaving behind sterile and paternalistic customs.To achieve these laudable goals, the figure of contracts of public-private partnerships or PPP contractsis established, which include the figure of the private sector and regulates the use of trusts, present inParaguayan Act since the enactment of the Act 921/1996.The guiding principles of this new way of work ar: monitoring and control of the State, transparencyand accountability, social profitability , economic efficiency , competition and equality, legal security,temporality, fiscal responsibility, environmental sustainability, legality, rationality, efficiency andgeneral interest. These principles are set out in the Act itself and Decree 1350 complements andintegrate them. The principles are mandatory and they design the entire structure of the ActBFISCAL AND LEGAL INCENTIVESParaguay’s government policy is to promote foreign investment in all economic sectors with noGovernment approval required, enabling companies to be fully foreign-owned.In general, all types of business activities are open to foreign investment. However, special preferenceis given to those that will use local raw materials and labor. Act 60/1990 foresees the system foreconomic development through incentives by granting special benefits, enabling repatriation of capitaland profits, and providing guarantees against inconvertibility. An application must be filed to obtainthe special benefits granted by Act 60/1990.Recent years have revealed the implementation of a new legal framework in terms of banking andfinancial issues, insurance, stock market, taxes, labor Act, environment, intellectual property,investments, telecommunications, among others.Investment environment in Paraguay is attractive for its long-standing free-enterprise support, whichrelatively low labor cost, abundant energy and the lowest tax burden in Latin America investors benefitfrom. It should be noted that personal income tax has not yet been introduced in Paraguay.12Berkemeyer Attorneys and Counselors | Asunción - Paraguay

1. EQUAL POLICIES FOR NATIONAL AND FOREIGN INVESTMENTSThere are no restricted areas, no discrimination and no limitations. The only difference betweenforeign investments and those made by Paraguayan nationals lies on taxation on net earnings, asforeign investments are subject to a five percent additional tax on remittances or credits in favor ofbeneficiaries, who are not residents of this country. Said profits or dividends are taxed 5% (the generalrate of tax is 20%, adding a 10% if incorporated as foreign branches). If these funds are reinvested inthe improvement of installations, renewal of the capital assets or destined to cover the costs ofplanting, forestation and reforestation in rural areas, then this additional tax is not levied. The profitsand dividends are exempt from taxation for a period of five (5) years if the investment is benefited byAct 60/90, paragraph (h), of article N° 5.2. INVESTMENT ACTThe Investment Act promulgated in late 1991 as Act 117/1991 guarantees a framework of equalconditions for local and foreign investment aiming to promote Paraguay’s social and economicdevelopment. This Act allows investors to obtain investment insurance locally or overseas. It also setsthe requirements for the establishment of joint ventures.3. INVESTMENT PROMOTION ACTInvestment Promotion Act 60/1990, promulgated on March 26, 1990, establishes a special tax systemoffering incentives for foreign investment projects. Companies falling under this legislation enjoy totalexemption from all kinds of taxes on certain aspects of the investment project, such as taxes on theincorporation or recordal of companies, capital increase, exchange operations and the import ofcapital goods. Additional benefits are applicable on investments of at least US$5 million.The procedure for obtaining benefits include the submission of a feasibility study to the InvestmentCouncil, based on information required by legal provisions; the Investment Council’s approval of theproject; and a joint resolution by the Ministry of Finance and Ministry of Industry and Commercegranting the respective fiscal benefits.The recent fiscal reform introduced a reduction of the income tax rate in contrast with our previoustax Act from 30% to 20% in 2006, dropping to 10% the following year.134. INVESTMENT GUARANTEESBerkemeyer Attorneys and Counselors | Asunción - Paraguay

The Paraguayan Ministry of Foreign Affairs has signed Investment Guarantee agreements with thegovernments of: Argentina, Austria, BENELUX, Brazil, Chile, China (ROC), Ecuador, France, Germany,Great Britain, Hungary, Korea, Peru, Romania, South Africa, Spain, Switzerland, United States ofAmerica, Uruguay and Venezuela. These agreements seek to promote commerce, investments andindustrial cooperation.The Paraguayan Government has also signed an agreement with the World Bank’s MultilateralInvestment Guarantee Agency (MIGA), ratified by Act N° 124 dated February 6, 1992. Moreover,investment guarantee agreements have been signed with the Overseas Private InvestmentCorporation (OPIC), ratified by Act N° 155 dated May 3, 1993.In addition, within the framework of the MERCOSUR, a protocol has been signed for mutual promotionand protection of investments in the member countries and conflict resolution therein.5. BANKING AND INSURANCEAct 861/1996 establishes the requirements and procedures for the opening of banks, financialundertakings, general stores and warehouses, security, brokerage firms and other credit entities,without restriction, except for compliance with operational and supervisory regulations.Act 827/1996 regulates the Insurance market. This Act foresees the requirements for authorization tooperate, as well as the minimum capital. The Insurance Superintendent, a technical body of the CentralBank of Paraguay, acts as enforcement authority.6. STOCK MARKETSThe Stock Market Act 1284/1998 was approved replacing an earlier Act for the sector. The NationalSecurities Commission has produced a series of regulations covering requirements for the issuance ofsecurities, opening of securities exchange and brokerage agents, qualification of issuing corporations,etc.The Stock Market Act established fiscal incentives for companies listed on the Asuncion StockExchange. The recent fiscal reform introduced an exemption from corporate income tax for interestsand profits earned on securities placed through the local exchange and on government and municipalbonds.The Act is aimed at strengthening the local stock market to provide a source of capital for privateinvestments.14Berkemeyer Attorneys and Counselors | Asunción - Paraguay

7. TRUST AND FIDUCIARY RELATIONSHIPSTrust and Fiduciary Relationships are regulated pursuant to Act 921/1996. This Act defines trust andfiduciary relationships and establishes procedures to be upheld to form and execute a trust.The Central Bank of Paraguay is charged with oversight responsibility for all fiduciary or trustinstruments. Only banks and financial institutions may act as trustees. Trust assets may be transferredto the institution acting as trustee or not. Transferred assets form part of a special autonomous fundnot included in the institutions’ assets and therefore not subject to bankruptcy proceedings. The Actalso establishes basic rules that are applicable to the auditing and bookkeeping requirements for trustand moneys.8. MIGRATION ACTAct 978/1996 regulates immigration of foreigners and nationals with the purpose of promotingimmigration and incoming of labor force required by the country.This Act establishes categories of immigrants, on the basis of particular characteristics and theobjectives of foreigners entering the country. Foreigners can become permanent residents under oneof the following categories: spontaneous immigrants, assisted immigrants, immigrants with capital,investors, retirees and those who have independent incomes.The Act creates an interesting concept: “organized immigration”, seeking to facilitate the entry andpermanence in Paraguay of communities that devote themselves to activities that are of interest tothe Nation. It is to be regulated by the Executive Branch, with the intervention of the GeneralMigration Office.In addition, the procedure established to obtain residence is innovative, since it permits a foreignerabroad to initiate immigration procedures through a third party who may submit the requireddocuments to the General Migration Office.9. LABOR LEGISLATIONParaguayan labor legislation is based on the Labor Code, adopted by Act 213/1993. Parties subject tothe provisions contained in the Code are employees with intellectual, manual or technical skills in adependency relation, and their employers; teachers of private academic institutions and thoseperforming sport or professional activities; labor unions and employers of the private sector; and,employees of State and Municipal offering goods and services. All other State employees, or those15Berkemeyer Attorneys and Counselors | Asunción - Paraguay

employed by Decentralized entities or by the Municipality or Departments shall be ruled by a specialAct. Therefore, if an employee enjoys notorious independence in view of his/her position as companyrepresentative, pay level, nature of work and technical ability, such administrators, he/she is notsubject to the Labor Code, in which case the general regulations of the Civil Code would apply.Furthermore, Article 3 of the Code sets forth that the rights recognized by such code may not bewaived, limited, renounced, or transacted upon in any way. The Code is inspired by the principlescontained in the Universal Declaration of Human Rights and the American Bill of Rights and remaininginternational labor conventions ratified by Paraguay. Paraguay has also ratified numerousInternational Labor Organization Agreements such as the Regulation for Safety, Hygiene, Convenienceand Medicine in the Workplace.The Government sets minimum daily wages and monthly salaries according to the type of work.Current levels set for unskilled labor amount to Gs. 70.155, per day and Gs. 1.824.055, per month,which at the current exchange rate amount to USD 15,59 and USD 405,35 respectively.Except for special cases mentioned in the Labor Code, ordinary working hours shall not exceed 8 hoursper day or 48 hours per week for dayshift; 7 hours per day and 42 hours per week for nightshift.There is no Unemployment Insurance in Paraguay. The Social Security Act and Regulations rule SocialSecurity. The Social Security Institute [Instituto de Previsión Social] is an autonomous entity with legalcapacity created by Decree-Act N° 17071/1943, in charge of directing and administrating socialsecurity. It is funded with contributions from employers and workers, as well by its own sources; 9% isdeducted from employees’ base salary to be paid to IPS, and 14.50% contributed on employee basesalary by employer (employer is also obliged to pay 1% to the National Professional Promotion Serviceand an additional 1% to the Ministry of Health). Social security covers risks of non-professionalsickness, maternity, occupational accidents and illness, handicapped conditions, old age and death ofsalaried workers in the country.The Constitution and the Act guarantee labor organizations. The role of unions and federations is stillvery limited. The great majority of these organizations are new and lack the experience and standingof higher level organizations. However, they do participate in the defense of worker’s interests. Theperception of the organizations’ actual ability to represent the sector is another problem. Lack oftradition of association for the representation and defense of interest is an additional factor in thelimited representation of unions and federations. Employers’ unions can be formed with a minimum ofthree members. Workers’ unions require a minimum of 20 members for company unions, 30 for tradeunions and 300 for industrial unions. The recordal of a Union gives it full legal status.The recordal of an individual labor contract is not compulsory, except in the case of apprentices.10. REPRESENTATION, AGENCY AND DISTRIBUTION ACT16Berkemeyer Attorneys and Counselors | Asunción - Paraguay

Act 194/1993 was adopted together with the amendments thereto pursuant to Decree Number 7,dated March 1991. This Act, as amended, establishes specific provisions for representation, agencyand distribution agreements.The Act foresees representation, agency and distribution agreements between foreign firms ormanufacturers and real or legal persons domiciled in Paraguay. Any other type of distribution, agencyor representation agreement remains subject to the general provisions of the Civil Code.The Act establishes that any party of one of the above mentioned types of contracts may cancel,revoke, modify or refuse to grant the renewal of such agreement without the need to prove causethereto; however, said party will be obliged to pay and indemnify the other party within three monthsof cancellation, revocation or non-renewal. The amount of indemnity is to be set according to twomain factors: the length of the contractual relationship and the average of all annual gross profitobtained under the representation, agency or distribution agreement. The Court or the ArbitralTribunal will use these factors to establish the minimum amount that will be required as an indemnity.In the event the contract is terminated, canceled, revoked, modified or not renewed, therepresentative, agent or distributor holds the option of selling back to the other party the stock orinventory merchandise, under the terms and conditions of the agreement, at a price at which normalprofit would be performed in conformity with current prices established in the market place.The Act also states that any type of foreign firm or manufacturer that is a party to a representation,agency or distribution agreement may cancel, revoke, modify or deny renewal of such agreement ifjustified reasons set forth by the Act are caused. In the event justified cause for cancellation exists, theforeign firm shall not pay any type of indemnity.Justified reasons must be proved before the competent Judge or Arbitror, if so agreed. Otherwise, itshall be shall be assumed that the termination, revocation, amendment or denial of extension isunjustified.According to the Act, the above-mentioned provisions may not be waived. Moreover, the Act requiresthat the parties submit themselves to the jurisdiction of Paraguayan Courts. Finally, as from the date ofenactment of this Act, the documents and agreements referred must be recorded at the PublicRegistry of Commerce.11. PHARMACEUTICAL AND HEALTH PRODUCTSAct 1119/1998 introduces important innovations as well as an integral system regulating healthproducts. The Act not only offers a more adequate consumer protection but also provides national andforeign companies with more legal assurance as to what the norms related to authorization, registry,inspection, laboratory analysis, liability, quality control, and applicable sanctions, among others, are.17Berkemeyer Attorneys and Counselors | Asunción - Paraguay

This Act seeks to regulate the manufacturing, elaboration, partition, quality control, distribution,prescription, dispensation, trading, representation, import, export, storage, rational usage, priceregime, information, publicity and evaluation, authorization and registry of medical products forhuman use, drugs and chemical products, reagents and all other products used and applied in humanmedicine, as well as products considered as cosmetics and cleansing products.The Ministry of Health is the national authority in charge of verifying the compliance of the normscontained in the Act hereof, issuing regulations in accordance with the Act, and the application ofsanctions. The National Department of Sanitary Surveillance (Dirección Nacional de VigilanciaSanitaria), dependent on the Ministry of Health, is the executive organ.The manufacturing, import, trading and sales of pharmaceutical specialties shall be subject toauthorization from the national sanitary authority (Dirección de Vigilancia Sanitaria- DVS).Pharmaceutical specialties authorized for expenditure within the national territory shall be, uponmanufacturer and representative’s request, registered in a specific registry at the Ministry of Health.The latter shall also apply to any amendment, transfer or cancellation of the authorizations granted tothe pharmaceutical specialties.In order to guarantee the quality of the raw materials, semi-elaborated products, products in processand final products, the DVS shall set the type of control required. Such controls shall be extendedduring commercialization and production. Any modification in regards to technological or scientificdevelopments shall be informed to the DVS.The Ministry of Health shall regulate, according to the Act hereof and its corresponding decree, theevaluation procedure, concession and denial of authorization as well as the registration in thepharmaceutical registry.The authorization or registration certificate of pharmaceutical specialties shall extend to five years andmay be renewed according to the Act. To such effect, the proprietor shall file the correspondingapplication and, if required, a previous update of the technical documentation.The Act also states that the authorizations granted may be temporarily suspended by the nationalsanitary authority for reasons similar to the ones stated above with regard to the grounds for denial ofauthorization, including the case when an international health organisms such as the World HealthOrganization or the Pan-American Health Organization recommends the suspension. Likewise, thenational sanitary authority, may, for public health reasons, modify or restrict the conditions of theauthorization due to the composition, indications or adverse reactions. The national sanitary authoritymay limit the validity of the authorization and restrict the commercialization and use for hospitalsonly.A special provision has been included for cases in which the medicine is well known and itseffectiveness, safety in usage and adverse reactions have been sufficiently tried nationally orinternationally. Consequently, the national sanitary authority may require an extract of the documentsavailable, exempting applicable requirements from compliance, adopting a simplified process ofauthorization.18Berkemeyer Attorneys and Counselors | Asunción - Paraguay

12. INTELLECTUAL PROPERTY PROTECTIONA. TRADEMARK ACTThe new Trademark Act was promulgated on August 6, 1998 under Act 1294/98. This Act definestrademarks in broader terms, including the concept of trade dress. Likewise, the Act namely states thatthe list contained does not constitute a limitation to what may be considered as trademarks.Regarding procedures and formalities, applicants may invoke a priority right based on the applicationfiled in a foreign country, which must be party to the treaties or conventions ratified by Paraguay.The introduction of new concepts gives titleholders a better chance to prevent misappropriation;provisions grant specific protection to notorious marks; the concept of risk of confusion is broadenedto embrace risk of association; protection against the risk of dilution is also introduced.Registrations are valid for a term of ten years and may be renewed for indefinite periods of ten years.A grace period of six months following expiration date is now allowed for renewal applications, subjectto a penalty fee.An innovation of utmost importance is the introduction of cancellation for non-use. Any third partymay file a cancellation action against a trademark registration if it has not been used within the fiveyearterm following its concession, or if its use has been interrupted for a term of over five consecutiveyears or if the mark has been used departing from its original appearance as recorded under theregistration certificate. Failure to use may be justified by force majeure. The Regulatory Decreeconcerning the new Act states that the use in any country shall constitute valid use to preventcancellation based on non-use.Additional innovations aiming to further protect titleholders were introduced, such as higher prisonterms and non-exoneration of imprisonment; preliminary measures such as seizure, suspension ofimport or export and the suspension pendente lite of the effects of a registration obtained throughfraudulent means. Finally border measures were also introduced. Consequently, Customs Authoritiesmay suspend the import of presumably infringing goods upon request of a legitimate owner.B. COPYRIGHTS AND RELATED RIGHTS.Act 1328/98 follows relevant international conventions offering stronger protection to all kinds ofcreative works regardless their class, means of expression, merits or purpose, author’s nationality,author’s domicile or that of the titleholder or site where work was published. The enjoyment orexercise of the rights acknowledged by the Act hereof is not subject to the registration requirements19Berkemeyer Attorneys and Counselors | Asunción - Paraguay

or compliance with any other type of formality. The author of a work, by the sole fact of havingcreated it, enjoys the legal entitlement derived from the right that may be held against everyone, andincludes the patrimonial and moral rights set forth by the Act.According to Act 1328/1998, the National Copyrights Department, dependant on the Ministry ofIndustry and Commerce, shall manage the national registry of protected works stated herein.Registry’s effect is merely declaratory and not constitutive and, consequently, its omission does notprejudice the enjoyment or exercise of the rights acknowledged by this Act.Criminal offenses and misdemeanors included in the Act are, by virtue of Act 1444/1999, publiccriminal action offenses, and may consequently be promoted or initiated ex officio without prejudiceto the victim’s prosecution of the action, as opposed to the original provision stating that all offensesshould be addressed by means of private action.Finally, in accordance with the TRIPS (adopted by Act 444/1994), this Act foresees that the Judge, uponrequest of the National Copyrights Department or any person legally entitled, his representative ormanaging entity, may order the immediate execution of preliminary measures required to prevent thecommission of a breach, its continuance or repetition of one already committed. Therefore, thetitleholder of a right protected by this Act, aware of and with well- founded motives related to thepreparation of import or export of products that infringe said right, may request the CustomsAuthorities the suspension of the import or export operation in accordance with the applicableprovisions regarding guarantees of preliminary measures.C. PATENT ACTPatent Act 1630/2000 is currently in compliance with international conventions on the subject.Patents are valid for a term of twenty (20) years counted from the filing date of the application inParaguay.In relation to Industrial models and designs only protect the ornamental features, not the technicalfeatures. Novelty is mandatory. If it is already protected abroad, the term to apply in Paraguay is sixmonths from the date of registration in the country of origin. Up to ten variations of the same modelor design can be claimed under one single application. Industrial models and designs are protected forfive years from the date of application. Registrations are renewable for two consecutive five yearsterms.Patent RequirementsPower of Attorney granted by applicant, witnessed or sworn before a Notary Public. Consularlegalization is not required provided that Power of Attorney is granted only for the purpose ofapplying for a patent of invention. A provisional faxed authorization or power is acceptable;the original documents may be submitted within sixty working days from the filing date.20Berkemeyer Attorneys and Counselors | Asunción - Paraguay

Full name and address of the applicant.Full name, nationality and address of inventor.Assignment document (No assignment document is needed if a link between the applicant andthe inventor exists).Date, number and country of the patent’s first application. If priority is to be claimed,application must be filed in Paraguay within one year from the date of the original filingabroad.Priority in accordance with the Paris Convention can be claimed.Four (4) Spanish copies of the Abstract, Specifications and Claims. If this material is in a foreignlanguage, translation into Spanish can be performed by our firm.Four (4) copies of the designs or technical drawings, if any.REMARKSMedical and pharmaceutical inventions are patentable in Paraguay. The patents forpharmaceutical products may be granted as of January 1, 2005.Annuity payments are mandatory in order to maintain the patent in force in Paraguay.It is also mandatory to file priority documents.The revalidations or patent confirmations are no longer allowed in our country.13. ACKNOWLEDGMENT AND ENFORCEMENT OF FOREIGN JUDGMENTSImportant treaties, signed and ratified by Paraguay, regulate the recognition of foreign judgments.A) THE MONTEVIDEO TREATY OF 1889 AND 1940.Argentina, Bolivia, Brazil, Colombia, Uruguay and Paraguay are Signatory States of this Treaty.Judgments and arbitral awards issued in regards to civil and commercial matters by one of thesignatory States shall have the same force in the rest of the territories as in the country of origin,provided that the following requirements are met:a) the judgment must be rendered by a competent Court in the international sphere.b) the judgment must be final or have the character of res judicata in the State where it has beenrendered.21Berkemeyer Attorneys and Counselors | Asunción - Paraguay

c) the party against whom the judgment has been rendered should have been duly notified, andlegally represented or declared in default according to the Acts of the country where theaction was pursued.d) the judgment must not be contrary to the provisions of public order in the country whereexecution is sought.The Judge before whom the petition for foreign judgment execution is filed, may, without any furtherstep, and upon party’s request, as well as ex officio, order any preliminary measure necessary toensure the enforcement of the judgment, according to the local legislation related to seizure andattachment, restraining orders and other preliminary measures. (Art. 8)B) INTER-AMERICAN CONVENTION ON EXTRATERRITORIAL ENFORCEMENT OF FOREIGNJUDGMENTS AND ARBITRAL AWARDSParaguay is a signatory of the 1979 Montevideo, Uruguay Convention. Act 889/81 ratified theConvention and it applies to any judicial judgment and arbitral award rendered in civil, commercial, orlabor procedures in a signatory State, provided that at the moment of the ratification, any one of themexpressly reserves the right to limit the application to the condemnatory judgments on patrimonialmatters. Likewise, any of them may declare at the time of ratifying the Convention that it shall alsoapply to final judgments rendered by authorities with jurisdictional duties as well as to criminaljudgments when referring to the compensation of damages caused by an offense.Judgments, arbitral awards and foreign judicial judgments referred to above shall have extraterritorialeffectiveness in the signatory States if the following conditions are met:a) judgments must comply with all required external formalities and be considered authentic inthe State from where they proceed.b) judgments, awards and jurisdictional resolutions and annexed documents, required pursuantto the present convention, must be duly translated into the official language of the Statewhere they are to become effective.c) they must be duly legalized according to the Act of the State where they are to becomeeffective.d) the competent Judge or Court must have jurisdiction in the international sphere to judge andhear the case in accordance with the Act of the State where it should have effect;e) the defendant must be duly served or summoned according to the Act, which should besubstantially equivalent to the Act of the State where the judgment, award and jurisdictionalresolution should have effect;f) the defense of the parties involved must have been secured;22Berkemeyer Attorneys and Counselors | Asunción - Paraguay

g) the judgment must be final or have the characteristic of res judicata in the State where it hasbeen rendered;h) it must not be manifestly contrary the principles and Acts of public order of the Staterequesting its acknowledgment or the execution;The procedures, including the jurisdiction of the respective judicial organs shall be regulated by the Actof the State in which execution is being requested to ensure the effectiveness of the judgments,arbitral awards and the foreign jurisdictional resolution.14. ARBITRATIONA) ARBITRATION IN PARAGUAY IS RULED BY ACT 1879/2002, ACT DRAFTED BASED ONTHE UNCITRAL MODEL OF THE ARBITRATION ACTB) THE INTER-AMERICAN CONVENTION ON INTERNATIONAL COMMERCIAL ARBITRATION– PANAMA, 1975.Paraguay is a signatory of the Panama Convention. The Convention was ratified by Act611/1976.C) THE UNITED NATIONS ON THE RECOGNITION AND ENFORCEMENT OF FOREIGNARBITRAL AWARDS – NEW YORK, 1958.Paraguay adopted the 1958 New York Convention. The Convention was ratified by Act948/1996.15. PRELIMINARY MEASURESThe Protocol of Preliminary Measures, ratified by Paraguay by means of the Act 619/1995, becameeffective on April 13, 1996 for MERCOSUR member countries.Article 3 of the Protocol namely states that: “Preparatory preliminary measures, incidental to aprincipal action and the ones that seek to guarantee the execution of a judgment, shall be admitted”.23Berkemeyer Attorneys and Counselors | Asunción - Paraguay

Article 11 states that: “The Judge or Court before whom the execution of a foreign judgment isrequested may order preliminary measures to ensure the execution, pursuant to their legislation”.Preliminary measures shall be complied with, unless lack of main requirements, documents orinformation, making its granting inadmissible. In this case, the Judge or Court shall summon applicantin order to immediately amend such defect.Consequently and according to the provisions above-mentioned, it is perfectly possible to orderpreliminary measures over any company’s assets in order to ensure the execution of a foreignjudgment, provided that they do not contravene public order provisions and comply with the abovementionedprovisions.CMERCOSURIn international relations, Paraguay has achieved important agreements for cooperation andcommerce, including the Mercosur Treaty, signed in Asuncion in 1991 by the Presidents of Argentina,Brazil, Uruguay and Paraguay. The MERCOSUR opens a large market of nearly 200 million consumersand its objective is the total elimination of customs tariffs by establishing gradual reductions every sixmonths after the signing of the Treaty.The improvement in the possibility of productive specialization for a market of 200 million ofinhabitants, with further possibilities of supplying external markets with Paraguayan products isamong the effects caused by the creation of the MERCOSUR.This also implies new requirements for the national production, including quality, entrepreneurialcapability and productivity, use of the adequate technology, and renewal of products destined tolarger markets. In addition, integration will help satisfy the needs of the nation’s population regardingemployment, together with a better use of natural resources.Paraguay has an attractive geography with a wide range of natural resources of interest to investors.With the MERCOSUR and the process of internationalization of its economy, Paraguay opens its doorsto capital investment.Expectations for the country’s future are highly positive and Paraguay is expected to become animportant business center in South America.1. GENERAL PRINCIPLES24Gradual implementation: to establish a reduced number of projects in each stage, integrated in allaspects, including the harmonization of policies.Berkemeyer Attorneys and Counselors | Asunción - Paraguay

Flexibility: to bring about adjustments in scope, pace and objectives.Equilibrium: to stimulate inter-sector integration and the progressive exchange balance betweenlarge sectors and segments through the expansion of trade.Reciprocity: to promote reciprocal rights and obligations among the signatory States.2. INSTRUMENTS FOR MEETING MERCOSUR’S OBJECTIVESA Free Trade Program to be implemented among member States, which consists of gradual andautomatic tariff reduction, the elimination of non-tariff restrictions or measures with similar effects, aswell as restrictions to commerce among member countries.≠ A Common Tariff of 0% as from January 1 1995, except for a list of items for which the tariffrate is above 0%.≠ A Common External Tariff applied to third countries, with rates of 0-20%. Each membercountry has its List of Exceptions. The List of Exceptions includes capital goods; computer science andtelecommunication items; automotive products; tractors and their parts; other exceptions. The tariffrates for products on the List of Exceptions are to converge towards the Common External Tariff by theyear 2006.≠ Coordination of macroeconomic policies and regional agreements among the memberCountries.≠ An Origin Regime, establishing the minimum requirements for products, in order to beconsidered as coming from the member Country, which will enable them to enjoy exemption-relatedbenefits.≠ A System for Conflict Resolution. Any controversy arising among the MERCOSUR countriesshall be resolved through mechanisms included in the provisions of the Protocol of Olivos; those thatarise with a third country are to follow the terms of the World Trade Organization.3. BENEFITS FOR PARAGUAY IN JOINING THE MERCOSURAs an economic block, the Common Southern Market – MERCOSUR - offers its member countries abetter chance defending the block’s common interests in negotiations with the European Union, theWorld Trade Organization, and within the future Free Trade Area of the Americas.Paraguay enjoys advantages regarding production, among which are three factors that contribute toprofitable export: natural resources, location and human resources. The combination of these25Berkemeyer Attorneys and Counselors | Asunción - Paraguay

conditions provides both factories and assembly plants a competitive edge towards production forregional and world markets. Some of those advantages are:≠ The protection of investments and interests of economic units (both private and public) setforth by the Asunción Treaty, the Ouro Preto Protocol (an addendum to the former) and the BrasiliaProtocol on Conflict Resolution.≠ The creation of a greater export capacity to other countries, as well as the possibility of gainingeasier access to the world market, based on a more competitive local production.≠ Increase of direct investments due to a larger market, simplification and harmonization ofnorms and procedures.≠ Participating with neighboring countries in regional production by furnishing certain links ofthe productive chain of an enlarged market.DESTABLISHING A COMPANY IN PARAGUAY1. BRANCHES OR REPRESENTATIVES OF FOREIGN COMPANIESCompanies established in a foreign country that wish to undertake commercial transactions inParaguay may establish a branch or any other type of representative. The branches are subject, as areParaguayan companies, to the Civil Code’s provisions regarding the recordal of documents, bylaws andpowers of attorney at the Public Registry of Commerce and at the Registry of Juridical Persons andAssociations.A) REQUIREMENTSFor such purposes, the following documents must be prepared by the parent company, certified by anotary public, and legalized before the nearest Paraguayan Consulate.(1) The parent company’s bylaws or documents of incorporation.(2) A certificate from a public officer or from the chamber of commerce proving that theparent company is legally registered in the country of origin.(3) A Minute from parent company’s Board of Directors resolving to:Berkemeyer Attorneys and Counselors | Asunción - Paraguay26

B) RECORDALa. establish a branch office in the Republic of Paraguay.b. allot a nominal capital to the branch office (a minimum of USD 10.000 to operate asexporter).c. establish the address of the branch office in Asuncion or in another city.d. appoint the person or persons that will administer the branch office.e. grant powers of attorney to the person or persons that will administer thecorporation.(4) The powers of attorney for the administration of the corporation, granted by the parentcompany in favor of the person or persons that will administer the said corporation.The documents are verified by the Internal Revenue Office and by the Ministry of External Affairs andthen registered at the protocol of a notary for recordal at the Public Registry of Commerce and in theRegistry of Juridical Persons and Associations.C) REGISTRATIONAt the same time, the branch office must register the corporation at the corresponding administrativeand tax offices so that it can operate and undertake commercial transactions. Governmentauthorization is not required. The procedure requires approximately 30 days.The branch must comply with the tax Acts just as the local companies must. Inspectors of the Ministryof Finance control the accounting records, annual balance and other documentation. The agents(proxy holders) of the parent company that administer the branch as well as the administrators of localcompanies share the same responsibilities before third parties.2. LIMITED LIABILITY CORPORATIONS (SOCIEDAD DE RESPONSABILIDAD LIMITADA –S.R.L.)Companies in the form of an LLC (Limited Liability Corporation / S.R.L.) can be established by two ormore natural or juridical persons but no more than 25. Investment is made in fixed payments andliability for corporate debts is limited to the amount of each partner’s contribution stated in thecharter.A Limited Liability Corporation may not engage in activities typically conducted by banks, financialorganizations, insurance companies or savings and loan organizations.27Berkemeyer Attorneys and Counselors | Asunción - Paraguay

A) DENOMINATIONThese corporations can adopt any denomination, including the name of one or more partners,followed by the words “Sociedad de Responsabilidad Limitada” or “S.R.L”.B) FORMATION AND CAPITAL STOCKThe legal contract is undertaken in the form of a legal document (deed), which must comply withformalities set forth by the Civil Code. The S.R.L. may operate once the contract has been recorded atthe Public Registry of Commerce. This recordal is not binding, but its omission will hold all partnersjointly and fully liable for any act regarding third parties.Nominative, bearer or endorsable shares cannot represent the capital stock. The capital is divided intonominative shares of a value of Gs. (Guaranies) 1,000 each, or multiples of said amount to be indicatedin the contract.The capital stock must be fully subscribed and at least 50% must be integrated in cash. There is nominimum capital required but this must be sufficient to comply with the proposed objectives of theS.R.L. 50% of capital paid in cash must be deposited at a local bank or the Central Bank. This isrecoverable once the S.R.L. is constituted.Companies dedicated to export or import activities must meet certain requirements assessed by theCentral Bank of Paraguay.The capital stock may also be incorporated by type kind or by fixed assets that shall be transferred tothe corporation in the initial document, or once the contract has been recorded at the Public Registryof Commerce. The partners continue to be liable before third parties for the value of the assets andcapital according to the type incorporated into the company’s capital.C) TRANSFER OF SHARESIf the S.R.L. has more than five partners, then a transfer of shares to third parties will have to beapproved by the partners representing three fourths of the capital. If the number of partners is lessthan five, the approval must be unanimous. The transfer of quotas between partners does not havelimitations.The partner willing to transfer shares must notify other partners of his/her intention, and theremaining partners shall have a 15-day period to reply.Approval is deemed as granted if not expressed otherwise. The partner that did not obtain the consentrequired for the transfer of his/her shares will be unable to resort to court proceedings. If opposition isconsidered unjustified, the other partners will be able to acquire the shares under the same conditionsoffered by the mediator or to the same. The S.R.L. can also acquire shares with the net liquid profits, orBerkemeyer Attorneys and Counselors | Asunción - Paraguay28

y reducing the capital. The transfer of shares must be made through a legal document and will nothave effect until it is recorded at the Public Registry of Commerce.D) ADMINISTRATIONThe administration and representation of limited corporations can be delegated to one or moremanagers, who may or may not be partners, with the same rights and obligations as corporatedirectors. There are no limitations to their mandate.Managers are unable to act on their own in business operations included in the objectives of the S.R.L.,nor may they assume the representation of a third party of a commercial enterprise with similarcommercial practice without express authorization of the partners. Managers are wholly responsiblebefore the S.R.L. for bad administration or for breach of contract.E) DECISIONS RESOLVED BY PARTNERSAll partners have a right to take part in the decisions of any undertaking. If the S.R.L. contract does notdetermine the way in which the partners shall resolve matters, then the norms ruling the corporationshall be applied. Any decision that changes the objectives of the S.R.L., transforms, merges it withother undertakings or reviews the contract, such as to raise the responsibility of the partners, shallrequire partners’ unanimous consent. The majority of capital holders shall approve decisions. Eachshare represents one vote.F) RESERVE FUNDFive percent (5%) of the net profits shall be destined to each exercise to form a reserve fund untilreaching twenty percent (20%) of the S.R.L.’S capital.G) BOOKS AND RECORDSAn S.R.L. must keep the same books and records as a corporation, except for the shareholder’sregister. The same stamping and registration formalities apply.H) DISSOLUTION29Berkemeyer Attorneys and Counselors | Asunción - Paraguay

An S.R.L. is not dissolved by a partner’s death, interdiction or bankruptcy, nor by theremoval/resignation of the manager or managers or a managing partner appointed in the contract,unless otherwise stated in the contract. Bankruptcy of an S.R.L. does not imply bankruptcy of thepartners.3. CORPORATIONS (SOCIEDAD ANÓNIMA – S.A.)The Civil Code contains provisions ruling the formation of corporations in which the participation ofthe partner is represented by stock shares, and the corporation’s liability before third parties is only tothe extent of capital contribution or assets.The Corporation’s name must contain the description that it is a corporation holding stock by includingthe words “Sociedad Anónima” or the initials “S.A.” in Spanish.Most large enterprises and foreign investors prefer this type of organization. Shares of stocksubstantiate ownership of the corporation; capital ownership is described as shareholders orstockholders and their liability is limited to the amount of their stock.A) FORMATIONThe procedures to form a corporation are as follows:1. A founding shareholders’ meeting is held to approve the corporate by-Acts, appoint directorsand syndics and subscribe the entire corporate capital.2. The bylaws must be notarized by public deed complying with formalities set forth in the CivilCode.3. The Civil and Commercial Court must approve the bylaws.4. The bylaws must be recorded at the Registry of Legal Entities and Associations and at the PublicRegistry of Commerce.5. The bylaws must be published for three days in the Official Gazette and in another newspaper ofbroad circulation.Companies become corporate entities and begin to operate once their inclusion in the Registry ofLegal Entities and Associations has become into effect. Founder shareholders are jointly and severallyresponsible, without limitation, for all acts and business entered into before the legal constitution ofthe corporation and before its recordal at the Public Registry of Commerce.The bylaws must contain the corporation’s name, which must include the words “Sociedad Anónima”(or the abbreviation “S.A.”) and indication of the activity; commercial, industrial, farming, financial,30Berkemeyer Attorneys and Counselors | Asunción - Paraguay

etc, business objectives, duration, corporate capital and regulations ruling its internal management(e.g. election, duties and responsibilities of directors, meetings). A shareholder’s extraordinarymeeting must approve subsequent amendments to the bylaws with the same formalities required forthe initial formation.Any unregistered stipulation that detracts from that established by the Civil Code shall not be validwith regard to third parties, whether said stipulations restrict the rights of said third parties or thepowers granted to the administrators.B) CAPITAL STRUCTUREThe Civil Code does not establish a minimum capital amount required to set up a corporation. It onlyrequires that capital be fully subscribed by the shareholders in order to form the corporation.Stock shares may not be issued for less than their stated or nominal value. Capital may be issued asbearer or registered nominative shares and as common or preferred stock, with different voting rights.Shares may be deposited in banks for safekeeping. The banks shall issue a holder certificate for votingpurposes at shareholder’s meeting.Capital may be increased or decreased upon authorization at the shareholder’s meeting. Authorizationfrom the Central Bank of Paraguay is required for banks, finance companies and insurance companies.Shares may be freely transferred, unless a preferential right can be duly proved.If allowed by corporate bylaws, corporations may obtain funding from private or public sourcesthrough the issuance of negotiable debt securities or debentures.C) ADMINISTRATIONOne or more directors, appointed in the annual General Assembly shall undertake the administrationof the corporation. The number and duration of the mandate will be determined by the bylaws.The directors may or may not be shareholders. They can be re-elected and their appointment isrevocable. The appointment of directors shall be made for one fiscal exercise, unless otherwise statedby the provisions in the bylaws.D) RESPONSIBILITY OF THE BOARDDirectors are not responsible for the obligations of the corporation, except in the event of incorrectexecution of duties, or breach of Law or bylaw or any other damage incurred by deceit, abuse ofpowers or serious fault. In such cases, the director’s responsibility before the corporation,shareholders and third parities shall be unlimited. The director that did not participate in the meeting31Berkemeyer Attorneys and Counselors | Asunción - Paraguay

or resolution, or who has left a record in writing of his/her dissension shall be exempted fromresponsibility.The directors shall undertake commercial operations with the corporation only in specialcircumstances. They shall not perform, in representation of the company, any operation that iscontrary to company’s objectives.E) CONTROLOne or more internal auditors (syndics) may also be nominated by the annual Assembly to oversee theadministration of the corporation. Internal auditors should be competent regarding the controlentrusted to them by virtue of the bylaws.The bylaws shall establish the time period for which the Internal Auditors shall be appointed, namely amaximum of five years. The trustees should be domiciled in Paraguay and they may be re-elected.The Internal auditor shall oversee the administration and management of the corporation and shallparticipate without vote in the annual Assemblies and meetings of the Board. He/she shall alsooversee accounting records and documents when deemed convenient. Moreover the Internal Auditormust ensure the corporation’s compliance with all the legal obligations and resolutions of theAssembly.F) SHAREHOLDERS’ ASSEMBLYGeneral Assemblies may be Ordinary or Extraordinary and they shall be held at the company’sregistered office.Ordinary Assembly shall be called, each year, by the directors or by the internal auditors, to considerand resolve the following:a) Annual report of the directors, balance, profit and loss account, payment of dividends, reportof the trustee(s) and all other pertinent measures, according to the competency granted byAct and the bylaws, or those submitted to the Board and Trustees’ decision.b) The appointment of Directors and Internal Auditors and the establishment of their fees.c) Responsibility of the board and internal auditors and their replacement.d) Stock issues.Extraordinary Assemblies shall be called by the directors at any time, or by the internal auditor(s)when deemed necessary or convenient, or upon request of shareholders representing five percent(5%) of the capital stock (unless otherwise stipulated by the bylaws) to consider the following:a) Amendment of by-Acts.b) Capital increase or reduction.32Berkemeyer Attorneys and Counselors | Asunción - Paraguay

c) Redemption, reimbursement or stock amortization.d) Merger, transformation or dissolution of the company and all matters related to theliquidation and the liquidators.e) Debenture or stock exchange issuancef) Share-bonds issuanceG) CALL TO MEETINGThe call to meeting of the Assembly must include the complete agenda of the items to be consideredand any requirement contained in the bylaws regarding shareholders’ participation. The call tomeeting must be published for five days, at least ten days prior to the date of the Assembly. Thesecond call, if the first meeting was not held, shall be made within the following thirty days.Resolutions adopted over matters not included in the agenda shall be null and void.H) ATTENDANCETo attend the Assemblies, shareholders shall deposit their stock certificates or bank depositcertificates with the Secretary of the corporation for their registration, not less than three businessdays prior to the meeting. Representatives (proxy) that are not directors, internal auditors, managersor personnel of the corporation may represent shareholders at the Assemblies.I) STOCKNominative (or bearer) stocks shall represent the corporation’s capital. The stock certificates should benumbered and signed by one or more directors.The certificates shall bear the name of the corporation, date and site of their constitution, amount ofthe capital subscribed, number, face value and stock type. Stock certificates may be issued when fullypaid. Until then, shareholders may receive nominative provisional certificates and they may berequired to pay the balance due. The bylaws may create different stock types with different rights;stocks may be nominative or issued to the bearer.The alienation of nominative capital may be adjusted to particular conditions.Corporations shall be able to acquire their own stock when the purchase is authorized in anExtraordinary Meeting. Said purchase shall be made with the net profits, provided that the purchasedstock is wholly integrated.33J) PATRIMONIAL STATEMENTBerkemeyer Attorneys and Counselors | Asunción - Paraguay

Directors shall prepare an annual inventory, itemized profit and loss account, balance sheet, annualreport and any other required documents to prove the patrimonial state of the corporation. Theaccounts and annual report should be submitted to the Annual Assembly for consideration thereof.Five percent (5%) of the net profit shall be annually destined for reserves until they represent twentypercent (20%) of the subscribed capital. Only dividends originating from the corporation’s net profitsmay be paid. Directors shall be jointly liable for the breach of this norm.Act 772/1979 and the Civil Code authorize corporations to issue debentures pursuant to the provisionsestablished by Law.4. THE HAGUE CONVENTION ON APOSTILLESThe Hague Convention is approved through Act 4987/2013 and symbolizes an important breakthroughin overcoming the inconveniences, disadvantages and bureaucracy involved in the process of legalizingof foreign documents.The enactment of legislation N° 4987/2013 by the Paraguayan President on July 10, 2013, symbolizesan important breakthrough in overcoming the inconveniences, disadvantages and bureaucracyinvolved in the process of legalizing of foreign documents. The approved legislation makes The HagueConvention of 5 October 1961 an internal Paraguayan law, abolishing the Requirement of Legalizationfor Foreign Public Documents, commonly known as the Apostille Convention.Even though Paraguay through this legislation approves and adopts the Apostille Convention it is notimmediately applicable. In order to become, applicable Paraguay must deposit the instrument ofaccession at the Ministry of Foreign Affairs of the Kingdom of the Netherlands. Secondly, the abovementioned Ministry of Foreign Affairs must notify the Contracting States of this enactment anddesignate a the Competent Authority for Paraguay.Finally, from the official notification the Contracting States dispose of a 6 month objection period toobject to the accession of a Country seeking to join the Convention. If an objection is raised, theConvention does not enter into force between the newly acceding State and the objecting State.Finally, the Convention will enter into force between Paraguay as an acceding State and eachContracting State that has not objected its accession on the 60th day after the 6 month objectionperiod has ended or expired.ESOURCES OF INFORMATION34REDIEX- Red de Inversiones y Exportaciones del ParaguayBerkemeyer Attorneys and Counselors | Asunción - Paraguay

PROPARAGUAY – Office for the Promotion of Exports and InvestmentsCENTRAL BANK OF PARAGUAYMINISTRY OF COMMERCE AND INDUSTRYMINISTRY OF FINANCEMINISTRY OF FOREIGN AFFAIRS35Berkemeyer Attorneys and Counselors | Asunción - Paraguay

FOR MORE INFORMATION:Contact: Mr. Hugo T. BerkemeyerBerkemeyerATTORNEYS AND COUNSELORSThe Firm provides a broad range of legal services with particular expertise in internationaltransactional work, such as mergers and acquisitions, joint ventures, and foreign investments and ahistorical strength in the area of intellectual property Act and protections. An increasingly importantpart of our practice today also centers on the Agreement to create a Common Market among theMercosur Countries of South America and the economic liberalization policies that are propelling theregion into the mainstream of the world economy.Corporate & Commercial Act: Formation of Corporations (Start-Ups); Joint Ventures; ForeignInvestment; Real Estate (Lease & Rental Agreements); General Contracts; Litigation; Privatization.General Counsel: Administrative Act; International Act; Immigration & Nationality; Health Act; LaborAct; Tax Act; Energy Act; Communication Act; Taxation and Customs Act; Integration Act; Mining andNatural Resources.Intellectual Property Act & Competition Act: Patents, Trademarks & Copyright Act; Licensing andFranchising; Technology and Know-how; Anti-counterfeiting; Litigation.36Berkemeyer Attorneys and Counselors | Asunción - Paraguay

Doing Business in PolandJanuary 2013

Doing Business in PolandPREFACEThis guide to Doing Business in Poland has been prepared by TGC Corporate Lawyers andis designed to provide important information to those contemplating investing or doingbusiness in Poland.Whilst every effort has been made to ensure accuracy, information contained in this guidemay not be comprehensive and recipients should not act upon it without seeking professionaladvice.Except where otherwise stated, the fiscal rates included in this publication are those in forceat 1 January 2013.2

Doing Business in PolandCONTENTS_______________________________________________________________________1. Introduction1.1 Geography1.2 People1.3 Government1.4 Economy2. Business Entities and Accounting2.1 Companies2.2 Partnerships2.3 Representative Offices2.4 Branches2.5 Audit and Accounting Requirements2.6 Filing Requirements3. Finance and Investment3.1 Types of Investment3.2 Polish Agency for Foreign Investments3.3 Incentives for Investment3.4 Exchange Control3.5 Sources of Finance4. Employment Regulations4.1 Industrial Relations4.2 Contract of Employment4.3 Health, Safety and Welfare at Work4.4 Minimum Notice4.5 Redundancy Payments Scheme4.6 Protection of Employment Act4.7 Transfer of Undertakings4.8 Dismissal4.9 National Minimum Wage5. Taxation5.1 General Structure5.2 Corporate Income Tax5.3 Personal Income Tax5.4 Social Security5.5 Indirect Taxes5.6 Inheritance and Donation Tax5.7 Local Taxes5.8 Double Taxation Avoidance Treaties5.9 Tax PlanningAppendicesAppendix 1Appendix 2Appendix 3Double Taxation AgreementsPersonal Income Tax RatesSocial Security Rates3

Doing Business in Poland1. INTRODUCTION1.1 GeographyLocationPoland is located in Central and Eastern Europe. Poland’s eastern borders are with Lithuania,Belarus and Ukraine, and its southern borders are with the Czech and Slovak Republics. Itswestern border is with Germany, and its northern borders are with Russia and the Baltic Sea.AreaPoland is the largest of the Central and Eastern European countries with an area of 312,685square kilometres.CoastlinePoland has 440 kilometres of coastline on the Baltic Sea.ClimateThe climate in Poland is temperate with moderate winters and warm summers with occasionalshowers.TerrainMostly flat plain; mountains along southern border.Time zonePoland uses Central European Time, which is 1 hour ahead of UK (GMT + 1) and 6 hoursahead of New York (EST + 6).1.2 PeoplePopulationThe total population of Poland is around 38.32 million and it is the 6 th largest country in theEU. Poland has the largest working population in Central Europe. With 50% of the Polishsociety under the age of 35 it is also one of the youngest populations on the continent.The majority of Poles live in towns and cities; 42% of Poles live in the 42 largestagglomerations of more than 100,000 inhabitants.Ethnic GroupsThe ethnic groups in Poland are: Polish 97.6%; other 2.4%.ReligionThe dominant religion is Roman Catholicism (90%) although there is freedom of religion.LanguageThe official language is Polish. Many people also speak a second language, includingEnglish, German, French, and Russian.4

Doing Business in Poland1.3 GovernmentGovernment TypePoland is a parliamentary republic. The supreme law of Poland is the Constitution passed on2 April 1997, ratified by a national referendum. The government system of the Republic ofPoland is based on the separation of and balance between the legislative, executive, andjudicial powers.The executive function is fulfilled by the Prime Minister elected by the Sejm, and President,who is elected every 5 years. There is a bi-cameral legislature comprising of the Sejm (LowerHouse of Parliament with 460 seats elected for 4 years) and the Senate (Upper House with100 seats elected for 4 years).The judicial authority is vested in independent common, administrative, and military courts, aswell as the Constitutional Tribunal. The Supreme Court is the highest body supervising thejudiciary, which ensures that the judicature of lower courts is uniform and in accordance withlaw. The consideration of appeals comes under its power. The Supreme Court arbitrates legaldisputes, hears election protests, and certifies the validity of parliamentary and presidentialelections. Moreover, it certifies the validity of constitutional and nationwide referenda.CapitalThe capital of Poland is Warsaw with a population of approximately 2.1 million inhabitants.The largest port is Gdańsk and other important cities include: Kraków, Poznań, Katowice,Wrocław and Łódź.Administrative DivisionPoland is divided into a national and local administrations. There are 16 provinces[województwa], 379 districts [powiaty], and 2,479 communes or counties [gminy].Political SituationIn the autumn of 2011, the vote was won by Civic Platform (PO) which formed a majoritycoalition with the agrarian Polish Peasants' Party (PSL). From 18 November 2011 theGovernment is formed by the PO-led Cabinet of PM Donald Tusk. The opposition currentlyrepresented in Parliament includes the conservative PiS (Law and Justice), the centre-leftUnion of Social-Democracy (SLD) and centre-left Ruch Palikota (RP).1.4 EconomyGDP real growthrateInflation rate(consumer prices)1.4 % (III Quarters 2012)2.8 % (November 2012 )Unemployment rate 13.30% (December 2012)Main exportcountries:Germany, France, Italy, Great Britain, Czech Republic,Russia, Netherlands, Sweden, Belgium, Ukraine5

Doing Business in PolandLabour ForceOne of the major factors drawing foreign investment to Poland in recent years is theavailability of highly skilled employees, with quality of work matching developed countries'standard, but at a much lower cost.UnemploymentThe current unemployment rate is about 13.30%.CurrencyThe official currency is the złoty (PLN). As at 4 January 2012, the median exchange rate ofthe złoty was PLN 3.15 to the US dollar, PLN 4.07 to the euro and PLN 5.00 to the poundsterling.Public holidays New Year’s Day 1 January Epiphany 6 January Easter varies Labour Day 1 May Constitution Day 3 May Corpus Christi varies Assumption 15 August All Saints’ Day 1 November Independence Day 11 November Christmas 25 and 26 December6

Doing Business in Poland2. BUSINESS ENTITIES AND ACCOUNTING2.1 CompaniesThe Polish legal system allows for the establishment of a wide range of commercial legalentities which include the following:Limited liability company – foreign capital participation allowed up to 100% except forcertain types of activity.The Polish limited liability company [spółka z ograniczoną odpowiedzialnością or sp. zo.o.] is the most popular type of commercial legal entity as it has limited liability, flexibility,and simplicity. The limited liability company is mainly regulated by the CommercialCompanies Code and is easy to establish. The company is managed by a managementboard [zarząd], which can have one member or more. A supervisory board [radanadzorcza] and audit committee [komisja rewizyjna] are generally optional, although theestablishment of such bodies may be required under certain circumstances.The minimum initial capital is PLN 5,000 and the lowest permitted value of a share is PLN50. A foreign investor may contribute to the initial capital in cash or in-kind. The shares ina limited liability company are only theoretical, as no actual paper representing the sharesin the company is issued.Corporations and individuals may establish a limited liability company. The main documentgoverning the internal administration and limitations of the company is the deed ofassociation, which sets out basic information relating to the company including the name,place of incorporation, activities, amount of equity capital, shareholders, etc. Registrationof a limited liability company is achieved by entry into the National Court Register.Stock company – foreign capital participation allowed up to 100% except for certain typesof activity.A stock company [spółka akcyjna or S.A.] is in many ways similar to a limited liabilitycompany, with the following main differences:The minimum initial capital is PLN 100,000, divided into equal shares of a nominalvalue of at least PLN 0.01;A supervisory board in addition to a management board must be appointed;Bearer shares must be issued.Companies listed on the Warsaw Stock Exchange must be public limited companies.2.2 Partnerships and Sole TradersAn individual from EU/EFTA member states (and certain other countries enjoying reciprocalarrangements with Poland) can undertake all business activities using the same legal entitiesavailable to Polish nationals including:Limited partnership with stock certificates [spółka komandytowo-akcyjna] -- this is normallyused for conducting business under its own business name. In practice, this type ofpartnership is suitable for large-scale business (e.g. large family enterprises with a capitalinvestor)7

Doing Business in PolandLimited partnership [spółka komandytowa] -- This is a partnership in which at least onepartner has unlimited liability and the remaining partners may have limited liability;Professional partnership [spółka partnerska] -- As the name suggests, this entity is mainlyused for professional partnerships. One partner must have unlimited liability;Registered partnership [spółka jawna] -- normally used for larger scale businesses tradingunder their own business name;Sole traders -- requires entry into the business register [rejestr przedsiębiorców].Normally used for business undertaken by an individual (EU nationals only).For all other persons, only the following forms are available:Stock companyLimited liability companyLimited partnershipLimited partnership with stock certificates2.3 Representative OfficesA foreign entity may establish a representative office in Poland. A representative officeoperates on behalf of the business of the foreign entity in Poland and is a part of theorganisational and functional structure of its business.The representative office has the sole function of advertising and promoting the business ofthe foreign entity and a representative office may not trade. A representative office must beentered into the Register of Representative Offices of Foreign Entrepreneurs kept by theMinister of Economy.The representative office must notify the Minister of Economy about liquidation or anyprohibition on conducting its activities.2.4 BranchesForeign businesses may establish a branch office in Poland for the purpose of carrying outbusiness activity. The business activity of a branch office must be the same as the entity’sactivities.A branch office must:use the name of the foreign entity in the language of the country where its registered officeis located, together with the Polish translation of its legal form and the phrase „oddział wPolsce”;maintain accounting records in compliance with Polish accounting law;comply with tax and other laws applicable to Polish entities;notify the Minister of Economy of liquidation or any prohibition on conducting its activities.The relevant provisions of the Commercial Companies Code on liquidation of a limited liabilitycompany also apply to liquidation of a branch office.8

Doing Business in Poland2.5 Audit and Accounting RequirementsPolish accounting law sets out regulations and principles regarding accounting and financialreporting. Accounting records must be maintained in the Polish language and in Polish zlotys.Entities must comply with the format for financial statements specified under the accountinglaw. An annual report by the board of directors of the company is also required. Theaccounting records must be held at the company’s registered office or at the office of anauthorised independent accounting service.Compliance with accounting regulations must be maintained at all times and even thoughthese are broadly similar to international standards, local expert assistance is required.An audit is required for certain limited liability companies and all stock companies, banks andinsurance companies.2.6 Filing RequirementsAll companies and partnerships registered in the National Court Register must file financialstatements and an annual report with the Business Register of the National Court Register.The audit opinion, where applicable, is also filed with the Register.9

Doing Business in Poland3. FINANCE AND INVESTMENT3.1 Types of InvestmentThe types of investment in Poland are far ranging and include acquisition of state-ownedcompanies being privatised, setting up a limited liability company or stock company, purchaseof shares on the Warsaw Stock Exchange, and providing venture capital to the growingentrepreneurial sector. As well as direct investment, there is considerable indirect investmentthrough the import of capital goods, spare parts, and other assets.3.2 Polish Agency for Information and Foreign InvestmentThe Polish Agency for Information and Foreign Investment (PAIiIZ:www.paiz.pl) is the maingovernment organisation assisting investors in Poland. Its mission is to increase the flow offoreign investment into Poland and it provides foreign investors with comprehensiveinformation on the investment environment and guidance throughout the initial stages of theinvestment process.3.3 Incentives for InvestmentPoland has several natural incentives for investors which include a large domestic population,access to adjacent markets, rich in natural resources, a skilled and comparatively cheaplabour force, and a relatively open market.Investors fulfilling relevant criteria may apply for investment, training or employment grants.Typical criteria include large investments, 5-year employment guarantees, or technologicalinnovations. There are also a number of Special Economic Zones (SEZs), established toencourage investment in areas of high unemployment. These zones potentially offer totalexemption from corporate income tax for 10 years for up to 50% - 65% of the amountinvested. There are 14 SEZs covering an area of 6,324 hectares.3.4 Exchange ControlAs of 24 of January 2009 it has been allowed to make payments in foreign currencies,according to the Polish Civil Code and the Foreign Exchange Act.3.5 Sources of FinanceForeign currency borrowings may be used and the National Bank of Poland encourages theintroduction of such funds into the country.Overdrafts are available for short-term and seasonal fluctuations in the company’s workingcapital requirements.There are generous opportunities available to companies for EU funds. We provide assistancewith regard to obtaining such funds, including EU Structural Funds, Cohesion Funds,International Financing Institutions programme, aid programmes, commercial sources offinance, and tax incentives.10

Doing Business in Poland4. EMPLOYMENT REGULATIONS4.1 Industrial RelationsThe system of industrial relations in Poland is regulated by the Labour Code, which providesminimum guarantees for employees, such as holidays, working hours, minimum notice,dismissals, and employment equality. Any employment contract provision which iscontradictory to the Labour Code is superseded by the appropriate provision of the LabourCode.Employers employing at least 20 employees must have Work and Pay Regulations setting outthe principle obligations of employer and employee.The state does not intervene in collective bargaining. Currently collective bargainingagreements are in force mainly in the former state-owned enterprises.4.2 Contract of EmploymentUnder the Labour Code all employees should be given a written agreement setting out thedetails of their contract such as type of work, place of work and remuneration. The LabourCode provides that parties can conclude the following types of employment contracts:indefinitedefiniteperformance of a specific taskEach employment contract may be preceded by a probationary term contract.4.3 Health, Safety and Welfare at WorkMinimum standards regarding health, safety and welfare at work are required by the LabourCode and related regulations. Health and safety at work is enforced by inspections.4.4 Minimum NoticeMinimum notice periods exist for the termination of employment contracts. Notice periods aredetermined by the length of service for the employer. For example, for an indefinite termcontract the notice period is between 2 weeks and 3 months.4.5 Redundancy PaymentsStatutory redundancy payments apply to employers with at least 20 employees. The amountof a statutory redundancy payment depends on the length of service for the employer and isusually 1 to 3 months’ salary.4.6 Protection of EmploymentEmployers are required to notify the appropriate labour office of a mass redundancy situation30 days prior to issuance of any notices to staff. Additionally, the employer in co-operationwith a representative of employees (or trade union) should prepare specific regulationsregarding the proposed redundancies.4.7 Transfer of UndertakingsThe Labour Code provides that employee rights are automatically transferred to the new11

Doing Business in Polandemployer in the event of transfer of ownership of a business. Either the new or the oldemployer should notify the employees of the transfer of the undertaking in advance.4.8 DismissalThe Labour Code provides protection for employees from being unfairly dismissed from theirjobs. A dismissed employee can file a claim to the court for either reinstatement orcompensation.4.9 National Minimum WageThe national minimum wage from 1 January 2013 is PLN 1.600 gross per month.12

Doing Business in Poland5. TAXATIONThe Polish tax system is comprehensive and tightly regulated. Effective tax levels arerelatively high and careful fiscal structuring is recommended.5.1 General StructureEach tax is regulated by separate legislation which is supplemented by ministerial decrees.The tax system is comprised of the following main taxes:corporate income tax (CIT)personal income tax (PIT)value added tax (VAT)excise dutycustom dutiescivil transactions tax (previously stamp duty)inheritance and gift taxlocal taxes, including real estate taxAlthough Poland is not a common law country, the decisions of tax courts and tax authoritiesare an important part of the tax system and in numerous situations have substantial impact onthe application of tax law.5.2 Corporate Income TaxAll Polish companies are taxable on their worldwide income. Partnerships are tax transparent.Non-resident companies are taxable only on Polish sources of income, subject to double taxtreaties and EU law. The current rate of CIT is 19%.Taxable income is calculated on a cumulative monthly or quarterly basis. The amount of taxpayable for a particular month or quarter is the difference between cumulative tax due and thecumulative payments of tax made in preceding months or quarters. An annual return is filedwithin 3 months of the year end.Although corporate income tax rate is fixed by reference to a calendar year, taxpayers maychoose an alternative financial year.Tax deductible costsAll costs borne for the purposes of receiving income or for securing or maintaining asource of income are tax deductible, subject to an exhaustive list of exclusions set out inthe CIT law.Tax lossesTax losses may be carried forward for up to 5 years and deducted from taxable income inany of these years. A maximum 50% of the tax loss from any given year can be deductedduring a single tax year. No carry backwards is available.DepreciationTax depreciation rates are prescribed by law by reference to the type of asset. Low valueadditions and improvements are tax-deductible when incurred. Increased depreciationrates are available in a number of cases.13

Doing Business in PolandTax GroupsTwo or more trading companies can form a tax capital group. The companies can belimited liability companies (sp. z o.o.) or stock companies (S.A.), or a combination of bothtypes. Companies wishing to form such a group must fulfil a number of conditions.A group is created for a minimum period of three tax years. From set-up, the companiescomprising the group cease to be separate taxpayers for CIT purposes, and the groupbecomes a taxpayer as an entity. Each company remains liable for VAT, personal incometax, and social security payments due. The companies constituting the group are obligedto achieve each tax year a profitability of at least 3% of the total revenues of all theconstituent companies. If this profitability is not achieved, the constituent companies willlose their group status. Tax groups are restricted to Polish companies.Transfer PricingPolish transfer pricing regulations are based on OECD standards and the tax legislationpermits transfer pricing adjustments between connected parties both in internal and crossbordertransactions. The Polish tax authorities are showing an increased interest in usingtransfer pricing investigations against multinational entities operating in Poland.OECD transfer pricing documents, in particular the Commentary to the Model Convention,are considered non-binding interpretation guidelines, although tax authorities tend tofollow them.Advanced pricing agreements are also available.5.3 Personal Income TaxGeneralPolish tax residents are subject to tax on worldwide income.Individuals who are not tax resident in Poland are subject to tax only on income fromPolish sources of income.Individuals non-resident for tax purposes in Poland are subject to tax in Poland on incomefrom income sources located in Poland, subject to double taxation treaties.Tax is levied on total income with certain sources of income being exempt.Tax deductible costsIn principle, all costs borne for the purposes of receiving income or for securing ormaintaining a source of income are tax deductible, subject to an exhaustive list ofexclusions set out in the PIT law. However, costs are deductible only against the sourceof income to which such costs relate, with some sources of income eligible only for tokentax deductible costs (e.g. employment income).RatesThe current rates of personal income tax are set out in Appendix 2.Reporting and PaymentPersonal income tax advance payments are made on a monthly basis in respect ofmost sources of income, with an annual tax return due together with any balance of tax14

Doing Business in Polandon or before 30 April of the year following the year of assessment.Tax-Free Government SecuritiesInterest payable on certain Government Securities issued by the Ministry of Finance isexempt from taxation for individuals.Taxation of Savings IncomeInterest income on cash deposits, bank accounts, and other savings is taxed at 19%flat rate for individuals.5.4 Social SecurityThe current rates of social security contributions are set out in Appendix 3.5.5 Indirect TaxesVATAs in most other states in the EU, Poland imposes value added tax (VAT) on the addedvalue in the goods and services supply chain. In economic terms VAT is borne by theultimate consumer and businesses are responsible for the administration and collection oftax.If a company is registered for VAT purposes it is entitled to deduct input tax from outputtax. If input tax exceeds output tax it may be set off against future VAT liabilities or claimedfrom the tax authorities. The general rule is that VAT returns are required on a monthlybasis, however, in certain circumstances they may be filed on a quarterly basis.There are at present four rates of VAT: 23%, 8%, 5%, and 0%, with the standard rate being23%. In case of sale of goods or services, VAT is calculated on the sales price. With theimport of goods, VAT is calculated on the customs value plus customs duty and excise tax.Exports are subject to a 0% rate. Intra-community supply of goods is also subject to a 0%rate. Certain goods and services are exempt from VAT.Customs DutiesPoland is a part of the EU customs area. Imports and exports are, in principle, regulatedby the EU Customs Code.In case of trade with non-EU countries customs duty arises on the customs value of manyimported goods. The customs value includes costs such as transport, packaging, andinsurance etc. The calculation of custom duty is complex and dependent on individualcircumstances.Under special measures the temporary use, storage and transport of imported goods inPoland are possible without paying customs duty upon the goods on arrival. For example,it is possible to bring goods into Poland under a temporary customs clearance and then reexportfree of customs duty. This applies to regular commercial transactions as well as topersonal effects of expatriate staff.Stamp DutyThe current rates of stamp duty applying to most transactions governed by civil law are0.1% - 2%. The stamp duty on the share capital upon establishment of a company is0.5%. The stamp duty on loans is 2.0%, while shareholders’ loans are exempt.15

Doing Business in Poland5.6 Inheritance and Gift TaxTax is levied at between 3% and 20%.Inheritances and donations received from the closest family (parents, children, etc) are freefrom taxation.Tax exempt amounts vary by recipient group:I tax group (in–laws) PLN 9,637II tax group (other family members) PLN 7,276III tax group (others) PLN 4,9025.7 Local TaxesLand is subject to local taxation. The maximum rates in 2013 are:land- business related PLN 0.88 per m 2 / year- other PLN 0.45 per m 2 / yearbuildings- business related PLN 22.82 per m 2 / year- residential purposes PLN 0.73 per m 2 / year- other PLN 7.66 per m 2 / yearStructures, e.g., roads, bridges, parking, are subject to tax at 2% of their initial book value or,when fully depreciated, of their book value from 1 January of the year when the last write-offwas made.Local authorities may reduce these rates and introduce exemptions, both applying locally.Other local taxes include tax on transport, dog tax, market-trader duty and various otherlocal charges.5.8 Double Taxation Avoidance TreatiesPoland has a well-developed tax treaty network, with treaties concluded with 87jurisdictions. The Double Taxation Avoidance Treaties provide for the tax treatment of bothindividual and corporate operations across Polish borders. Efficient tax structuring musttake into account the provisions of the relevant Double Tax Avoidance Treaty.It should also be borne in mind that under current tax legislation the transfer of a Polishasset by a non-resident investor to another non-resident investor would appear to besubject to Polish taxation, even though there is no mechanism in place to assess andcollect the tax due. Therefore, particular attention must be paid to the capital gainsprovisions of a relevant treaty.16

Doing Business in PolandInterest, royalty and dividend payments are subject to withholding tax in Poland. The basicrate of withholding tax is 20% for interest and royalties and 19% on dividends paid by aPolish entity. These rates are usually lowered by a double tax treaty if the recipient holds acertificate of tax residency. Most of the double tax treaties provide for 5%, 10% and 15%rates, although in some cases an exemption is also available.Poland has implemented the Parent–Subsidiary Directive and the Interest and RoyaltiesDirective. The former provides for participation exemption for dividends paid betweenrelated EU companies. The latter provides for exemption for interest and royaltiesbetween related EU companies. Poland also negotiated an interim period for fullimplementation of the Interest and Royalties Directive: interest and royalties paid betweeneligible companies will become exempt from withholding tax in Poland from 1 July 2013;until then a 5% rate applies.5.9 Tax PlanningThere are opportunities for advantageous tax planning. Also, significant tax efficiencies forforeign individuals may arise from careful remuneration structuring.Poland is a complex environment in fiscal terms. We provide a wide range of specialistservices to ensure timely and accurate compliance.17

Doing Business in PolandAPPENDIX 1Double Taxation AgreementsPoland has signed Avoidance of Double Taxation Treaties with 87 countries. All treaties follow theOECD model.Treaty tax rates (%) with Poland's main trading partnersCountry Dividends Interest RoyaltiesBelgium 5 / 15 5* 5Cyprus 0 / 5 5* 5Czech Republic 5 /10 10* 5France 5 / 15 0 0/10Germany 5 / 15 5* 5Greece 19 10 10Ireland 0 / 15 10* 0/10Italy 10 10* 10Latvia 5 / 15 10* 10Lithuania 5 / 15 10* 10Luxembourg 5 / 15 10* 10Malta 5 / 15 10* 10Netherlands 5 / 15 5* 5Russia 10 10* 10Slovakia 5 / 10 10* 5Slovenia 5 / 15 10* 10Switzerland 5 / 15 10* 10Ukraine 5 / 15 10 10United Kingdom 0/10 5* 5USA 5 / 15 0 10* in some cases 0% e.g. paid to government units or paid on bank loans18

Doing Business in PolandAPPENDIX 2Personal Income Tax RatesTaxable income* perannum (PLN)Tax rateTax liability0 – 85,528 18% 18% less PLN 556.0285,528 + 32% 14,839 + 32% over 85,528Income amount free of tax – PLN 3,09119% flat rate (optional)available for individuals conducting business activitynot available for those individuals who are e.g. invoicing their former or current employers.Directors’ fees and income from civil law contracts for persons with limited tax liability are taxed at20%.APPENDIX 3Social Security Rates:FundEmployee%Employer%Retirement * 9.76 9.76Disability * 1.50 6.50Sickness 2.45 -Accident ** - from 0.67 to 3.86Labour - 2.45Guarantee - 0.10Total 13.71 from 19.48 to 22.67Additionally employees are required to pay a health care contribution of 9%, of which 7.75% isdeductible from personal income tax liability.* on income up to of PLN 111,390 in 2013** depending on the company’s profile and the number of employees19

Doing Business in PolandCONTACT DETAILSTGC Corporate Lawyers is an international corporate law firm with offices inPoland (Warsaw, Łódź, Wrocław, Kraków), Czech Republic (Prague, Brno), andSlovakia (Bratislava).We act for some of the world’s leading companies, navigating them through thelocal business environment whilst understanding the international commercialenvironment. We offer the full range of legal services including corporate, M&A,litigation, finance, employment, real estate and tax.Together with our affiliate business support practices (Baker Tilly Poland, BakerTilly Czech Republic, Baker Tilly Slovakia and Contract Administration), our 390staff provide complete professional and administrative support to businessesoperating in Poland, Czech Republic and Slovakia.Baker Tilly Poland, Baker Tilly Czech Republic and Baker Tilly Slovakia are leading professionalpractices specialising in accounting, audit, tax and IT consultancy. All are independent members ofBaker Tilly International, the 8 th largest accounting and business advisory network in the world.Contract Administration is one of the largest providers of outsourced payroll administration and HRadministration in central Europe, managing a portfolio of more than 100,000 payslips per month.Contact:Christian FieldingE: cfielding@tgc.euD: + 48 22 295 3309TGC Corporate Lawyersul. Hrubieszowska 201-209 WarsawT: + 48 22 295 3300F: + 48 22 295 3001W: www.tgc.euwww.bakertilly.plwww.bakertillyczech.czwww.ca-staff.eu20

TABLE OF CONTENTGENERAL PRESENTATION OF THE LEGAL SYSTEM APPLICABLE WHENDOING BUSINESS IN ROMANIAI. INTRODUCTION...................................................................................................................... 31. Location and Population ........................................................................................................ 32. Language ................................................................................................................................ 33. Administrative division .......................................................................................................... 34. Currency................................................................................................................................. 3II. GENERAL OVERVIEW UPON THE ROMANIA’S POLITICAL AND ECONOMIC STRATEGY ......... 4III. GENERAL PRESENTATION OF THE LEGAL SYSTEM ................................................................. 4IV. CORPORATE LAW ................................................................................................................... 61. Different forms of investments.............................................................................................. 62. Type of structures set out by investors in Romania .............................................................. 73. The setting-up procedure of a company in Romania............................................................. 74. The setting up procedure of a foreign company’s branch office in Romania........................ 9V. TAX LAW................................................................................................................................. 91. General taxes and fees........................................................................................................... 92. The tax per profit ................................................................................................................... 93. The tax per income .............................................................................................................. 104. The income tax paid by the small and medium enterprises (SME) ..................................... 115. The tax paid by branches of foreign companies in Romania............................................... 116. The VAT ................................................................................................................................ 117. The excises ........................................................................................................................... 128. The local taxes...................................................................................................................... 12VI. LABOUR LAW........................................................................................................................ 131. The individual labor contracts.............................................................................................. 132. Documents regulating the labor reports ............................................................................. 133. The collective labor contract................................................................................................ 144. Minimum holiday period...................................................................................................... 145. The trial period..................................................................................................................... 146. The prior notice.................................................................................................................... 157. The contributions at the state’s budget .............................................................................. 158. The salary ............................................................................................................................. 15VII. PROTECTION OF PERSONAL DATA ....................................................................................... 16VIII. RENEWABLE ENERGY RESOURCES ....................................................................................... 161. The wind energy................................................................................................................... 172. Biomass ................................................................................................................................ 183. Solar energy ......................................................................................................................... 184. Geothermal energy .............................................................................................................. 185. Hydro energy........................................................................................................................ 186. Future plans ......................................................................................................................... 19IX. COMPLIANCE IN BUSINESS ETHICS AND ANTICORRUPTION ............................................... 19

GENERAL PRESENTATION OF THE LEGAL SYSTEM APPLICABLE WHEN DOING BUSINESS INROMANIAThis publication represents only a brief description of the legal system applicable when doingbusiness in Romania, its purpose not being to present an exhaustive report. Consequently, foreach particular case, a specific legal advice shall be necessary.I. INTRODUCTION1. Location and PopulationRomânia is located at the crossroads of Central and Southeastern Europe and is the ninth largestcountry of the European Union by area, having 237.500 square kilometers, and the seventhlargest population with 21,5 million people.The capital of Romania and also its largest city is Bucharest, southern city having approximatelytwo million people.As regards the Romania’s climate, we must include it into the category of the countries having atemperate-continental climate, having four seasons and an annual average temperature of 11 °C(52 °F) in its south part and 8 °C (46 °F) in the north. Thus, the climate conditions are wellappropriate for living and conducting business in Romania, events of such nature that couldinfluence a company’s activity - like the sudden changes of temperature or unexpecteddifferences of temperature - are unlikely to happen.2. LanguageThe official language is Romanian, a Latin language related to Italian, French, Spanish,Portuguese and other such languages, spoken by 91% of the population. Hungarian and Germanare the most important minority languages especially in the Banat and Transylvania region.However, English, German, French and Italian are also spoken by many Romanians.3. Administrative divisionRomania is divided into 41 counties and the municipality of Bucharest. Each county isadministered by a county council, responsible for local affairs, as well as a prefect responsiblefor the administration of national affairs at the county level, which is appointed by the centralgovernment.4. CurrencyRomania's official currency is Leu.Foreign currencies may be exchanged at banks or authorized exchange offices, but thoseexchange rates may differ from the official rate established by the National Bank of Romania. Aslandmark, the official exchange rate for July 1 st , 2011 is:3

1 Euro = 4,23 Lei1 US dollar = 2,92 Lei1 British Pound = 4,67 LeiII. GENERAL OVERVIEW UPON THE ROMANIA’S POLITICAL AND ECONOMIC STRATEGYAfter the Romanian revolution in December 1989, as result to which the communist regime wasreplaced by democracy, Romania pursued a policy of strengthening relations with the UnitedStates and the European Union. Consequently, it joined the European Union on January 1 st , 2007and the North Atlantic Treaty Organization (NATO) on March 29, 2004.Moreover, Romania was already interested in the development of the economic-financial sectorand hade joined the International Monetary Fund and the World Bank in 1972, becoming alsofounding member of the World Trade Organization.The adhesion to the European Union was accompanied by the harmonization of the nationalcommercial and fiscal legislation to the European applicable law. However, this effect should notlead to the conclusion that the European norms are automatically applied in Romania in thesame form as the one established by the EU authorities. Thus, the European legislator simplyprovides the general rules, leaving to the national authorities the ability to transpose the EU’sregulations as they seem apropiate, but only in compliance with those European provisions.As result of the memberships presented above, Romania was submitted to a complex and longreform in several areas, such as the economic, social and judicial domain. However, althoughRomanian legislation is still subject to some changes, the legal framework is increasingly stableand the economy registers a steady growth.III. GENERAL PRESENTATION OF THE LEGAL SYSTEMRomania has a civil law system in which the jurisprudence is not source of law and thus, onecourt’s decision is not compulsory for the other competent courts. The main body of laws iscontained in the Civil Code, respectively the Civil Procedure Code, both recently modified anddue to come into force at the end of July 2011.The entire judicial activity is supervised by the Ministry of Justice, which ensures the necessarymanagement conditions for the functioning of the judicial system in Romania. Nevertheless, thejudges act independently when ruling. The independence of the judges arises from the principleof state powers’ separation, and their authority is not subordinated to the legislative or theexecutive power.The Romanian courts of law are organized on 4 levels: lower district courts (in the main citiesbut also in smaller cities), tribunals and specialized tribunals (one in each county), courts ofappeal (16 in the entire country) and the Supreme Court of Justice, each of them havingspecialized judicial panels (civil, commercial, penal, administration and fiscal, labor and socialsecurity) with the possibility of creating other special panels if necessary.4

In addition, there are also military courts of law, organized on only 3 levels, and arbitrationtribunals.Regarding the use of arbitration (private justice), we must mention that this type of justicerepresents an alternative to the settlement of litigation by a court of common law and is notonly permitted but encouraged by the judges. The arbitration procedure can be chosen bymeans of a compromissory provision included in the contract by the parties or through aseparate express agreement. Object of arbitration may be only the disputes that can beevaluated in money or which are related to rights upon which the parties are allowed to reach asettlement, according to the applicable legal provisions.Furthermore, because Romania joined the EU, the Romanian citizens gained access to the courtsestablished by the European Community.The authority that ensures the compliance of the legal provisions with the provisions of theConstitution is the Constitutional Court, with four judicial bodies each having five judgesappointed by the Parliament and the President of Romania for a nine-year period, havingresponsibilities regarding the control of the law, before its enactment and a control of the lawafter its enactment.As regards the principle applicable to the system of justice in Romania, the rule is that of thedouble jurisdiction principle. Therefore, any litigation settled by a decision of a first-degreecourt, may be subject to a retrial by a superior court in all of its aspects. Thus, the generalcompetence was granted to the tribunals under the law with respect to certain categories oflitigations of medium importance and they may also judge legal actions brought against thedecisions passed by the courts of law in the first instance. There are also 16 courts of appeal,which have jurisdiction over several tribunals. The decisions ruled by the Courts of Appeal mayonly be challenged by last appeal before the High Court of Cassation and Justice.The protection of the legal order and of the citizens` rights is ensured by the Public Ministry.This authority exercises its duties through public prosecutors organized in offices, whichfunction alongside each court, while still keeping their independent statute towards them.In respect to the evidence system, the Romanian’s law provisions establish that the evidencebrought before the court may be: written documents – if the signature or the writing isquestioned in court, a judicial examination will take place, witness testimony – the witnesses’number can by reduced by the court and they are submitted to the obligation of taking an oath,research conducted on field, interrogatory and expertise – experts in different areas ofcompetence chosen by the parties or appointed by the court if they do not agree. Furthermore,the Romanian legislation allows the evidence presentation by lawyers, in consideration of theimportant advantage of this procedure, namely its short duration. However, this proceeding israrely used in practice because of several reasons, from which we may mention: the conditionthat its object includes only the disputes that can be evaluated in money; the fact that, in reality,the parties need the permission of the court for every action involved and at the end of theprocedure they still have to go before the court so that a ruling can be made etc.5

Regarding the judicial fees, Law no. 146/1997 that regulates this area, establishes two differentsystems of calculation, depending on the object of the claim or action. If the object of a claim isassessable in money, the value of the goods will determine the judicial fee. The more valuablethe goods are, the higher the judicial fee will be. In all other situations, if the object is notassessable in money, the judicial fee is established according to the rights and claims appealedfor. Nevertheless, the aforementioned law establishes specific situations in which the party doesnot have to pay the judicial fee or in which a reduced fee shall apply, grading or postponing ofthe payment.IV. CORPORATE LAW1. Different forms of investmentsIn case of a new investment, a foreign company has two main possibilities: to enter into arelationship of cooperation with a Romanian company or to initiate a venture in an unknownterritory based of their own achieved experience. Both alternatives entail risks. The firstalternative is risky because it implies long term relations based on trust with local associatesthat m0.ight prove unreliable, and consequently, these partners ought to be carefully selected.The second alternative has the inconvenient that, in most cases, the foreign investor is notfamiliar with the local rules and customs. In both cases, it would be advisable resorting tospecialized consulting services in areas such as the legal, tax, management or businessconsultancy.In consideration of the above, there are four main types of investments:• Greenfield (new investments, built on a so called green field)• Brownfield (purchase of shares in an already existing Romanian company)• Joint Venture (new structure set up in collaboration with a local partner)Although the greenfield investment seems to be the least safe, this form of investment may bepreferable and may bring profit in a short period of time, if thorough planning is carried out andif certain specific elements are taken into consideration.Thus, important successes were gained in Romania by many foreign companies, very oftensubsidiaries or other structures of these companies established in our country proved to bringbigger profits in comparison with other corporate structures of the same companies set up inother countries.In case of the brownfield investments, both the aspects of the applicable legislation and thegeneral situation of the company whose shares are to be purchased must be examined.Consequently, many foreign investors decide to conclude a shareholders agreement (a contractbetween associates) that must not be mistaken with the social contract (article of association)that needs to meet specific prior conditions and that must be submitted to the Trade Register,whilst the shareholders agreement can be drafted, obviously observing certain mandatorydispositions, without any formal or substantial preestablished requirements. Also, a Duediligence verification may be carried out, the report that concludes the analysis having the roleof pointing out the problematic aspects or possible risks.6

The joint venture is an agreement concluded more often between a Romanian partner and aforeign one, which can take various forms, ranging from a simple commercial cooperation to thesetting up of a new common structure, for eg. a venture agreement, a commercial company,etc. At present time, there is no actual regulation regarding the joint venture, only disparatelegal provisions, especially fiscal ones.2. Type of structures set out by investors in RomaniaThe main general regulations applicable are: Law no. 31/1990 regarding the companies, Law no.26/1990 regarding the Trade Register and the Civil Code, noting that after the modifications ofthe Civil Code that shall become applicable since July 2011, the Civil Code shall include theprovisions before established by the Commercial Code).Investments in Romania can be conducted by means of a structure that does not have juridicalpersonality, respectively a structure that has juridical personality.If a structure having juridical personality is established – thus a commercial company is set up –,according to the Romanian law, the investor may choose the type of structure from thefollowings:a) Limited liability companyb) Joint stock companyc) General partnershipd) Limited partnershipe) Limited partnership by sharesThe types of commercial companies most likely to be used are the joint stock company and thelimited liability company. However, the most common form is undoubtedly the limited liabilitycompany. Taking quick and informal decisions; limiting the associates’ responsibility to thevalue of their contribution (the minimum value of the share capital is currently 200 Lei -approximately 50 Euro), the unlimited responsibility being applicable only in certain expresslystated conditions, are only some of the advantages corresponding to this type of company.3. The setting-up procedure of a company in RomaniaThe setting up procedure for the forms of company aforementioned, established by Law no.31/1990, has been modified several times, the most recent being the amendment brought byLaw no. 202/2010 that has a role of transition between the prior regulations and the new onesof the Civil Code. However, currently, we can even argue that the legal framework benefits froma significant degree of stability.As aspects that should be taken into consideration when setting up a company, it should beforemost noted the name of the company. When establishing a subsidiary in Romania, manycompanies (especially multinationals) opt for including the term “Romania” within the name ofthe new company. In such case, Romanian legislation stipulates a compulsory prior approvalproceeding, which can lead to delays of several weeks in the setting up procedure.7

Furthermore, the headquarters of the new company is also of considerable importance, as inpractice there are many cases when the setting up of a company is delayed because of it lacks asuitable seat.In order to choose the headquarters’ location, there are several possibilities. Thus, in casecollaboration exists with a local partner, the last mentioned company shall more often assumethe task of identifying a suitable location, either through its own representatives or by resortingto a real estate agent. In all cases, the legal aspect should not be overlooked, because in order toregister the new company it’s necessary to bring the so called “proof of the headquarters” –namely either a lease contract, a property title if the new seat is purchased or anotherdocument attesting the right of use the respective location –, and to register it at the competenttax authorities, followed by its’ attachment to the registration file that shall be transmitted tothe Trade Register.As regards the acquisition of land, we would like to point out that the Romanian subsidiary of aforeign company is considered to be a Romanian legal person and thus is competent to fullyacquire and transfer lands and other real estates in Romania. Nevertheless, the relevantlegislation has been amended at the same time with the EU accession of Romania, meaningthat, at present time, foreign legal persons can acquire lands in Romania but only under certainrestrictive conditions.The legal framework for the land acquisition is the Law 312/2005, law that establishes thedifference between incorporated and unincorporated areas, and also between inner and outerlands.Foreigners, natural or legal persons, which are not Romanian residents, may acquire land inRomania for setting up branches only after a period of 5 years from the Romania’s accession tothe EU has passed. This means that from 2012 this restriction shall not be applicable anymore.In respect to the property right of the foreigners upon agricultural lands, forests and forestrylands, the Romanian law mentioned above establishes a condition according to which thesepersons can not acquire such lands during a 7 years period starting from the moment whenRomania was accepted as member state within the EU, meaning that from 2014 this conditionshall no longer be applicable.Regarding the company’s object of activity, in Romania, unlike in other states, the legislationprovides a classification of the economic activities – classification also known as the CAENclassification –, that must be observed when defining an article of association.In respect to the company’s management, many foreign companies prefer to appoint both aRomanian manager and a foreign one who will implement the strategy of the parent companyand will exercise a certain control upon all the staff’s activity. Therefore, when drafting thearticle of association, certain aspects must be taken into consideration, such as the expressestablishment of the transactions subjects to the general assembly’s approval, the advantages ofthe management contract by comparison with the individual labor contract, as well as theprecise separation of the attributions in case the company has several managers.8

4. The setting up procedure of a foreign company’s branch office in RomaniaAccording to the Romanian legislation, a company may set up two types of legal entities: onethat has judicial personality – called “filială”, and the other that does not have judicialpersonality – called “sucursală”, each one having as correspondent a specific set up procedure.In consideration of the fact that the grate majority of foreign companies decide to set up the lastmentioned structure in Romania, we shall present in the followings the steps that must be takenin order to perform this operation.In this matter, the authority of the Trade Register from where the headquarters of the newbranch will be established and registered shall be considered to be a competent authority. Thus,the foreign mother company must prepare a file containing the general documents required bythe Romanian legislation for setting up a branch in Romania, such as: the company’s decision bywhich the setting up of the branch is decided, the document that asserts the right of use uponthe immovable that shall be used as headquarters of the branch, the financial statements of thecompany drafted in accordance with the legislation of the state where the company’sheadquarters is registered, the company’s Registration Document or Certificate having suchstatute, issued by the foreign authorities, in a translated and notarised form, letter of goodstanding issued by at least a bank that works with the company, a detailed description of theobject of activity in accordance with the CAEN, different notarized liability statements, thenotarised power of attorney for the person that will submit the necessary documents in order toregister the branch or an attorney delegation, the proof of registration tax payment etc.Also, according to the Romanian legislation in force, all the documents must be drafted either inRomanian language or in a bilingual form (one of the two languages being the Romanianlanguage) or they must be translated by an authorised person in Romanian language.V. TAX LAW1. General taxes and feesThe Fiscal Code, regulation governing the tax system, applies upon the following taxes and fees:a) the profit tax;b) income tax – payable by the natural persons;c) the tax on the small enterprises’ income;d) the tax on the incomes obtained by the non residents in Romania;e) branch taxes;f) value added tax (VAT);g) excise;h) local fees and taxes.2. The tax per profitAccording to the provisions of the Fiscal Code, the profit tax shall be paid by the following taxpayers:9

• the Romanian legal persons;• the foreign legal persons which perform their activity by means of a permanentestablishment in Romania;• the associations that do not have juridical personality;• the foreign legal persons who receive incomes from or related to land propertieswithheld in Romania or from selling/transferring their stocks held in a Romaniancompany;• the resident natural persons associated with Romanian legal persons, for the incomeobtained in Romania as well as abroad, in associations having no juridical personality; inthis case, the tax payable by the natural person shall be calculated, retained and paid bythe Romanian legal person.According to the nature of the tax payer, the Fiscal Code stipulates more ways to pay the taxprofit, either annually or by anticipated payments every trimester. In most cases, the due datefor the payment is the 25 th including of the next month following the trimester for which the taxis calculated.In Romania, as a general rule, the profit tax quota is of 16%.3. The tax per incomeAccording to article 39 of the Fiscal Code, the following persons are obliged to pay the incometax:• the resident natural persons;• the natural persons who are not residents in Romania but perform an independentactivity by means of a permanent establishment in Romania;• the natural persons who are not residents in Romania but perform dependent activitiesin Romania;• the natural persons who are not residents in Romania but obtain income from otheractivities performed here.In Romania the income tax quota is of 16%.The Fiscal Code also mentions the incomes which are subject of the income tax payment, asbeing the followings:• incomes obtained from independent activities;• salary incomes;• incomes obtained from renting goods;• investment incomes;• retirement incomes;• incomes obtained from agricultural activities;• incomes from prizes;• incomes from other sources.10

The non residents who obtain incomes from their activities performed in Romania, either fromindependent activities or from dependent activities have the obligation to pay the income tax of16 % applied on the brute incomes taxable in Romania. The persons obliged to retain the taxowed by the non residents have also the obligation make the payment.Also, they have to submit a declaration the competent fiscal authority, by the 28th, respectively29th February of the following year for which the tax was paid.4. The income tax paid by the small and medium enterprises (SME)If a company fulfils the conditions established by the Romanian Fiscal Code in order to beconsidered as being a SME, the income tax applies to the incomes obtained from any source,with the exception of those foreseen by the Code aforementioned. According to the sameprovision, the tax quota for these incomes is 3%.The calculation and payment of the tax on the SME incomes is done each trimester, by the 25thincluded of the following month of the trimester for which the tax is calculated. The SMEs havethe obligation to submit, by the term of the tax payment, the declaration for the income tax.5. The tax paid by branches of foreign companies in RomaniaAny foreign legal person, having an authorized branch in Romania, has the obligation to pay anannual tax. According to the dispositions of the Fiscal Code, the branch tax for a fiscal year is theequivalent of 4.000 Euro, calculated at the exchange rate set by the National Bank of Romaniafor the payment day.The tax shall be paid in two equal rates, one due on June 25 and one due one December 25.Also, the foreign company is obliged to submit an annual declaration to the competent fiscalauthority, by February 28/29 of the taxable year.6. The VATThe standard quota of the value added tax, according to the Fiscal Code in force is of 24% andit applies on any taxable operation which is not exempted from the value added tax or which isnot submitted to a reduced quota.As regards the reduced quotas, in accordance with the applicable legal provisions, the quantumof these reductions may be of 9% or of 5%, and are applicable for special cases such as theservices consisting in permitting the access to castles, museums, memorial houses, historicalmonuments, architectural and archeological, zoos and botanic gardens, markets, exhibition andcultural events, cinemas, if they are not exempted; the delivery of school manuals, books,newspapers and magazines, with the exception of those meant exclusively or mainly forpublicity; the delivery of medicaments for human and veterinary use; housing in hotels andsimilar places, including the rental of camping spaces – for the quota of 9%; the delivery ofbuildings and the land on which these buildings are situated, as part of the social policy – for thequota of 5%.11

The exemption from VAT payment regards the operations having social character such as theones regarding the health care services, the teaching service provided by professors as extraactivity etc., but also the banking financial services; assurance and reassurance; leasing, rentingimmobile goods with specific exceptions; the imports and the acquisitions within theCommunity referring to goods delivered in Romania in certain cases; international transport ofpeople etc.The value added tax deduction shall include data regarding the acquisition of goods andservices, from which a deductible value added tax shall result, as well as data regarding thecommercialization of goods and services, from which a collected added value tax shall result.The difference between these two value added taxes shall indicate if the payer has to pay thevalue added tax or if he has to recuperate it.The information which was inserted incorrectly in the tax deduction can be corrected by meansof the deduction of a future fiscal period and shall be registered with the regularizations.7. The excisesAccording to the Romanian legislation, the excises are special taxes for consume, which areowed to the state budget for the following products coming from internal production or fromthe import:• beer;• wines;• fermented beverages, other than beer and wines;• intermediary products;• ethylic alcohol;• processed tobacco ;• energy products;• electric energy.Based on the monthly statement of the economic operator, excise payer, a quota shall beapplied by the competent fiscal authority. The quota taxes can be found in Annex 1 and 2 fromthe Fiscal Code.8. The local taxesAccording to the provisions the Fiscal Code, the local taxes and fees are:• taxes on buildings;• land tax;• taxes for transport;• taxes for issuing the certificates, approvals and authorizations;• taxes for advertising and publicity;• taxes for performances;• hotel tax;• special taxes;12

• other local taxes.However, for the good functioning of the local public services, the Local and the County Councilscan set special taxes, that are not mentioned in the above list, falling into the category of “otherlocal taxes”.VI. LABOUR LAW1. The individual labor contractsThe individual labor contracts are closed in writing, the law establishing binding minimal legalconditions and they require, as any other contract, a prior agreement of the parties – employeeand employer. After the signing in and with at least one day before actual starting of theemployee’s activity, the individual labor contract must be registered by the employer in its ownregisters, by using a program provided by the competent labor authority (namely the REVISAL).The Romanian legislature permits the conclusion of two main categories of individual laborcontracts, each heaving their one special provision, namely:• we must differentiate between an individual labor contracts closed for a determinateperiod of time and those closed for an indeterminate period of time.• we must distinguish between full time labor contracts and part time labor contracts.In case the amendment of the contract shall be desired, this operation may be performed mymeans of an additional document, according to the understanding of the parties, in maximum20 working days from the moment when the modification appeared. The main objects of theaddendum may be:• the execution of the individual labor contract – for eg. the working place, the workingconditions, the salary• the suspension of the individual labor contract• the modification of the individual labor contract• the termination of the individual labor contract2. Documents regulating the labor reportsThe main documents that must be bared in mind by the every employer, as being necessary forregulating the labor reports, are the followings:a) The personal file of the employeeThe employer must keep a strict record in respect to each of its employee, especially since theregistration of the labor documents is no longer necessary in Romania. Every such file mustcontain the following documents:• the individual labor contract13

• the additional acts to the individual labor contract, closed as a consequence of themodifications to which the individual labor contract was submitted• the job description signed by the employee and the employer, including a set ofevaluation criteria• the medical chart (obtained from a doctor specialized in labor law)• copies of the birth certificate, marriage and identity card• the documents attesting the employee’s professional studiesb) The internal rules of procedureThe internal rules of procedure, having the form of a unique regulation, must be brought to theemployees’ knowledge by posting it at the company’s headquarters.c) The contract regarding the labor medicine, concluded by the employer with aspecialized cabinetd) The contract concluded with a natural or legal person specialized in the labor protectiondomaine) The holiday planning chartf) The presence chartg) The unique control register3. The collective labor contractConcluding a collective labor contract is binding for the companies that have more than 21employees. The initiative make be taken by the employer or the employers’ organization.4. Minimum holiday periodThe employee has the right to a holiday of minimum 20 working days per year, according to theLabor Code. In case of a partial norm, the holiday is calculated proportionally with the period oftime in which the labor has been performed. However, before the modification of the LaborCode, the law regulating the collective labor contract – which is currently abrogated –established a holiday period of at least 21 working days per year. Consequently, all individuallabor contracts concluded before this abrogation offer a holiday period of minimum 21 workingdays. As the practice reveals, the level of 21 working days is still applicable, employers choosingto maintain the previous minimum period. Moreover, depending on the employee’s seniority,employers have the possibility of setting a longer period for the holiday.5. The trial periodThe duration of the trial period is of 90 days for the executive positions, respectively of 120 daysfor the management positions. After or during this period, the individual labor contract may be14

terminated by either party, by means of a written notification, without prior notice ormotivation.6. The prior noticeAs regards the prior notice period, the Romanian legislature establishes the followings:• 15 working days in case of firing an employee• 20 working days in case an employee resigns from an executive position, and 45working days for leading positions7. The contributions at the state’s budgetThe main contributions that have to be paid by the employer are the followings:• Pension insurance: 20,8% for normal work conditions• Unemployment contribution: 0,5%• Health insurance contribution: 5,2%• Contribution for the medical vacation: 0,85%• Wages guarantee fund: 0,25%• Work accidents and professional diseases contribution – different percentcorresponding to the degree of risk afferent to the employer’s object of activity• Sick leave contribution: 0,85%• Tax per profit: 16%The main contributions that have to be paid by the employee are the followings:• Pension insurance: 10,5%• Unemployment contribution: 0,5%• Health insurance contribution: 5,5%• Tax per income: 16%8. The salaryBecause the individual labor contract reflects the agreement of the two parties involved,namely, the employer and the employee, the salary shall be negotiated and established inconsequence. Nonetheless, in order to protect the employee, the legislator has established aminimum level of the wage and also specific provisions according to which the specification of awage smaller than this level is strictly forbidden and sanctioned accordingly.Before the latest modification of the Labor Code, a National Labor Contract was in force andestablished a minimum wage of 600 lei (approximately 143 euro), value to which specific quotaswere applied corresponding to the professional training of the employee and the working hours(the maximum wage was 1200 lei – approximately 285 euro- for the employees that worked for8 hours per day and who had a diploma attesting their superior studies, necessary and legalpremises for achieving that position).15

The minimum salary set for 2011 is of 670 Lei (approximately 160 euro) per month for a normalworking program, but up to present time, no quotas have been established by law. Inconsideration of that fact, the employer shall not be obliged to offer a wage bigger than 670 lei,irrespective of the qualification of the employee. However, if a collective labor contract wasconcluded when the National Labor Contract was still in force, the quotas mentioned above shallcontinue to be binding for the employer.VII. PROTECTION OF PERSONAL DATAAccording to the Romanian Law no. 677/2001 – regulation transposing the provisions of theEuropean Directive 95/46/EC –, data such as the name, surname, e-mail address, telephonenumber, profession etc. pertain the category of personal data.The aforementioned legal document defines the data processing operation as being any actionperformed upon personal data, such as the data collection, the data registration, the datatransmission etc. Consequently, as a general rule, any individual or natural person performingthis type of operations shall be considered to be a personal data operator and as result, shall besubmitted to the data protection rules.In the situation in which data shall be transferred outside Romania’s territory, the registration asa data protection operator becomes compulsory. In consideration of the security provided bythe state where the transfer shall be made, no specific conditions must be fulfilled if suchtransfer shall be made to a company having its headquarters in the European Union, in theEuropean economic area (Liechtenstein, Island and Norway) or in one of the countries to whichthe European Commission has recognized an adequate level of data protection (Argentine,Canada, Switzerland, Guernsey, Jersey, The Isle of Man and the USA if the operator company hasa Safe Harbor certificate).VIII.RENEWABLE ENERGY RESOURCESAlthough the government still owns a large portion of industrial assets, privatization of thisenergy sector has begun. Thus, private investors are encouraged to set up business or to investin existing companies, in Romania, major upgrades to the energy sector being planned over thenext ten years.If specific conditions are fulfilled, according to the applicable legal provisions, all investors shallbenefit from:• incentives for small hydro, solar, wind, geothermal, biomass, biogas, and waste watersludge and gas projects. Incentives are offered for 3 years after completion of smallhydro non-refurbished to 15 years for new power plants;• an outline for a green certificate trading market. Typically one certificate represents 1MWh of electricity that can be traded. Suppliers must meet the annual mandatorytarget for green certificates;• priority access for electricity produced from renewable energy sources, as long as suchpriority does not affect the safety of the National Energy System;16

The economic and technical operations and the development of the electricity sector isregulated, supervised and monitored by the Romanian Energy Regulatory Authority (ANRE), setup by an Emergency Ordinance in October 1998 as a public institution, independent andautonomous.Romanian electricity market is fully liberalized since July 2007, being removed all administrativebarriers for imports and exports of energy or energy resources.Map of the renewable energy resourcesI. The Danube Delta – solar energyII. Dobrogea – solar and wind energyIII. Moldavia – wind energy, biomass, micro hydroIV. Carpathian mountains – biomass, micro hydroV. Plateau of Transilvania – micro hydroVI. West plain – geothermal energyVII. Subcarpathians – biomass, micro hydroVIII. South plain – biomass, geothermal, solar energy1. The wind energyRomania’s potential for obtaining electricity from wind power is extremely high, namely of 23TWh per year, in 2010, in Romania having installed approximately 560 MW.In future time it is estimated that, from the Central and South-Easter European countries(including Austria and Greece), Romania shall probably occupy the first place considering the17

capacity installed, the only competition coming from Turkey. One of the most important reasonson which this change was based on, is the clarification of the applicable legislation regulating theprocedure of obtaining the necessary authorizations and approvals, and also the complexpromoting system applicable in Romania that encourages private and PPP investments.2. BiomassRomania has great biomass potential, which is estimated at 318 PJ per year. According to thestatistics of the National Authority Regulating the Energy, in 2010, approximately 14 MW wasthe value for the installed capacity for energy obtained from biomass.3. Solar energyRomania is located in an area that has a good solar potential of 210 sunny days/year,respectively 60 PJ/year to be used for heat and 1,2 TWh to be used for electricity. Also, becauseof Romania’s meteo-solar climate, a solar - thermal panel can function almost the entire year,specifically from March until October.Nevertheless, the factual data proved that in 2010, this area was not exploited. Thus, the solarenergy was only used for private consumption not for transmitting this type of energy to thegrid, the installed capacity for solar energy not reaching the level of 1%.4. Geothermal energyExploration for geothermal resources began in Romania in the early 1960’s. Over 250 wells,drilled to depths between 800 and 3.500 m, showed the presence of low enthalpy geothermalresources (40 - 120°C).As effect, Romania has the third highest geothermal potential of European nations, after Italyand Greece – 7 PJ, with major potential locations on the Western Plain, South Plains in theregion of Bucharest, and in the Carpathian regions. At present Romania has a total geothermalinstalled capacity of about 145,1 MWt producing 2,8 TJ/year. This energy is produced fromabout 96 direct-use wells with hot water in the temperature range of 55-115 °C. Of the 96direct-use wells, 37 are used exclusively for health and recreational purposes.5. Hydro energyRomania’s hydropower potential is extremely large, with an estimated potential of over 36 TWhof which 3.6 TWh represents the potential of the hydroelectric having a capacity of maximum 10MW.The most important source of hydro power are the rivers – the most important rivers beingDanube, Olt, Lotru, Bistriţa, Someş, Dragan, Argeş, Dâmboviţa, Râul Târgului, Sebeş, Râul Mare,Cerna, Bistra, Buzău and Motru -, but also the lakes – there are more than 2.500 lakes, rangingfrom the glacial lakes of the mountains to those of the plains, and the marshes of the Danubedelta region.18

In respect to the installed capacity of hydropower, according to the statistics presented by theRomanian competent authority, in 2010, the total value was of 6.413 MW, of which 387 MWcorresponded to the micro hydroelectric with a capacity of maximum 10 MW.6. Future plansThe economic and social long term development requires a well-balanced energy policy, whichmust have the following objectives:• economic stability and security when supplying from the international market inconditions of price incertitude, because of the continues growth of the energy demand;• environmental protection – by introducing new technologies for the production andconsumption of energy with low impact upon the environment and for the reduction ofthe climate changes;• well-functioning of the internal market on which the electric energy and the naturalgases are traded, guarantee for the regional and European market’s transparency nondiscriminatory;• development and production of new technologies for electric energy and environmentalprotection. Thus, the energy sector shall contribute to at the general wellbeing;• improvement of the entire production line – transport – energy consume by means ofnew and more efficient informatics and communication technologies. This technologiesoffer the potential for a structural transition to the processes and services that imply alow resources consumption and to a more efficient and intelligent distribution.Regarding the targets established, for 2010, 33 % of gross electricity consumption should havebeen from renewable energy resources, according to the Directive 2001/77/EC (amended by2006/108/EC). However, because 2010 was a very productive year, this target was not onlyachieved but exceeded, the percent accomplished being of approximately 35.In respect to the Romania’s strategy, the national targets imply for 33 % of gross electricityconsumption in 2010, 35 % of gross electricity consumption in 2015 and respectively 38 % ofgross electricity consumption in 2020 to be made from renewable energy resources. Inconsideration of the above, it is estimated that the targets established for 2015 and 2020 willalso be exceeded.IX. COMPLIANCE IN BUSINESS ETHICS AND ANTICORRUPTIONRomanian legislation does not regulate in any way the compliance program and consequently,the general rules existing at an international level become applicable.This type of program involves two major components:• The verification regarding the compliance with the Romanian regulations of the norms,contracts, rules and procedures existing within a foreign company that has a branchoffice in Romania19

• The verification regarding the compliance of the employees working for the Romanianbranch office, with the internal rules and procedures, or code of ethics established bythe mother-companyAs regards the second mentioned component, when breaching an internal rule or procedure, animportant role is played by the falling of such behavior into the category of offenses.Hence, according to the Romanian Law no. 78/2000 regarding the prevention, disclosure andsanction of the corruption deeds, a corruption deed represents an abusive use of the powersentrusted in order to receive personal or group benefits, or an use of the professional positionwithheld, of the attributions or assignments received, with the scope of gaining money,obtaining goods or other unjustified advantages, for himself or for another person. Subject ofthe corruption deed may be any persons which permanently or temporary withholds a positionor is entrusted with an assignment, if this person is involved in the decision taking procedure ormay influence such decisions, including but not limited to the managers, the directors, theadministrators or other persons having controlling competence.However, there are also offenses that are not considered to be corruption deeds, but aredirectly connected, that require for special conditions to be fulfilled and whose breachingimplies different sanctions. These aforementioned offences may be: forgery, use of forgery,blackmail, money laundering, tax evasion, fraudulent bankruptcy, special offences establishedby the law regulating the companies.Kind regards,Team Haţegan20

DOING BUSINESS IN SPAINSeptember 2014www.buigas.com

TABLE OF CONTENTSGENERAL INFORMATION ................................................................................................ 3INVESTMENT FACTORS .................................................................................................... 5FINANCIAL SERVICES ....................................................................................................... 8ESTABLISHING A BUSINESS ............................................................................................. 8FORMS OF BUSINESS ENTITIES...................................................................................... 9EXCHANGE CONTROLS .................................................................................................. 15LABOUR ............................................................................................................................... 16TAXATION .......................................................................................................................... 22FAQ’S .................................................................................................................................... 382

GENERAL INFORMATIONLocation and AreaSpain is located in the southwest of Europe and it is the second-largest country in the EuropeanUnion (EU) with 504.030 square kilometres. It includes the Canary Islands in Atlantic Ocean, theBalearic Islands in the Mediterranean Sea, the North African cities of Ceuta and Melilla and somesurrounding uninhabited islands. Spain has a typical Mediterranean climate due to its 8.000kilometres of coastline and lovely beaches.Population and LanguageSpanish is the official language of the country. There are other official languages, such as Catalan,Basque or Galician that are spoken in their corresponding Autonomous Community, accordingto their Autonomy Statute. The population of Spain in Januarny 2014 is approximately 46 millionpeople, with a population density of 93 inhabitants per square kilometres.Spain is organized into 17 Autonomous Communities, each of which generally includes one ormore Provinces (50), plus the Autonomous cities of Ceuta and Melilla in the Northern Africa.Each Autonomous Community exercise the powers assigned to it by the Constitution of 1978 asspecified in its Autonomy Statute. Such Statutes, enables the Autonomous Communities tostipulate their institutional organisation which includes the basic powers: legislative, executive andjudicial.The Autonomous Communities are financially autonomous and also receive financing of theCentral Government in the yearly budget.CurrencyAs of 1st January 2014, the exchange rate for one Euro against the main world currencies was:SourcesUnited States dollar 1.3754Japanese yen 141.470British pound sterling 0.827Swiss franc 1.2225The main government department or agencies which aid foreign companies in Business activitiesare:3

Bank of Spainc/ Alcala, 4828014 MadridTel.: 0034 91 338 5000www.bde.esMinistry of Industry, Energy and Tourism,c/ Panama, 128046 MadridTel: 0034 902 44 60 06www.mityc.esSocial Securityc/ Cedaceros, 1128014 MadridTel.: 0034 91 429 66 61www.seg-social.esSpanish Institute for Foreign Trade(ICEX)Pº de la Castellana 1428046 MadridTel.: 0034 900 349 000www.icex.esMinistry of Economy and CompetitivenessPaseo de la Castellana, 16228046 MadridTel: 0034 91 583 74 00www.meh.esState Tax Agencyc/ Infanta Mercedes 3728020 MadridTel: 0034 91 583 70 00www.aeat.esState Credit Agency (ICO)Paseo del Prado 428014 MadridTel: 0034 91 592 16 00www.ico.esSpanish Agency for InternationalCooperation for Development (AECID)Av. Reyes Catolicos 428040 MadridTel: 0034 91 583 81 00www.aecid.esDirectorate General for Small and MediumEnterprisesc/ Panama, 128071 MadridTel: 0034 900 19 00 92www.ipyme.orgNationals of EU-Member StatesNationals of EU-Member States are not subject to the requirements applicable to otherforeigners to obtain a work permit as an employee or self-employed person, because the EU ruleson the free movement of workers are fully in force.EU nationals must register themselves in the Central Register of Foreigners only if they areplanning on staying more than three months in Spain, either to live or to work, being subject tothe same obligations as an Spanish citizen. EU nationals might also be required to obtain a taxidentification number (NIE) to enter in certain type of contractual obligations (i.e leaseagreements).If the period of residence is less than three months, the individual only needs his identity card orpassport. If the individual has plans to engage economic activities on his own account, he mustprovide documentary evidence of having applied for the administrative authorizations requiredfor such purpose.4

INVESTMENT FACTORSGovernment Attitude towards Foreign InvestmentIt is important to emphasise the various incentives and the help given to those EU member statecompanies that want to invest in Spain. These incentives will be explained below.The Spanish Government and the rest of the Public Administrations have established a systemfor the encouragement of work and competitiveness. There is a great variety of aid and incentivesfor permanent employment and research in technological investigation.Economic TrendsAfter almost 15 years of above average GDP growth, the Spanish economy began to slow downin late 2007 and entered into a recession in the second quarter of 2008. GDP contracted by 3.7%in 2009, ending a 16-year growth trend and by another 0.3% in 2010, before expandingmoderately in 2011, making Spain the last major economy to emerge from the global recession.The economy, however, has once again fallen into recession as deleveraging in the private sector,fiscal consolidation, and continued high unemployment weigh on domestic demand andinvestment, even though exports have shown signs of resiliency. The unemployment rate rosefrom a low of about 8% in 2007 to roughly 25% in 2012. The economic downturn has also hurtSpain's public finances. This led to the start in 2012 of an ambitious program of structural reformwith a view to boosting growth and creating jobs, coupled with related fiscal consolidationmeasures. Since then the Government has passed several Acts that not only have reduced theincreasingly unemployment rate but also helped restructuring the financial sector, and haveimplemented a major process to restructure the balance sheets of financial institutionsconsolidating a strong and secure banking system.Although Spain's large budget deficit and poor economic growth prospects remain a source ofconcern for foreign investors, the government's ongoing efforts to cut spending and introduceflexibility into the labor markets are intended to assuage these concerns. The government is alsotaking steps to shore up the banking system, namely by using up to $130 billion in EU funds torecapitalize struggling banks exposed to the collapsed domestic construction and real estatesectors.Investment IncentivesSpain has developed and implemented a wide range of aid instruments and incentives in order toattract national and foreign investors. The main points in which the Spanish government hasfocused on are:5

1. Training and employment;2. Research and development;3. Tourism and Industry.Moreover, as Spain is an EU member, the foreign investor who decides to invest and start abusiness in Spain will be able to access to European programs addressed to support investmentsin Spain. Spain has traditionally benefitted from EU funding from the Structural Funds and theCohesion Fund. It is estimated that between 2014 and 2020 European funding from the ERDFand financing for Trans-European Transport Networks (through the Connecting EuropeFacility) will make a positive contribution of an estimated €2.5 billion to certain regions andpriority areas.European institutions are tasked with encouraging and supporting technological research anddevelopment. The Seventh Framework Programme (PF7) for technological research anddevelopment is the EU’s the main tool for funding research in Europe. Its aim is to strengthenthe scientific and technological base of European industry and encourage its internationalcompetitiveness.Requirements and RegulationsRoyal Decree Number 664/1999 is the legal regime of foreign investments in Spain, as well as forSpanish investments in foreign countries. These investments can be, for example, theparticipation of a foreign investor on a Spanish company, constituting branches of a foreigncompany, or participating in investment funds.For the completion of the requirements set out by the Royal Decree Number 664/1999, theforeign investor has to fulfil a set of forms depending on the intended activity. As a general rule,foreign investments are only subject to reporting requirements once the investment has beenmade, while exchange control and capital movements are fully deregulated in Spain, there beingcomplete freedom of action in this regard in all areas. Nevertheless, there are some exception tothe latter specially regarding investments from tax havens and investments in certain regulatedactivities (air transportation, national security, etc.)Freedom of Operations and anti-money laundering obligationsSpain, as part of the EU, signed the Maastricht Treaty which proclaimed the free movement ofcapitals in between member states and with third parties. Royal Decree Number 664/1999 is theresult of the Treaty’s aims, establishing freedom of investments as its main goal with a series ofadministrative requirements.6

The only limit to the freedom of investments is the prerogative that the Council of Ministers hasto suspend the investing whenever the activities may affect the exercise of public powers, publicorder, state security, or health.The Directorate-General for Trade and Investments (“DGCI”) can generally or specificallyrequire Spanish companies which have foreign shareholders, and Spanish branches of nonresidentpersons, to file an annual report with it on the status of their foreign investments, justfor statistical purposes.Ministerial Order EHA/1439/2006 on reporting movements of means of payment in the contextof anti-money laundering, in force from February 13, 2007, establishes that export of coins,banknotes and bank checks to bearer, in euros or in foreign currency, although deregulated, issubject to prior administrative disclosure for purely informative purposes if the amount involvedexceeds €10,000 per individual per trip. If the disclosure is not made, Spanish customs officialsmay confiscate these means of payment.In addition, there is an specific regulation against money laundering (Act Number 10 of 28 April2010 on the Prevention of Money Laundering and Terrorist Financing), which defines theobligation to declare who is the last beneficial owner that holds and/or controls more than the25% of the share capital of the relevant company (if any transaction is carried out in Spain beforea notary public), this excludes companies listed on a regulated market of the European Union orequivalent third countries..7

FINANCIAL SERVICESSpain’s financial system is composed of credit market, stock market, monetary market andfutures and option markets. The Bank of Spain acts as a settlement agent; it is the central bankoperator in the country. Moreover, there are credit institutions that are mainly national orinternational banks, savings banks and savings unions. There are also the official creditinstitutions, investment institutions such as investment societies, investment funds or venturecapital societies, market brokers and assurance or reassurance companies.The Public Administration mainly intervenes in the monetary market and in the credit and stockmarket. Its powers are limited to the control in the access of the different agents, as well as forthe control of the different operations. The institution in charge of these functions is the SpanishNational Securities Market Commission (CNMV).ESTABLISHING A BUSINESSInvesting in Spain by foreign companies is connected to the general regime of liberalisationwhich can only be suspended by the Council of Ministers in those cases in which the investmentcan affect the exercise of public powers, public order, security or public health measures. It isconsidered as a “foreign investor”, the non-resident physical or legal person, domiciled abroad orwith his principal residence outside Spain.Before setting-up a Spanish corporation or limited liability company, formation of a SpanishBranch or entering in any other kind of business venture the foreign investor must note that theapplicable Spanish legislation requires that any individual or legal entity with economic orprofessional interests in Spain, or involved in a relevant way for tax purposes, must hold a taxidentification number (in the case of legal entities) or a foreigner identity number (for individuals)a N.I.F./N.I.E. respectively. Such a identification number shall be usually obtained beforeexecuting the relevant transaction.It is also important to underline the different regulations in force in Spain dealing with dataprotection and intellectual property. Data protection is regulated by the Act 15/1999 whichprotects data relating to individuals and in relation to their personal and familiar spheres. At thesame time there is the Spanish Agency for the Protection of Personal Data (AEPD), a publicentity which ensures the compliance of the abovementioned regulation and controls the access,rectification, opposition and cancelation of personal data held by third parties.Royal Decree 1/1996 approves the Act for Intellectual Property which protects the copyright ofSpanish, EU Member state, and third-state authors with regular residence in Spain and, if they8

have habitual residence outside Spain or the EU, if the first publication is in Spain or at leatstpublished in the Spanish territory withing 30 days since the first publication.FORMS OF BUSINESS ENTITIESIn generalThe main regulation for the incorporation of business entities is established in the Royal Decree1/2010, which approves the Spanish Companies Act.In addition, the restructuring of companies, such as merger and acquisitions, split-off, etc. areregulated by the Act 3/2009 of April 3..CorporationIn generalCorporations (SA) are most commonly used for financing important investment projects, beingthe most representative form of capital based entities.Forms of Business EntitiesAn SA’s capital is divided into shares, and the decisions are taken by the board of directors andthe shareholder’s meeting. The responsibility of the shareholders is secondary to the one of thecompany itself.Formalities of incorporationFounder shareholders of the company (either individuals or entities) or their representatives (withsufficient powers of attorney) must appear before a Spanish Public Notary in order to executethe public deed of incorporation, which must include the company’s by-laws. The public deedmust be recorded at the Mercantile Register of the province where the corporation is based. Onlywhen the company is recorded it acquires legal capacity. In between the execution of the publicdeed and its recording in the Mercantile Register, contracts can be celebrated on behalf of thecompany on formation but its enforceability shall be conditioned to the effective recording of thesaid incorporation deed in the relevant Mercantile Register, otherwise the representatives of thenew company who have signed of its behalf will be deemed jointly liable.Shareholders can be individuals or companies of any nationality or residence. In the case ofcompanies of foreign nationality wishing to become shareholders of an existing SA orincorporate a new one it is necessary that a certificate be issued by the Commercial Register ofthe country where the company is resident, which evidences the incorporation and existence ofsaid company as well as its management body. Such document, as well as the relevant powers of9

attorney, if applicable, must be duly apostilled accordingly to The Hague Convention dated on 5October 1961.Corporate nameThe first step in order to incorporate a company is to determine a corporate name and to requestsuch name to the Spanish Central Mercantile Register.If no other company registered in Spain holds the same corporate name, the Register issues acertificate reserving such name on behalf of one of the partners of the new SA. This certificatemust be attached to the public deed of incorporation.Minimum capitalThe minimum amount of issued capital required for an SA is EUR 60.000. The capital must befully subscribed and at least 25% of the nominal value of the shares must be paid in. The capitalis divided into shares, which may be either bearer or registered adopting necessarily this last formwhile they are not fully paid-up.The company’s by-laws must state the manner and time period for the payment of the remainingportion of issued capital. No maximum time period for cash contributions is stated in the Law,and the maximum time period for contributions in kind is five years from the date ofincorporation. Once the amount of the capital is agreed and paid in, the following steps must betaken:1 Open a bank account in name of the company “in process of incorporation”. To thiseffect, the bank will require a copy of the certificate issued by the Central MercantileRegister proving the reservation of the corporate name.2 Transfer into this account an amount of at least equal to the 25% of the subscribedcapital.3 Obtain from the bank a certificate proving the reception of the amount transferred. Ifthe shareholder is a non-Spanish-resident, the bank must state in the certificate theforeign origin of the funds. The certificate must be included in the incorporation deedthat must be authorised within the two months after the bank deposit.ShareholdersNo minimum number of shareholders is required to form an SA. However, a specific regime isapplicable to sole shareholder companies.Sole-shareholder companies must state such circumstance in in all company correspondence andcommercial documentation. Likewise, contracts between the company and its sole shareholderneed to be declared in the Annual Accounts and recorded in a special company registry.10

Foreign Investments in SpainWhen incorporating a new company or when pre-existing shares are being acquired before aNotary Public, a special form (D-1A) shall be signed by the foreign investor and later lodged inthe Foreign Investment Registry with a copy of the transaction document.Management BodyA board of directors, a sole director, two joint directors or two joint and several directors cancompose the management body of an SA. The form selected must be stated in the by-laws. It canbe changed at any time by the shareholders’ meeting. If a board of directors is created, it musthave a minimum of three members. There is no maximum. The members of the governing bodycan either be Spanish or foreign citizens.The term of the post is to be set at the by-laws and cannot exceed six years, but can be renewedfor equal periods indefinetly.The chairman is engaged in summoning and chairing the board but has no casting vote, unlessotherwise provided in the by-laws. The secretary can either be a board member or non-boardmember and is the person in charge of issuing the certificates of the corporate resolutions andgranting the relevant deeds. The legal advisor of the company usually occupies this post. Powersof attorney to conduct day-to-day business can be granted to any of the board members or anemployee of the company.Business purpose, domicile, duration and restrictionsTogether with the above explanation, some other aspects have to be foreseen: (i) the businesspurpose of the company, which shall be accurate and precise and usually establishes the generalframework for the activities of the company, (ii) the duration of the company, usually the by-lawswill stipulate that the duration is indefinite (iii) the corporate domicile, which must be located inSpain, (iv) the restrictions, if any, on the free transferability of shares or (v) the accounting yearend,on 31 st December.Limited-Liability CompanyThe limited-liability company (SL) is a company that allows one or more founding partners(either individuals or entities) that must subscribe to the entire, fully paid-up share capital. Thenumber of investors in this type of company is unrestricted.This type of company is currently the most used investment vehicle in Spain, specially amongstart-up projects and new entrepreneurs The capital of the company is divided into equalparticipations, which must be fully paid-up and are not freely transferable. The subscribers’11

liability is limited to the fully paid-up value of the participations. The capital of the SL has to beof at least EUR 3.000.Limited Liability Companies were traditionally used for small or family-owned businesses and, inrecent years, the form has become popular with other types of businesses. The requirements forincorporating a SL are almost the same as for an SA and thus the same comments made abovefor SA apply to SL, except for the following:1. FORMATION: An SA may be incorporated through a successive (public) placement,pursuant to which the promoters prepare the incorporation documents and offer theshares to the public. This possibility does not exist for an SL2. IDENTITY OF SHAREHOLDERS OR MEMBERS; The shareholders of an SA can maintaintheir anonymity, assuming they hold bearer shares, unless they are the sole shareholdersof the company, in which case the reporting requirements applicable to sole shareholdercompanies are triggered. On the contrary, there is greater control over the identity ofmembers of a SL, who must appear in the company’s member registry book. Solemember SL companies are subject to the same reporting requirements applicable to soleshareholder SAs.3. NEGOTIABILITY OF SHARES OR PARTICIPATION; The shares of an SA are fully negotiable,while SL’s participations are non-negotiable.4. TRANSFER OF SHARES OR PARTICIPATIONS: The transfer of shares in an SA is generallyunrestricted unless the by-laws provide otherwise. In practice the transfer is normallyformalised in a public document issued by a notary, commercial broker or authorisedconsular official, but it can be also executed by means of a private contract, whereas thetransfer of participations in an SL is generally subject to pre-emptive right and it must beexecuted according to the legislation by means of a public document issued by a Notary,Commercial Broker or authorised consular official.5. FINANCING: An SA can participate in all types of financing activities, including theissuance of bonds, public offerings of shares and inter-company loans and guarantees. AnSL, on the other hand, cannot issue bonds or participations in a public offering and maybe restricted in its ability to provide loans or guarantees to members or companyDirectors.6. MANAGEMENT AND REPRESENTATION; Unlike in an SA, an SL’s by-laws may providealternative types of director bodies, appoint directors for an indefinite term and designatesubstitute directors. However, an SL’s board of directors may have no more than 12members.7. INTERVENTION OF APPRAISERS AND AUDITORS: Unlike an SA, the intervention ofappraisers and auditors is not generally required for an SL, such as for the appraisal ofnon-monetary contributions and increase of capital by debt.8. WITHDRAWAL AND REMOVAL OF SHAREHOLDERS AND MEMBERS: Compared to an SA,there are more extensive circumstances under which a member of a SL can be withdrawnfrom the company. In addition, the Companies Act provides the rules for the removal ofSL members. There is no analogous provision for the removal of shareholders of an SA,nevertheless, the by-laws of the latter can include removal causes.12

9. INACTIVITY: Unlike an SA, the inactivity of an SL company for three consecutive years isgrounds for dissolution of the company, although the SL company may be reactivated ifit has been dissolved but not yet liquidated.10. LIABILITY OF SHAREHOLDERS AND PARTNERS: Both SA and SL are companies withcapital in which the liability of the shareholders is generally limited to the amount ofcapital contributed by each. The general rule is clearly one of limited liability; however,under very exceptional circumstances, the corporate veil can be pierced to protect theinterest of third parties.In these exceptional cases, the courts have followed the criteria of “piercing of the corporateveil” as a reaction against the abusive taking advantage of the company’s legal status by theshareholders or partners for fraudulent purposes. The courts may obviate it and differentiate theequity of each of the partners to establish liabilities.Super simplified steps for formation of limited liability companies were stablished under RoyalDecree-Law 13/2010, of December 3, on Tax, Employment and Deregulation Measures toPromote Investment and the Creation of Employment in order to expedite the formation oflimited liability companies by telematic means.BranchIn addition to the forms of business, enterprise created under Spanish law that constitute separatelegal entities, a foreign investor may operate in Spain through a branch that is a separateestablishment without own legal personality. Its function is to carry on and develop the samebusiness activity as the parent Company, being dependent for management support on the parentcompany.The branch must have a legal representative who is empowered by the home office to managethe affairs of the branch. Apart from this requirement, there are no formal administration ormanagement bodies. From the foreign investment legislation perspective, the branch must havean assigned capital that is not subject to any minimum amount.The formation of a branch requires the execution of a public deed that must be registered at theMercantile Register. The submission of several documents certifying that the parent company isincorporated and authorised according to the legislation of the country of origin is also required.Except for the obvious differences in terms of internal structure and organisation, a branchoperates much like a corporation in its dealings with third parties.For both exchange and tax purposes it is considered as an independent entity and treated underpractically the same rules as a Spanish-resident company but its liability is not limited to capital inSpain but it spreads to the whole capital of the parent company.13

Representative OfficeA representative office is an office opened by a non-resident in order to promote a particularactivity of the company represented through the office. The representative office cannot generateany income, being only a source of expenses due to the need to maintain the office. Arepresentative office is not subject to taxes in Spain (exception is made with municipality taxes).Joint VenturesThere are three types of join-venture structures in Spain, namely:1. Temporary Joint Venture, which is not a corporation. They are useful for specificprojects, especially for constructions or engineering projects. Despite they do not havelegal capacity, their registration is compulsory.2. Limited partnership agreement, which includes two types of members, i.e., theentrepreneur who contributes to a project and the managing participant. The first one hasthe right to participate in a percentage of the total benefit made by the project. It doesnot require any formality and one of its main characteristics is that the non-managinginvestors do not become shareholders.3. European Economic interest groupings (EEIGs) which are non-profit legal entities,incorporated by notarial deed. These types of company structures were created on 1985-07-25 under European Community (EC) Council Regulation 2137/85. It is designed tomake it easier for companies in different countries to do business together, encouragecross-border cooperation, or to form consortia to take part in EU programmes..Insurance CompaniesAct Number 50/1980 regulates insurance contracts, which are those concluded by the insurancecompany with the insured person. Moreover, Act Number 26/2006 regulates mediation ininsurances and private reassurance between mediators, insurance agents, and insurance brokerswith the insured subject.BanksRoyal Decree 1245/1995 regulates the creation of banks, transnational activities, and the legalregime of credit institutions. The Ministry of Economy and Finance, with a prior report by theBank of Spain and the Service for Prevention of Money Laundering, must authorize the creationof ex novo Banks.Payment Services ProvidersThe Spanish Act 16/2009, which transposes the directive on payment services in the internalmarket and complementary regulations establishes the minimum requirements that all payment14

services providers shall meet before and after obtaining the relevant authorization to be grantedby the Ministry of Economy Bureau and the Bank of Spain, most of the requirements concernthe share capital of the company, honorability of its partners and directors and economicguarantees for the users of the service.Besides having the company being incorporated in Spain with a corporate domicile anywherewithin the country, the law establishes a minimum share capital that ranges from the 20.000.-€ ifthe company only provides payment services, up to 125.000.-€ when the company performs allthe activities listed in section 1.2 of the Spanish Act (Money remittance, execution of paymenttransactions where the funds are covered by a credit line for a payment service user…).In GeneralEXCHANGE CONTROLSThe freedom of movement of capitals and economical transactions in Spain is free for EU-Residents due to the Maastricht Treaty signed up nearly twenty years ago. Furthermore, Spain hasextended this regime to all foreign investors, with no differences between EU-residents and nonresidents.The only exception is for those investments done from tax havens which require a prior controlby the Spanish Public Administration. These investors may be either physical or legal personnon-resident in Spain.Inward Direct InvestmentThe general rule is that there is no need for authorization or declaration in case of foreigninvestments due to the fact that not only EU-Member states are treated equally, but additionallySpain has extended this regime to the rest of the countries with a few requirements legallyestablished, only an ex post control.External investments are submitted in general to later declarations with the exceptions of taxhaven, non-EU Member’s investment in real estate for their embassies and foreign investments innational defence. Special requirements for air transport, radio, television, raw materials andstrategic minerals among others are required.Imports and ExportsThe Decree EHA/1439/2006 which regulates the declaration of movements of paymentmethods in the scope of the prevention of money laundering requires that the export of any typeof payment method is subject to administrative declaration when the total amount is above EUR10.000 per person and transaction. If the subject does not declare the abovementioned15

movement, the customs officers may seize them. This administrative declaration is required forinformation purposes.Furthermore, the movement in national territory of any kind of payment method that is equal orabove EUR 100.000 has to be previously declared to the custom officers.Outward InvestmentThose residents willing to make an investment outside of Spain have to declare in special cases tothe Bank of Spain. For example, it is mandatory to declare those investments for financing andadjourning of payments and receipts over one year, or credit offsets and debts between residentsand non-residents.Another requirement is the declaration of credits and financial loans given by non-residents toresidents, which further requires the obtaining by the resident of an identification number forfinancial operations, whenever the amount equals or exceeds EUR 3.000.000.In GeneralBasic LawLABOURThe basic law in this field is the Workers’ Statute (Royal Legislative Decree Number 1/1995),which defines the respective rights of employees and employers, general terms of labourcontracts, procedures for dismissal, and collective bargaining rules.In addition, there are specific regulations for different production sectors and certain groups ofemployed persons, such as commercial representatives and top management personnel.Another important source of labour law is collective bargaining agreements, which may benegotiated at state, industry, regional, or company level. Individual employment contracts arethus subject to a number of mandatory provisions that condition the labour relationship. Therealso are detailed regulations affecting working hours and worker safety and health in specificindustrial sectors.Non-discriminationThe Workers’ Statute generally prohibits employment discrimination on the basis of sex, maritalstatus, age, race, social status, religion, political ideology the different official languages in Spain.It also prohibits discrimination because of physical or mental handicaps if the candidate isotherwise suitable for the job in question.16

Minimum agePeople under the age of 16 cannot be employed. Nevertheless there are certain protectivemeasures for people under 18, such as the prohibition of working overtime or at night, or incertain dangerous or unhealthy activities or jobs.Employment durationTemporary contracts are generally “circumstance driven”, i.e., except for specific cases, theremust be circumstances justifying such temporary hiring. The types of temporary contracts thatcan be arranged are as follows:1. A “contract for a specific project or service” is arranged for the purpose of performingwork or providing a service which is temporary, being the maximum duration of thiscontract three years and may beextended 12 months by collective labour agreement. Afterthis period, the workers will acquire permanent status in the company.2. A “casual contract due to production overload or backlog” has a maximum duration of 6months within any 12-month period, unless otherwise stipulated in a collective labouragreement pertaining to a specific segment of workers of the activity. In that case, themaximum duration of the contract will be taken into account within any 18-month periodand may neither exceed the 3/4 of it nor 12 months. .3. A “contract to substitute employees entitled to return to their job” has a duration of theperiod during which the absent employee retains the right to return to his job.4. A “work experience contract” can be arranged either with a university,junior collegegraduates or people with vocational qualifications or recognized equivalent qualifications,provided that not more than five years -seven years for disabled people- have elapsedsince they completed the related training. The duration is from six months to two years.The contract is regulated by the Royal Decree Number 488/1998.5. A “trainee contract” replaces the previous apprenticeship contract and can be arrangedwith workers over 16 and under 25 years old who do not have the necessary qualificationsto obtain a work experience contract. This age limit does not apply to disabled people.The duration of this contract ranges from one year to three years, even though differentduration can be established by a collective labour agreement with a minimum of sixmonths and a maximum of three years. The contract is regulated by the Royal DecreeNumber 488/1998.Indefinite employmentNew modes of indefinite contracts have been regulated by acts 3/2012 and 4/2013:17

- Indefinite contract to support entrepreneurs, for companies with less than 50 employees.- Indefinite contract of a worker under 30 years old by a microenterprise.- Contract for new entrepreneurship projects for employers under 30 years old who hireworkers over 45 years old.There are other modes of indefinite contracts for unemployed workers registered at theemployment office that hold one of the following conditions:- Persons between the age of 16 and 30 and over 45, employed with the contract tosupport entrepreneurs.- persons with disabilities.- victims of domestic or gender violence (no need of being registered as unemployedworkers ar the employment office).- victims of terrorism and human trafficking .- workers in social exclusion.- women to serve in professions or occupations with lower rates of female employment.- women in the two years immediatly following the date of childbirth, adoption or fostercare of children.- women who return to employment after a period of five years off work.- workers who have been registered one month continuously as applicants foremployment.- workers who, during the two years preceding the entering of the contract, were employedexclusively through temporary contracts, including training contracts.- workers who, during the two years preceding the entering of the contract, had indefinitecontracts extinguished by a diferent employer.-The indefinite hiring could entail some benefits and discounts in the employer input to the SocialSecurity contribution.Trial periodIf the relevant collective agreement sets limits for trial periods, the trial period for a newemployee must be stipulated in writing, and in accordance with such limits. Otherwise, trialperiods cannot exceed six months for graduate technicians and two months in all other cases.In companies with fewer than 25 employees, the trial period for non graduate employees cannotexceed three months.In the temporary contracts with a six-month limited duration, the trial period cannot exceed onemonth, except as otherwise provided in the collective labour agreement .The indefinite contract to support entrepreneurs can establish a trial period of one year.18

Working hoursWorking hours are as specified in collective agreements or individual employment contracts. Themaximum legal workweek is 40 hours on an annualized average basis. Unless exceptional cases,overtime (i.e. hours worked in excess of the maximum legal or negotiated working hours) isvoluntary and, if paid, cannot exceed 80 hours per year.Overtime can be compensated by time off within four months from the date on which theovertime was worked. If payment for overtime is agreed upon in the collective agreement orindividual contract, the hourly overtime rate cannot be less than the normal hourly rate. Overtimeoffset with time off does not count towards the 80-hour annual ceiling.A minimum of one-and-a-half-days off per week is mandatory (usually Saturday afternoon and allday Sunday, or all day Sunday and Monday morning). Workers under 18 are entitled to twouninterrupted days off per week.The public holidays designated as such by the Central Government, Autonomous Communityauthorities and by the respective municipal authorities cannot exceed 14 in number per year. TheGovernment can move national holidays falling during the week to the following Monday. Anannual vacation of 30 calendar days is obligatory. Employees are entitled to pay leave of absencein certain circumstances such as marriage (15 days), lactation, childbirth or death, among others.Wages and salariesThe official minimum annual wage for people over 18 years old is EUR 9.034,20 for 2014(including 12 monthly and 2 extra payrolls). However, the minimum wages for each professionalcategory are ordinarily negotiated in collective bargaining agreements.Salaries cannot be paid at intervals of more than one month. At least, two extra payrolls must bepaid each year: one at Christmas and the other one at the date stipulated in the collectivebargaining agreement (generally before summer vacation period). Thus an employee’s grossannual salary is usually apportioned in 14 payrolls; however, payment in 12 monthly instalmentsmay be agreed upon in a collective labour agreement.Work and Residence PermitsNationals of non-EU countriesUnder Spanish labour legislation, non-EU nationals over 16 years old intending to work in Spainmust obtain a special work visa and work and residence permit.Work permits are granted taking into account the employment situation of Spanish nationals forthe same kind of work. However, there are certain preferential categories such as foreigners who19

have a Spanish spouse, workers necessary to set up foreign imported machinery, or topexecutives.General InformationForeigners legally working in Spain generally have the same rights and obligations as Spanishcitizens under the labour laws.The Spanish company hiring non-Community foreign employees who are to work for thecompany in Spain, is responsible for the commencement of the application procedure for thework and residence permits through filing a set of documents before the Aliens office of theprovince where the work will be produced or, otherwise, in the Labour Area and Immigration ofthe Provincial Delegation. As long as the worker is hired as employee the Spanish company hasto create an employment vacancy that will hardly be covered by a Spanish worker and must besubmitted at the Public Employment Service.Once the company has filed the documents, the worker has, within a month, to apply to theSpanish Consulate of his last place of residence for a visa to work and reside in Spain, furnishingthe work permit application together with a copy of the visa application and other documentssuch as a medical certificate, a criminal law clearance, etc.The work permit efficacy shall be suspended until the visa of residence is granted and theemployee registered in the Social Security System within three months since his legal entry inSpain and by the employer who applied the procedure.The employee must request the Foreign Identity Card in the foreign office or in the policestation in the province in which the procedure will be applied, within a month since he isregistered in the Social Security System.Foreigners who intend to reside in Spain but who will not work in this country, either asemployees or self-employed must obtain a residence visa before establishing their residence inSpain and a residence permit which can be temporary or permanent.According to the Spanish regulations, a non-UE resident company may temporally relocateemployees into Spain as far as the company has a duly established working centre in Spain (i.e.subsidiary, branch, representative office, etc), to what effect a so called type G labour permitmust be obtain.For granting type G permit, the following requirements should be met:a. The relocated employee must have a labour contract with the foreign company of at least ninemonths of seniority having had a labour relation in the foreign country for at least one year.b. The maximum duration of the relocation in Spain is for a one year period, although it mightbe extended by afurther period of one year.20

Law on visas for entrepeneursThis Act is aimed at investors, entrepreneurs, highly skilled professionals, researches, and workersperforming inter-company business operations, including their spouses and children under 18.The Act facilitates a swiftness of processing, generally establishing a resolve within 10 days for allvisa applications relevant to this law.The Residence Visa issued under this law is sufficient to reside in Spain one year without havingto obtain a foreign identity card. The renewal of Residency may take place even if absencesexist for longer than six months per year in the case of Residency Visas and authorisations forforeign investors and for foreign workers performing inter-company operations abroad or thathave established their base of operations in Spain.General Requirements:‣ Not to be on Spanish soil irregularly.‣ Be older than 18 years.‣ No criminal record in Spain or countries lived in during the last five years foroffenses stipulated under Spanish Law.‣ Not listed as objectionable in the territorial space of countries with which Spain hassigned an agreement in this regard.‣ Have a public insurance or private health insurance with a Health Insurance Institutionauthorised to operate in Spain.‣ Have sufficient financial resources for yourself and for the members of your familyduring the period of residency in Spain (€2.130 monthly for yourself and€ 532 for everyfamily member that is in your care).‣ Pay the fee for the processing of visa(s).It is important to mention that the processing of the Residency Visa is extended to the spouseand children under 18 years of age or to elderly family members who are not able to provide forthemselves due to their state of health, when they unite with or accompanyapplicants. Consequently they may apply, jointly and simultaneously or successively for a familyresidence visa, with proof of compliance with the above requirements.The presence of the applicant of the visa is not required because biometric data is notrequired. The residency visa may be requested and obtained through a duly accreditedrepresentative.21

TAXATIONIn generalThe Spanish tax system is composed of direct and indirect taxes. Direct taxes include corporatetax, income tax, non-resident income tax, inheritance and donation tax, and local taxes. Indirecttaxes include value-added tax (VAT), wealth transfer and legal documented acts, custom dutiesand special taxes.Corporate Income TaxIn generalLegislative Royal Decree 2 of 5 March 2004, by which the Corporate Income Tax Law wasapproved, and implemented by the Royal Decree 1777/2004, represented a major reform ofcorporate taxation in Spain. Its main objectives are harmonisation of rules for determining thetax base and accounting rules and the systemization of existing legislation.The key factor in determining the application of corporate income tax is the “residence”. Acompany is deemed to be resident in Spain for tax purposes if it meets any of the followingconditions:- It is incorporated under Spanish law.- Its registered office is located in Spain.- Its effective management headquarters are in Spain.In the event of a conflict of residence, the provisions of Spain’s tax treaties with other countrieswill, where applicable, prevail.Resident companies are taxed on their worldwide income. Taxable income includes all the profitsfrom business activities, income from investments not relating to the regular business purpose,and income derived from asset transfers.In this connection, Spain’s tax treaties with other countries, where applicable, may influence thedetermination of the tax base for taxation in Spain. Taxation of non-resident entities is regulatedseparately under the Income Tax Act for Non-Residents.Taxable incomeTaxable income is the company’s gross income for the tax year, less certain deductions. It isdetermined from the annual financial statements prepared under Spanish generally acceptedaccounting principles as adjusted for certain statutory tax provisions.In general, all necessary expenses incurred in producing income during the year and depreciationon income-producing property may be deducted from gross income to arrive at taxable income.Certain items are not deductible from gross income, such as the following:22

1. Penalties and fines2. Corporate income tax payments3. Gifts and donations4. Expenditures for the improvement or enhancement of capital assets5. Depreciation charges that exceed the maximum rates prescribed by law, unless it can beproved that the rates correspond to the actual depreciation incurredTax ratesThe general tax rate for residents and non-residents that conduct business activities in Spainthrough a permanent establishment is 30%..Entities that earned net turnover of less than EUR 8million in the immediately preceding tax year are taxed at a rate of 25% on profits up to EUR300,000.00, and at a rate of 30% on profits exceeding this amount. A super-reduced rate of 20%-25% will also apply for certain companies of a reduced size that create or maintain jobs. Othertax rates apply to certain specified entities.Loss carry forwardsAs a general rule, a resident entity can carry forward tax losses for offset against the taxableincome of the following 18 years. For newly incorporated entities, this 18-year periodcommences in the first fiscal year in which the entity reports taxable income.For tax periods beginning in 2011 through 2015, companies must consider the followinglimitations when using (offsetting) tax losses generated in prior periods:• Companies or tax groups whose turnover during the 12 months preceding the beginning of theyear has been at least EUR 20 million and less than eUr60 million: carried forward losses mayonly be used to offset up to 50 percent of the taxable income.• Companies or tax groups whose turnover during the 12 months preceding the beginning of theyear has been at least EUR 60 million: carried forward losses may only be used to offset up to 25percent of the taxable income.Withholding Taxes and advance payments.Spanish companies are also required to make three advance payments ( in April, October andDecember of each year) based on any of the following methods:1. Payments are calculated as 18% of the previous year’s tax liability. General rate is 18%. Thepayments are due on 20 April, 20 October and 20 December.2. Payments are based on the forecasted taxable income of the period as follows. General rate is21%. Three payments due on:23

• 20 April: Taxable income of the period January-March less withholdings.• 20 October: Taxable income of the period January-September less withholdings and advancepayment of 20 April.• 20 December: Taxable income of the period January-November less withholdings and advancepayment of 20 April and 20 October.The second system is mandatory for companies whose annual turnover is more than EUR6,010,121.04.In this system and only during 2012, 2013 and 2014, the general rate will be 21% for companieswhose annual turnover is between EUR 0 and EUR 10,000,000, 23% for companies whoseannual turnover is between EUR 10,000,001 and EUR 20,000,000, 26% for companieswhose annual turnover is between EUR 20,000,001 and EUR 60,000,000 and 29% for those withturnover of more than EUR 60,000,000.DoubleTaxation ReliefTax credit for domestic double taxation of dividends and on transfers of shares. Thiscredit completely eliminates double taxation when the resident company collecting thedividend owns at least 5 % of the resident company paying the dividend and has its holdingduring the 12-month period prior to the date on which the dividend is distributed.If these requirements are not met, double taxation is not avoided altogether, since 50% of thedividend received is taxed (or 100 % should certain anti-abuse provisions be applicable). Thecredit can also be taken on transfers of shares in respect of the amount of undistributedearnings generated in the period of ownership of the holding, provided that the requirementsdescribed above are met.Tax credit to avoid international double taxation. Traditionally, Spanish legislation hasadopted the credit method and the three-tier-underlying tax credit (for dividends) to avoidinternational double taxation.The exemption co-exists with the tax credit system (the taxpayer may opt for one or the other,although the application of both is incompatible).Under the tax credit system, all the income or capital gains obtained abroad by companiesresident in Spain are included in the tax base in calculating the tax due. The amount of taxeffectively paid abroad will be deducted from the tax due, up to the limit of the tax that wouldhave been payable on the income had it been obtained in Spain.The exemption system is applicable to income from business activities carried on abroadthrough subsidiaries or permanent establishments: Under the exemption system, dividends or24

profit participations derived from holding securities representing the equity of entities which arenot resident in Spanish territory and the income (gains) obtained from the transfer of thesesecurities are tax exempt in Spain provided the following requirements are met:1 The direct or indirect interest in the capital or equity of the non-resident entity must beat least 5% and this interest must have been held by the Spanish entity uninterruptedlyduring the year prior to the date on which the profit distributed becomes claimable (orwill be maintained for the time necessary to complete a year).2 That the non-resident entity has been subject to a tax of an identical or analogousnature to the Spanish corporate income tax in the tax year in which the profit which isdistributed has been obtained.3 The income from which the dividends or profit participations arise must be derivedfrom the carrying on of business activities abroad as defined by the Act.Neutral tax regime for restructuring operationsThe Corporate Income Tax Act provides for a special regime based on tax neutrality, thatguarantees the exception from taxation (both direct and indirect taxation) for corporatereorganizations (mergers, spin-offs ; contributions of assets) based on economic grounds.The special regime based on the principles of non-intervention by the tax authorities and taxneutrality, which guarantees the deferral of or exemption from taxation of both direct andindirect taxation, for taxpayers carrying out such operations, along the same lines as the rest ofthe EU Member States.Foreign portfolio holding company regimeA special tax regime applies to companies that have foreign portfolio holding company (ETVE)status. ETVEs are ordinary Spanish companies that engage in the administration andmanagement of participation’s in the equity of non-resident entities.The regime of participation exemption and foreign tax relief method may be used to avoiddouble taxation on dividends received from abroad and on capital gains derived from transfers ofshares of foreign companies if the following requirements are met:1 At the time of the distribution of the dividend or the generation of the capital gain, theSpanish company has owned, directly or indirectly at least 5% of the share capital of thenon-resident company for an uninterrupted period of at least one year. ETVEs are notrequired to hold the 5% share interest in the foreign company if the acquisition costexceeds EUR 6 million. For dividends, the one year period can be completed after thedistribution. In addition, the time period in which the participation is held by other groupentities is taken into account for purposes of the computation of the one-year period.2 The foreign company is subject to and not exempt from corporate tax in a tax systemthat is similar to Spain’s corporate tax system.25

3 The foreign company is not resident in a country identified by the Spanish tax authoritiesas a tax haven.4 The foreign company derives at least 85% of its income from business activitiesconducted outside Spain.Groups of companiesFor tax purposes, a group of companies is defined as a group of corporations resident in Spaincontrolled by a parent corporation that is a resident of Spain and that is not controlled by anotherresident company.The parent company may adopt any of these legal forms or, otherwise, it must have legalpersonality and be subject to and not exempt from corporate income tax.A company is deemed to control another company if, on the first day of the tax year for whichthe consolidated regime applies, it satisfies the following requirements:1 It owns, directly or indirectly, at least 75% of the other company’s share capital, and itmaintains such ownership for the entire tax year of consolidation.2 It is not subject to certain look-through regimes.3 It is not a subsidiary of another domestic controlling company.Tax exempt companies, companies taxed at a different rate than the parent company andcompanies in specified legal situations, such as bankruptcy, may not be part of a group ofcompanies.Net operating losses of a group company suffered in tax years in which it did not belong to thegroup may offset only the taxable income generated by such company.The consolidated return has significant advantages, most notably the fact that the losses of somegroup companies can be offset against the profits of others and inter-company profits areeliminated in calculating consolidated income.Special Tax situationsThe EU has harmonized the regulation of the different special taxes. This harmonization affectsalcohol consuming, energetic products such as hydrocarbons, electricity, tobacco labouring andother intermediate products.These taxes apply in a unique phase, for very specific consuming, and especially in thefabrication, production and importation of the abovementioned activities. These indirect andinstantaneous taxes apply only to Spain and not to the Canary Islands, Ceuta or Melilla.Taxes on Individuals26

Personal Income TaxIn General. This tax is currently governed by the Act 35 of 28 November, 2006 on PersonalIncome Tax, and by the Royal Decree 439 of 30 March 2007, approving the Personal IncomeTax Regulations and Act 22 of 18 December 2009 that regulates the financing system of theAutonomous Communities.Persons subject to the tax. Individuals who usually are resident in Spain are subject to personalincome tax. A taxpayer is deemed to be a usually resident at Spanish territory if any one of thefollowing conditions is met: The taxpayer is physically present in Spanish territory for more than 183 days in thecalendar year, or The main centre or base of the taxpayer’s activities or economic interests is in Spain,either directly or indirectly.In the absence of proof to the contrary, an individual is presumed to be resident in Spain if hisspouse (from whom he is not legally separated) and dependent underage children are habituallyresident in Spain.Individuals who are payers of non-resident income tax and are resident in a member state of theEU may elect to be taxed under Spanish personal income tax if they demonstrate that theirhabitual domicile or residence is in another EU member state and that at least 75% of their totalincome during the year was obtained as salary income or business income in Spain.Taxable event. Taxpayers subject to personal income tax are taxed on their entire worldwideincome, including the income of foreign entities in certain circumstances. The Act distinguishes ageneral tax base and a Savings tax base. The general base is the result of adding:1 Salary income2 Income from real estate3 Income from movable capital derived from the assignment of own funds to entitiesrelated to the taxpayer.4 Other income form movable capital which is not considered savings income, such as thatderived from the assignment of the right to use the image and intellectual property.5 Income from business activities.6 Imputation of income from real estate.7 Imputation of income from entities under the international fiscal transparency system.8 Imputation of income from assignment of rights of publicity.9 Changes in the value of units in collective investment undertakings established in taxhavens.27

The positive balance resulting from adding and offsetting against each other, exclusively, capitalgains and losses which are not considered savings income, such as:1 Income derived from an entity due to the status of partner, shareholder.2 Income from movable capital derived from the assignment of own funds to third entitiesnot related to the taxpayer or derived from related entities that meet the requirements inorder not to be included as general income (indicated above); and3 The monetary return or payment in kind on capitalization transactions and life ordisability insurance contracts.Only the capital gains and losses which are classified as savings income will be included andoffset against each other. If such result is negative, it may only be offset against positive balancesof this type of income which are shown in the following four years, and only the maximum limitallowed by the law may be offset.Exempt income. Noteworthy among the exemptions is that relating to salary income for workperformed abroad. This exemption will apply to salary income accrued during the days spent bythe employee abroad up to a limit of EUR 60,100 per year, if certain requirements are met,namely:1 Salary income must be paid in respect of work effectively performed abroad, i.e., thetaxpayer must be rendering services physically abroad.2 In the case of services rendered by related entities to each other, an advantage or benefitoccurs or may occur for the recipient.3 The recipient of the services must be either a non-Spanish-resident entity or a permanentestablishment situated abroad of a Spanish-resident company, and4 A tax identical or similar to the Spanish personal income tax must exist in the othercountry and such country must not be a territory classified as a tax haven, thisrequirement being deemed to have been met when in that territory a Convention for theavoidance of double taxation with an exchange of information clause with Spain isapplied.Net tax base reductions. There are certain reductions which will be used to reduce the generalnet tax base without making it negative, while any remainder will be used to reduce the savingsnet tax base. The main applicable reductions are:1 The taxpayer’s personal allowance.2 Allowance for descendants.3 Allowance for ascendants.4 Allowance for disability:Determination of the gross tax payable. For the calculation of the (national and regional)gross tax payable for the general net tax base which exceeds the amount of the personal andfamily allowances, a general tax scale and an Autonomous Community tax scale are established.28

The maximum marginal rate (for the year 2013) of the general tax scale is 30.5% and of theAutonomous Community tax scale is 25.5%.Withholding. Payments of income from movable capital, gains on shares or units in collectiveinvestment undertakings, and salary income are subject to withholding at source that is treated asa prepayment on account of the final tax.Moreover, employers are obliged to make personal income tax prepayments in respect ofcompensation in kind paid to their employees. The base and rate of withholding and prepaymentfor the main types of income are detailed in the table below:29

THE BASE, RATE OF WITHHOLDING AND PREPAYMENT FOR THE MAINTYPES OF INCOMEIncome Base RateGeneral24.75 / 56 %(min.) / (max.)Contracts lasting less than(minimum 2 %)one yearSalary income Special dependent Total amount ofemployment relationships compensation paid Minimum 18 %Board of directors42 %membersCourses, talks, assignmentof literary, artistic orscientific works21 %tIncome frommovablecapitalProfessionalactivitiesGeneralFull considerationclaimable or paid21 %General 21 %Commencement of activity Amount of revenues or 7 %and subsequent two years consideration obtainedTHE BASE, RATE OF WITHHOLDING AND PREPAYMENT FOR THE MAINTYPES OF INCOMEIncome Base RateCapital gainsOther incomeTransfers of Real Estate orreimbursements of sharesand participations incollective investmentschemesAmount to be includedin the tax base,calculated according tothe Personal IncomeTax Regulations21 % applicable tothe first 6.000€25 %, from 6.000€ to24.000€27 %, from 24.000€Cash prizes Amount of the prize 21%Lease/sublease of urban Amount of rent andproperty other items paid to the 21%lessor or sublessor -VATIntellectual an industrialproperty lease/sublease ofmovable property and Full amounts paid 24%businessesLicensing of rights of Full amounts paid 21 %publicity30

Taxpayers who are required to file a personal income tax return must, when filing their returns,calculate the related tax payable and pay it over in the place and manner and by the deadlinesdetermined by the Ministry of Economy and Finance. The deadline is usually June 30.Non-residentIn generalIndividuals and entities non-resident in Spain are liable for non-resident income tax on theincome and/or gains they obtain in Spain.Non-resident with a permanent establishmentTaxpayers obtaining income and gains through a permanent establishment in Spain are taxed onall the income and gains attributable to the permanent establishment. Permanent establishment inSpain of non-resident individuals are subject to the same tax rate.Non-resident without a permanent establishmentTaxpayers obtaining income and gains without permanent establishment are taxed separately oneach full or partial accrual of income and or gains obtained in Spain.There are certain exceptions, including among others:1 Interest and other income from the transfer of own capital to third parties obtainedwithout the intermediation of a permanent establishment by residents of other EU-Member States (except tax havens).2 Dividends distributed by a Spanish subsidiary to its EU parent company.3 Income paid as a result of the international sale of goods.The tax rates applicable to non-residents without a permanent establishment are as follows Pleasetake note the tax treaties signed by Spain and certain special rules where the non-resident residesin an EU country.TYPE OF INCOME RATE ( %)General (including royalties) 24.75 %Dividends 21 %Interest 21 %Gains from transfer or redemption of units/shares in the capital 21 %or equity of collective investment institutionsCapital gains 21 %31

ExpatriatesSpanish personal income tax legislation contains a highly attractive regime for personnel assignedto Spain by multinational enterprises, since it allows individuals who become tax resident in Spainas a result of their assignment there to elect to be taxed either under the Spanish personal incometax rules or under the non-resident income tax rules during the tax period in which their taxresidence changes and for the next five tax periods.If they choose the latter, expatriates are only taxed on income and gains considered to have beenobtained in Spain, at a standard rate of 24.75%.Double Taxation Treaties in force with SpainSpain has signed a series of treaties with Germany, Saudi Arabia, Algeria, Argentina, Australia,Austria, Belgium, Bolivia, Bosnia and Herzegovina, Brazil, Bulgaria, Canada, Czech Republic,Chile, China, Colombia, South Korea, Costa Rica, Croatia, Cuba, Denmark, Ecuador, Egypt,UAE, Slovakia, Slovenia, United States, Estonia, Finland, France, Greece, Holland, Hungary,India, Indonesia, Iran, Ireland, Iceland, Israel, Italy, Jamaica, Japan, Latvia, Lithuania,Luxembourg , Macedonia, Malaysia, Malta, Morocco, Mexico, Moldova, Norway, New Zealand,Poland, Portugal, United Kingdom, Romania, Russian Federation, El Salvador, Serbia, SouthAfrica, Sweden, Switzerland, Thailand, Trinidad and Tobago, Tunisia, Turkey, States of theformer USSR (except Russia), Venezuela and Vietnam.The main aim of these treaties is to give legal security and reduce taxation on foreign investors.Currently Spain has signed 91 double taxation treaties being 79 of them in force. The rest ofthem are pending with Armenia, Barbados, Georgia, Hong Kong, Kazakhstan, Kuwait, Namibia,Nigeria, Pakistan, Panama, Peru, Senegal, Singapore and Syria.Value added taxIn GeneralThe Spanish value added tax (VAT) legislation (Act Number 37/1992, which came into force on1 January 1993) implements the EU Directives on VAT, whose main rules are harmonized within the different member states.The tax is of an indirect nature, its main feature being that it does not normally imply any cost totraders or professionals, but only to end-consumers as traders are generally entitled to deductVAT borne against VAT charged.Within Spain, VAT is not applicable in the Canary Islands, Ceuta and Melilla.The Canary Islands Indirect General Tax (CIIGT) is based on VAT and is an indirect general taxlevied on goods and services supplied in the Canary Islands by traders and professionals and onimports of goods. The standard CIIGT rate is 5 %.Another indirect tax (tax on production, services and imports) is applicable in Ceuta and Melilla.32

Taxable eventsThe following transactions are subject to the tax, when carried out by traders or professionals inthe course of their business activities:1 Supplies of goods, generally defined as transfers of the right to dispose oftangible property, although certain transactions that do not imply such transferalso may be treated as supplies of goods for the purposes of the tax;2 Intra-EU acquisition of goods (in general, acquisitions of goods dispatched ortransported to the Spanish VAT territory from another Member State).3 Imports of goods, these transactions being subject to the tax regardless ofwhether or not the importer is a trader; and4 Supplies of services.Value Added Tax Rates and ExemptionsThe standard VAT rate is 21 %, applicable to most sales of goods and services.A reduced rate of 10 % is applicable, amongst others, to sales and imports of:1 Human and animal foodstuffs, except alcoholic beverages;2 Water;3 Pharmaceutical products; and4 Private homes.5 Theatres and cinemas.VAT applies to the following services:1 Domestic transportation of passengers and their luggage;2 Hotels; and3 RestaurantsThere is a reduced VAT rate of 4% applicable to:1 Bread, flour, milk, cheese, eggs, fruits and vegetables;2 Books, newspapers and magazines not mainly containing advertising;3 Pharmaceutical specialties;4 Automobiles of handicapped people;5 Prostheses of handicapped people; and6 Certain officially sponsored housing.Following the EU model, certain transactions are VAT-exempt (e.g., supplies of goods andservices relating to insurance and financial activities, health, education and rental of residentialproperty). As these transactions imply that no VAT is charged by the trader, their performancedoes not qualify for the right to deduct the VAT borne as described below.33

Place of Supply of Taxable TransactionsSpanish VAT is levied on transactions that are considered to be performed within the territory inwhich it applies. The Act establishes rules to determine the place in which a certain transaction iscarried out.Thus, in the case of supplies of goods, the general rules establish that the supply takes place inthe Spanish VAT territory when the goods are made available to the acquirer in such territory.However, if the goods are dispatched or transported, the place of supply is generally that fromwhich such transport is initiated. Other specific rules apply to, for instance, supplies of goods tobe installed or assembled prior to supply.As a general rule, services are deemed to be supplied in the Spanish VAT territory when thesupplier has a place of business in such territory (see text, below).TaxpayerThe taxpayer is the person obliged to charge VAT. This obligation falls normally on the tradersor professionals who make the corresponding supplies of goods or services subject to the tax.Notwithstanding the above rule, some exceptions are established under which it is the recipientof the supply who has to account for the VAT due.It the supplier has a permanent establishment in the Spanish VAT territory, it will be consideredas the VAT payer of the corresponding supplies, regardless of whether or not it carries out thetaxable transactions from such establishment. The status of VAT payer gives rise to obligationsto:1 Submit declarations relating to the commencement, modification and cessation of theactivities that result in their being subject to the tax;2 Apply to the tax authorities for a tax identification number and notify and substantiatethe number in such situations as are required;3 Issue and deliver invoices or equivalent documents for their transactions, and keepcopies thereof;4 Keep such accounts and records as are required (specific VAT books);5 Submit regularly or at the request of the tax authorities information on its economicoperations with third parties;6 Submit the appropriate returns (and an annual summary return) and pay in theresulting amount of the tax, these returns being filed quarterly or monthly, dependingon the turnover of the VAT payer; and7 Appoint a representative to comply with its obligations when the VAT payers are notestablished (i.e., do not have their place of business or a permanent establishment) inthe Spanish VAT territory.This final obligation is only incumbent on traders not established in the EU, unless they are34

established in a country with which instruments of mutual assistance exist.Deduction of Input Value Added TaxVAT payers are generally entitled to deduct from the amounts of VAT charged on taxabletransactions carried out by them the amounts of tax borne, insofar as the goods and servicesacquired are used by them to perform the following transactions:1 Supplies of goods and services subject to and not exempt from VAT;2 Transactions that, although exempted, relate to international trade (exports or intra-EUsupplies); and3 Transactions performed outside the Spanish VAT territory that would have given rise tothe right to deduct had they been performed within the territory.The right to deduct also is conditional upon formal requirements, and it may be exercised in aperiod of four years.RefundsWhere the VAT charged exceeds the deductible VAT borne, the VAT payer must pay thedifference through its periodic monthly or quarterly returns.If, at the end of the year, the amount of deductible VAT borne exceeds the amount of VATcharged, the VAT payer is entitled to a refund which, in general, can only be requested throughthe last return of the year. Such refund must be obtained, in general, within the six monthsfollowing the deadline for filing the last return of the year (January 30). Special rules apply toVAT borne in Spain by non-established traders.Inheritance and Gift TaxInheritance and gift tax applies to Spanish resident heirs, beneficiaries and donees and is chargedon all assets received (located in Spain or abroad).Non-resident beneficiaries also are subject to this tax as non-resident taxpayers and must pay thetax in Spain only on the acquisition of assets and rights (that are located, exercisable, or to befulfilled in Spain).The tax is calculated by adjusting a tax scale of progressive rates with a coefficient that takes intoaccount the previous net worth and the degree of kinship with the donor.As with other taxes transferred to the Autonomous Community Governments, inheritance andgift tax legislation has been adapted to recognize the legislative power of those governments toapprove reductions in the tax base and rates and in the coefficients for adjusting the tax payable,based on the taxpayer’s previous net worth.35

The Government is considering the possibility of progressively eliminating this tax at centralgovernment level, although since it is a tax that the Autonomous Community Governments areresponsible for collecting, it has already been eliminated in practice by some AutonomousCommunity Governments (Cataluña, Cantabria, the Basque Country and Madrid).Transfer tax and stamp taxCorporate TransactionsTransactions such as incorporation, reduction at companies, are subject to a general tax rate 1%.The Corporate Law has eliminated the cases in which tax is levied on mergers, spin-offs, assetcontributions and exchanges of securities, these transactions being defined in accordance withthe Corporate Income Tax Law (special tax neutrality regime).Since December 2010, specific commercial operations such as the incorporation and socialcapital increase of companies are not subject to this tax.Transfers of Real EstateReal estate transfers are subject to a general tax rate 6%. The Autonomous Communities areentitled to apply a different rate in certain cases. Most of them have decided to apply a 7% to a10% rate to real estate transfers and a 1% to 2% rate of Stamp Tax to certain transactions.However, if the vendor is a company, the transfer of build or the first supply of buildings is taxedunder VAT. Second and subsequent supplies of real estate by companies, traders, orprofessionals in the course of their activity may opt to pay either transfer tax or VAT. Thisoption is applicable if the acquire is a trader or professional who can deduct all his VAT.Transfers of shares of Spanish companies are generally exempt from any indirect taxation, exceptwhen more than 50 % of the capital stock of a company is transferred (or shares increasing thestake in a certain entity when the acquirer already has more than 50 %) and at least 50 % of theassets of such company consist of real estate located in Spain: in this case the transaction will beconsidered for indirect taxation purposes to be a transfer of real estate subject to transfer tax.Transfer tax is a cost to the acquirer/beneficiary.Transfers of Movable Assets and Administrative Concessions.Such transfers are subject to a general tax rate of 4%.Mercantile Law Public Deeds36

Certain mercantile law public deeds are subject to a general tax rate of 0.3 %.Local TaxesIn GeneralLegislative Royal Decree Number 2 of 5 March 2004 regulates the local taxation system. TheLocal Authorities, under the referred legislation, are empowered to modify some points of thistype of taxes. The referred regulation states the following taxes:- Real Estate Tax. This tax is levied annually on owners of Urban or Rural Real Estates oron holders of rights in rem, based on the cadastral valued determined pursuant to theProperty Cadastral regulations.- Tax on Economic Activities. This Tax is levied annually on any professional or businessactivity done within the territory of the Municipality. Exempted are taxpayers who start abusiness activity and during their first two financial statements, individuals, and thosecompanies whose annual turnovers in the previous year were under EUR 1.000.000.Tax on Increase in Urban Land ValueThis Tax is levied on the increase in the value of any urban real state, when the land is transferredor levies a security interest of the referred properties. This tax is deductible for personal incometax purposes from the transfer value of Real Estate.Tax on Motor VehiclesThe Tax is levied annually on the ownership of any motor vehicles, on the basis of thehorsepower of the vehicle.Tax on Erection and Installation Projects and Construction workThe Tax is levied on the current cost of any Work or Construction activity that requires thepermit of the Municipality.37

FAQ’SWhat steps are necessary for setting up a company in Spain?The basic requirements for setting up a company in Spain are its incorporation before aNotary Public and its filing with the “Registro Mercantil” (“Mercantile Register”).Nonetheless, in order to meet these requirements, the following steps must be carriedout:ooooooooooooIn case of doing it by means of a representative, granting of representative powers bythe founder/s to the person who will be responsible for incorporating the company.Application for a Tax Identification Number (“NIF”) in the case of a legal entity, or aNIE (Foreigners Identity Number) in case of a natural person, of the partners andforeign directors of the company that is to be incorporated.Application for a certificate to prove that no other company is operating under thesame name.Opening of a bank account for transactions and to obtain a bank certificate.Incorporation of the company before a Notary Public by means of a deed ofincorporation.Application for provisional Tax Identification Number for the company.Settlement of the “Impuesto sobre Transmisiones Patrimoniales” –“Capital TransferTax”.Filing with the “Registro Mercantil” (“Mercantile Register”).Obtaining the final Tax Identification Number of the Company.Legalization of Official Trade Books.Tax procedures.Employment procedures.For further information, please click on the following worksheet.38

What is needed in order to formalize a valid power of attorney in Spain?A power of attorney may only be granted by someone with legal authority: either thegrantor himself, in case of a natural person, or a legal representative or director withsufficient powers, if the grantor is a legal entity.a) In case of a Spanish legal entity, the power of attorney is granted in Spain. The persongranting the power of attorney must appear before a Notary Public. Neither the presencenor the acquiescence of the attorney is necessary.b) In case of a foreign legal entity, the power of attorney is granted in the country oforigin. The person granting the power of attorney must appear before a Notary Public ofthe country where it is granted. The power of attorney must then be legalized via theHague Apostille of 1961 if the country where it is being granted is a country member ofthe 1961 Hague Apostille. If the country where the power is being granted is not amember, all the steps of document legalization applicable to each case must be followed.If the power is not granted in Spanish, then it must be translated by a sworn translator.In both cases, the grantor should present the document which proves her/his capacityand standing to grant the power.What documents are required for the granting of a power of attorney?The only document that is required in order to grant a power of attorney is proof that thegrantor is an authorized representative; specifically:If the grantor is a natural person, a document that proves his/her identity.If the grantor is the representative of a company, the public document which proves hisauthority.If the grantor is the Secretary of a company, the public document which proves his office.What is a NIE?The applicable regulations require in certain cases that foreign natural or legal persons inSpain obtain a Foreigner Tax Identification Number. In the case of natural persons,“NIE”, and, in the case of legal entities, a Tax Identification Number, “NIF”.39

Who needs a NIE or a NIF?Foreigners who, due to their financial, professional and social interests, have any interestsin Spain, will be given, for identification purposes, a sequential number that is personal,unique and exclusive. This number will be the identification number and must appear onall the documents that are issued or processed to such person.Foreign natural persons or legal entities in Spain must have a Spanish NIE or NIF,among others, in the following cases of mercantile practice: when they are partners ordirectors of Spanish companies, to grant deeds of sale of real property and deeds relatedto rights over properties, to carry out any sort of financial transaction within Spain (forexample, opening a bank account) or completing any government form from the Spanish“Oficina de Extranjeros” (“Provincial Immigration Office”) or “Agencia Tributaria”(“Tax Agency”).When can I apply for a NIE?A NIE may be previously applied for in the consulate of the country of origin, or afterarrival in Spain, at the relevant Provincial Immigration Office (“Oficina de Extranjería”).However, it is advisable to begin application proceedings before initiating any formalitiesin connection with incorporating a company, to avoid delays in the process. The filing ofthe NIE application shall be made in person or by a legal representative. Representativesmust have a power of attorney authorizing them to act on behalf of the foreigner toobtain his NIE.A NIF must be requested as a requirement prior to incorporating a company in Spain orbefore making any delivery, providing or acquiring goods or services, collecting sums ormaking payments, or for the performance of any corporate or professional activity.What documents are necessary when applying for a NIE?For requesting a NIE you need:1. A standard form (Form EX15).2. Complete passport or travel identification or, when necessary, a valid identitycard.3. Statement of the reasons for the application, issued by a Notary Public.Applications submitted by the representative appointed by the person concerned areaccepted, if the following documents are attached:40

4. Standard application form (Form EX15).5. Updated copy of all the pages of the passport, certified by a Notary Public,legalized or apostilled when necessary.6. Certification regarding the validity of the powers granted to the appointedrepresentative.7. Statement of the reasons for the application.When requesting a NIF, the following documents are necessary:8. Standard application form (Form 036).9. A photocopy of the identity card of the applicant, passport and NIE.10. Document certifying the existence of the foreign legal entity or “certificate ofgood standing/ k-bis” apostilled or authenticated and with a sworn translationinto Spanish. This document may be the deed of incorporation in its country andthe company by-laws filed with an official registry in its country or a certificateissued by a Notary Public or tax authorities certifying the company's existence.11. Applications filed in Spain by the representative appointed by the company areallowed, provided these enclose representation documents, in other words, apower of attorney granted by the authorized representative of the non-residentcompany, duly formalized before a Notary Public and apostilled or authenticatedand its sworn translation, if appropriate, which empowers a person to obtain aNIF.Where can I apply for a NIE or a NIF?NIEIn Spain: at the Government Delegations and Sub-delegations via their services and theProvincial Immigration Office (“Oficina de Extranjería”) corresponding to the place inwhich the procedure began (i.e. where the services are provided, where the company isresident or domiciled...).Abroad: at the diplomatic mission or consular section of Spain located in the foreigner'scountry of residence, where the reasons for the application must be communicated.NIFAt the Spanish Tax Agency (“Agencia Tributaria”) in Spain.41

What are the most common types of companies in Spain?The most common types of companies are:o “Sociedad de Responsabilidad Limitada” –“Limited Liability Company”-;o “Sociedad Anónima” –“Public Company”-;o “Sociedad Anónima europea” –“European Public Company”-;o “Sociedad Civil” –“Civil Company”-;o “Sociedad Colectiva” –“Collective Company”-;o “Sociedad Comanditaria” –“Limited Partnership”-;o “Sociedad Comanditaria por Acciones” –“Limited Partnership by shares”-;o “Cooperativa” –“Co-operative”-.Nonetheless, in practice, most companies in Spain are either “sociedades anónimas” –“public companies (S.A.)”- or “sociedades de responsabilidad limitada” –“limited liabilitycompanies (S.L.)”-, since both limit the liability of the shareholders to the amount thatthey have invested. Thus, according to statistics from the “Registro Mercantil Central” -“Central Mercantile Register”-, approximately 98% of Spanish companies are “sociedadesde responsabilidad limitada” –“limited liability companies (S.L.)”- and the remaining 2%are “sociedades anónimas” –“public companies (S.A.)”. The presence of other types ofcompany is negligible.For more information and for a comparison between public companies and limitedcompanies, see the following worksheet.What documents are necessary for the establishment of a company in Spain?The following documents are necessary when incorporating a company in Spain:1. Power of attorney.The founders should grant a sufficient power of attorney to the person responsible forincorporating a new company in their name in Spain.2. NIE or NIF of the foreign partners and directors.If the founders wish to appoint a non-resident person as their representative, then thisperson may give a power of attorney to someone who can apply for the NIE or NIF(depending on whether the new director is a natural person or a legal entity) on theirbehalf.3. Certificate of availability of the company name for registration.42

The chosen name of the new company must be requested to the “Registro MercantilCentral” –“Central Mercantile Register”- which will, in turn, confirm the reservation ofthe same and check to ensure that it is available and may be used by the new company.The certificate of availability of the company name can be requested by the Notary Publicthrough the use of Web-based technology.In principle, this certification is valid for three months and should be renewed if the newcompany is not incorporated within that period. Nonetheless, no one else may reserve thesame name within the following three months so, in practice, the reservation remainsvalid for six months.4. Bank certificate proving that the relevant payment has been made.When the new company is incorporated, the relevant sum is usually paid in cash ortransferred to a Spanish bank account in the name of the new company with the words“sociedad en formación” –“-in process of incorporation-” added at the end. For theopening of this account, the bank will require a document that proves that all the steps tocreate a company are being taken, normally a copy of a certificate stating that the namethat the new company intends to use is not being used by any other company.The deed of incorporation shall include the receipt of the bank certificate.5. Documents required by the Spanish Notary Public.In addition to the documents mentioned in the preceding paragraphs, the following willalso be necessary:oooBy-laws of the new company including, at least, the minimum requirements stipulatedby Spanish law.Original identification documents and powers of attorney of the founders thatincorporate the company.Foreign investment declaration duly filed (Form D-1A, available through downloadfrom Aforix by accessing the following link: Aforix) . This document is compulsoryalthough its purpose is only informative, and it must be delivered to the “Secretaría deEstado de Comercio” –“Secretary of State for Trade”- within the first month of thenew company’s existence. The Notary Public may take charge of this task, if sowished.6. Deed of actual ownership.Notaries Public shall identify the natural persons (name, surnames, nationality andidentification number) that own or control, directly or indirectly, a stake over 25% of theshare capital or of the voting rights of a Spanish company or the natural persons that by43

other means have control, either directly or indirectly, of the management of theaforementioned company. The companies that quote in a regulated market of theEuropean Union or other assimilated countries are exempt of this.7. NIF (Provisional Tax Identification Number) before the Spanish Tax Agency(“Agencia Tributaria”). Notaries Public may request the provisional NIF by electronicmeans on behalf of the company.8. Settlement of the Tax on Capital Transfer and Stamp Duty at the relevant paymentoffices according to the address of the company.9. Documents needed in the “Registro Mercantil” –“Companies Register”-.The public deed of incorporation of the company must be submitted. It can be submittedby the Notary Public by electronic means.10. Obtaining of the final NIF before the Tax Agency.11. Fiscal registration of commencement of activity before the Tax Agency, ifappropriate.12. Registration of the company with the Social Security, if appropriate.Which is the most appropriate manner for setting up a company according to mybusiness needs?As a general rule, setting up a business requires the creation of a “sociedad anónima” –“public company (S.A.)”- or a “sociedad de responsabilidad limitada” –“limited liabilitycompany (S.L.)”-- choosing which type of company depends, among other factors, on thestrategy for each business and the activities to be carried out in each specific case.A branch could be more convenient given the fewer legal obligations. A representativeoffice will only be used in the event that the activities carried out are merely those ofcoordination, collaboration or promotion of the head office’s activity....S.A. or S.L.?In general terms, a “sociedad de responsabilidad limitada” –“limited liability company(S.L.)”- is used because:1- It requires contributing less capital.2- It requires less administrative formalities to operate.3- It offers more flexibility for resolutions adopted by the partners.44

A “sociedad anónima” –“public company (S.A.)”- is used in the following circumstances:1- If an activity reserved by the Companies Act will be carried out (banking companies,pharmaceutical companies, pension funds management companies, insurance companies,among others).2- If significant movement of capital is expected.3- If, as a shareholder, who will not take part in the management of the company, theintention is to be especially formal in the performance of the company’s acts, which mayhave greater impact on the investment (for instance: merger, transformation, dissolution,convening an annual general meeting, capital reduction, non-monetary contributions, etc.)In either case, before making a decision, consulting a legal advisor is recommended....branch or subsidiary?A branch office is not a separate legal entity. It is dependent on the head office and doesnot require a minimum allocation. This option may be of interest if the head office wishesto have greater control over the branch’s activity. Keep in mind that the parent companywill be held accountable with its own capital for the activities of its branch.A subsidiary, because it is an independent legal entity, generally has greater flexibility ofaction and shares the risk with its head office....branch or representative office?The representative office will only be useful when no economic activity is to take place inSpain and only if it is engaged in coordination, collaboration or promotion of the parentcompany’s office.The above notes and comments are published as a service to our clients and collaborators onlyfor informative purposes. The object of such comments does not substitute the specific legaladvice that should be required for every case and its transmission does not create any bindingrelation lawyer-client between the sender and the recipient. Bufete B. Buigas, S.L. makes availableto you all the services of its law firm if further or additional information is required on the subjectcontained in this Report.Source of information:ICEX, The Spanish Institute for Foreign Trade.Ministry of Economy and Competition of Spain.45

BUFETE B. BUIGASABOGADOS ASOCIADOSOFFICE IN BARCELONA: Iradier 21, 08017 Barcelona - SpainOFFICE IN MADRID Paseo de la Castellana, 164, 5º izq, 28046 Madrid - Spainwww.buigas.com46

SENGULER & SENGULERLAW OFFICEDOING BUSINESS IN TURKEYTURKEY2013

TABLE OF CONTENTSINTRODUCTION 2BUSINESS STRUCTURES IN TURKEY 3Joint Stock Company 3Limited Liability Company 4Branches 4Liaison Office 5Nationality of Board of Directors and Managers 5TAXATION 6Corporation Tax 6Income 6Value Added Tax 7ANTI- CORRUPTION 8The UN Convention 9The OECD Convention 10EMPLOYMENT RELATIONS 11Fixed Term or Indefinite 11Termination of Employment Contracts 11Work Permits 12ACQUISITION OF PROPERTY 15Acquisition by Foreign Company 15Acquisition by Individuals 161

INTRODUCTIONIn the last 10 years Turkey has experienced a rate of economic growth close to the best inthe world. This has been attributed to several factors:• a shift from a focus on agriculture to a focus on industry and the services sector;• rapid modernisation of the existing industries and class leading technologytransfer;• Political stability and good economic management;• The EU accession process bringing massive legal infrastructure change;• Successful Privatisation programmes;• Istanbul becoming the go to place for Middle East/Asian business and tourists;• Strategic positioning as an Energy corridor between East and West;• Improved relations with neighbours.In addition, private investments were the driving force in accelerating economic activitiesin recent years. The liberalisation of capital movements and the willingness of foreigncreditors to lend to Turkish investors contributed to the high growth rate of privateinvestment.Turkey attaches a high priority to the encouragement of foreign investment and provides avariety of incentives.Please note that many of the laws referred to below are complex and the followingsummaries are very general in nature. This document is not legal advice. Please do not actin reliance upon it but always seek specific legal and other appropriate professional advicebefore taking action.2

BUSINESS STRUCTURES IN TURKEYThere have been recent reforms in respect of business structures following the New TurkishCommercial Code (“New TCC”) coming into force on 1 st July 2012.The New TCC brings in some very important changes. It is designed to achieve thefollowing:• increase competitive power;• establish public confidence in corporate entities; and• bring about greater transparency and accountability.Furthermore, the New TCC aims to meet Turkey’s long and short-term needs by regulatingcommercial issues in line with the changing local and global business environment,improve investor confidence, and by creating more efficient legal institutions andmechanisms. These developments will in turn enable Turkey to function better as a moredynamic member of the international community of trading nations.Among others the New TCC has brought in many novelties in the corporate governance ofTurkish legal entities. As a result establishment is easier and restructuring procedures aresimpler. Limited Liability Companies and Joint Stock Companies will enjoy many commonbenefits stipulated under New TCC.In light of the New TCC, we set out below the principal options currently available forforeigners establishing businesses in Turkey.Joint Stock CompanyThe main features of Joint Stock Company (“AS” or “JSC”) structure is as follows:i) The initial capital amount for a JSC must be minimum 50,000.00 TL (Turkish Liras). It isalso obligatory to deposit ¼ of the capital before registration into a bank accountopened for the company in the incorporation process. The remaining amount mustbe paid within twenty four (24) months following the incorporation. Real estates andother assets including intellectual property rights and virtual platforms can besubscribed as capital-in-kind. Any cash payments must be made to an account of abank established in Turkey.ii)With the new Turkish Commercial Code a JSC may be incorporated with a singleshareholder. The minimum number of board of directors for JSCs is one.3

Specific Characteristics of the JSCs• These entities can operate in banking and insurance businesses if they meet therequirements stipulated by relevant laws related with such industries.• This type of company is most suitable to run a Joint Venture between foreign investorsand locals since there can be a management control established by special votingrights on classes of shares.• A company must engage a locally qualified accountant, to be responsible for theaccounting records of the company, tax returns and annual accounts.• It is expected that it has a proper place of business (evidenced by a rent contract ortitle deed in Turkey).Limited Company (“LLC”)This commercial vehicle can be established with the following conditions:i) The initial capital amount for a LLC is 10,000.00 TL. Any cash payments must be madeto an account of a bank established in Turkey.ii)LLCs may also be incorporated with a single shareholder. LLC’s are run by dulyappointed managers and the minimum number of managers for LLCs is one.Specific Characteristics of LLC’s• It is expected that it has a proper place of business (evidenced by a rent contract ortitle deed in Turkey).• LLC must engage a locally qualified accountant, to be responsible for the accountingrecords of the company, tax returns and annual accounts.• LLC’s can be established for every kind of economic purposes which is not forbidden bylaw.BranchesIncorporation of a branch in Turkey is also allowed for foreign investors. Unlike companies,there is no managing board in a branch, instead a company representative is appointed toexecute the operations of the branch. The minimum number of representative to beappointed for a branch is also one. A Branch does not have a separate legal status and abranch of a foreign company can only acquire property in Turkey in very limited4

circumstances.Liaison OfficesAlthough Liaison offices are not actually an “investment entity”, they can be seen as a ‘firststep’ to further investment, though some foreign companies choose to continue tooperate through this vehicle:The main features of a Liaison Office are as follows:• Permission from the General Directorate of Foreign Investment (“GDFI”) is required toestablish a Liaison Office. In applying for permission a report justifying theestablishment of the office must be submitted. Permission is granted for no more than3 years at a time, and the GDFI may decide to refuse permission in subsequent years ifit decides that a company or branch should be formed to carry out the activities.• The liaison office must represent a corporate body established outside Turkey.• It is not entitled to trade in Turkey, and all its expenses must be met by foreigncurrency brought in from outside the country. As such, care must be taken to ensurethat its activities are not deemed as commercial and that it is not receiving funds fromanywhere other than the parent company.• Salaries of Liaison office employees are not subject to Income Tax. Foreign Employeesare also exempt from paying Social Security Contributions. However, Turkish employeesdo pay Social Security Contributions on their salaries and the office must payEmployer’s contributions.• A liaison office must be registered at the tax office, and although it pays no tax onincome it receives, the withholding tax applicable to rent payments and to chargesfrom independent professionals must be paid.Nationality of Board of Directors and ManagersAll of the shareholders, board of directors (JSCs) or managers (LLCs) may be foreigners or ifnecessary Turkish nationals may also be appointed for these roles.5

TAXATIONA brief outline of the principal taxes affecting foreign entities in Turkey is set out below.Other smaller taxes do exist and may apply from time to time.Corporation Tax• This is taxation applied on profits of corporate entities. Currently it is assessed at 20%and profits are computed according to Turkish accounting principles.• Quarterly interim corporation tax returns must be submitted and quarterly profits aretaxed at 20%. After the year end an annual return is submitted and any outstanding taxis payable in 3 instalments during the course of the subsequent year.• Tax losses may be carried forward and set off against future profits in the assessment offuture corporation tax.• Withholding tax of 15% is applied to dividends which are remitted to shareholders (orthe parent company in the case of a branch).Income Tax• Income tax is charged on salaries and the profits of non-incorporated bodies and selfemployedpeople.• Tax on salaries is applied progressively, from a starting rate of 15% up to a top rate of35%.• Tax on self-employed people is applied progressively, up to a top rate of 35%.• Withholding tax must be paid on rent of property from individuals, at a rate of 20% ofgross rent. It should be noted that generally rents are negotiated net, and so in effectthe withholding tax payable is added on to the agreed amount, and this works out to bea tax of 25% of the net rent paid. Withholding tax is also applied to the charges of localindependent professionals such as accountants, lawyers and architects.• The income and withholding tax return is submitted quarterly for companies with fewerthan 10 employees and monthly for those with more.6

Value Added Tax (VAT)• VAT is applied upon the sale of most goods and services, at varying rates, depending onthe nature of goods and services being sold. 18% is the standard rate and reduced ratesof 1% and 8% apply for certain basic food items, restaurants, education costs, booksand paper. Companies registered for VAT may set off the VAT paid on their purchasesagainst VAT charged on sales.• VAT is also paid on the importation of goods to Turkey, at the applicable rates. Whilstthis tax must be paid separately the amount of it may be set off against VAT on sales.• Exports of goods are not subject to VAT also the export of services is not subject to VATwhere they have been performed outside of Turkey or are clearly benefits a placeoutside of Turkey.• Where input VAT (on purchases) exceeds output VAT (on sales) the balance is carriedforward to be set off against future months’ payable tax. Generally a refund is notavailable except in the case of exporters who can apply for a refund, and this can bemade after certain inspections.• VAT returns are submitted monthly.• There is no minimum threshold for being subject to VAT.7

ANTI-CORRUPTIONCorruption poses an increasingly serious threat against Turkey as well as the rest of theworld in many respects. The fight against corruption is crucial, in particular, to achieve aneconomic and political stability, to attract foreign investors and to establish the rule of law.In addition those interests which are common for almost all countries, anti-corruption has aparticular importance for Turkey in the achievement of its goal of becoming a EuropeanUnion member, since anti-corruption is expected to feature prominently in Turkey’s talkson European Union accession.Under the Criminal Code, bribery is committed when a person and a public official agree toexchange a benefit for the performance or omission of an act contrary to the requisites ofthe duties of the official. The actual transfer of money or another benefit is not an elementof the crime of bribery. Under the Criminal Code, a person who gives or whom receives abribe, but then informs the investigation authorities about the bribe before initiation of aninvestigation, shall not be punished for the crime of bribery. Additionally, a public officialwhom receives a bribe, but then turns over the entire bribe to the competent investigationauthorities, shall not be punished for the crime of bribery. A public official whom receive abribe is subject to the same penalty as a person who gives a bribe. The Criminal Code setsforth that Turkish laws shall apply to the crimes of bribery committed abroad regardless ofwhether the crime is committed by a Turkish citizen or a foreigner. It is a general principlethat Turkish laws shall be applied to crimes committed within Turkey, whether committedby a Turkish citizen or foreigner. Thus, Turkish laws shall apply to the crimes of briberyregardless of whether committed by a Turkish national or foreigner or whether committedin Turkey or abroad.If a bribe creates an unlawful benefit to a legal entity, the entity shall be punished throughthree security measures: invalidation of the licence granted by a public authority; seizure ofthe goods which are used in the commitment of, or the result of, a crime by therepresentatives of a legal entity; and seizure of pecuniary benefits arising from or providedfor the commitment of a crime. Criminal liability of legal entities was not regulated underthe Old Criminal Code and is therefore a new concept under Turkish law.Turkey’s first attempt to criminalise bribing foreign public officials was the ratification in2000 of the OECD Convention on Combating Bribery of Foreign Public Officials inInternational Business Transactions (“OECD Convention”), which was followed by theenactment in 2003 of Law No. 4782 Amending Certain Laws for the Prevention of BribingForeign Public Officials in International Commercial Transactions (“Law No. 4782”) and theenactment of the new Criminal Code in 2005.8

Turkey supports the anti-corruption initiatives through various international conventionsincluding the United Nations Convention against Corruption (“UN Convention”) and theCouncil of Europe's Civil Law and Criminal Law Conventions on Corruption (“Council ofEurope Conventions”).The UN ConventionThe UN Convention was adopted by the General Assembly of the United Nations andentered into force on 14 December 2005.18 Turkey ratified the UN Convention on 11August 2006 and published in the Official Journal on 2 October 2006. Article 1 of the UNConvention sets forth its purposes as to promote and strengthen measures to prevent andcombat corruption more efficiently and effectively; to promote, facilitate and supportinternational cooperation and technical assistance in the prevention of and fight againstcorruption, including asset recovery; and to promote integrity, accountability and propermanagement of public affairs and public property.The UN Convention covers the prevention, investigation and prosecution of corruption aswell as the freezing, seizure, confiscation and return of proceeds from corruption. In orderto implement the UN Convention, it is not necessary for the offences set forth in it to resultin damage or harm to state property. Pursuant to the UN Convention, each State Party isrequired to adopt such legislative and other measures as may be necessary to establish thecrime of bribery as a criminal offence when committed intentionally.Pursuant to the UN Convention, the state parties are required to institute a comprehensivedomestic regulatory and supervisory regime for banks, financial institutions and othernatural or legal persons particularly susceptible to money-laundering in order to deter anddetect all forms of money-laundering. The Turkish anti-money laundering legislation mainlyconsisting of the Anti-money Laundering Law No. 4208, which entered into force on 19November 1996, and the Anti-Money Laundering Regulation, which entered into force on 2July 1997, meets this requirement of the UN Convention. In particular, the Anti-MoneyLaundering Regulation states that if there is a suspicion that money or convertible assetsare being used to launder or attempt to launder money, this shall immediately be reportedto the Financial Crimes Investigation Agency. A person or entity who fails to report suchsuspicious transactions are subject to imprisonment from six months to one year as well ascertain administrative fines.9

The OECD ConventionThe Organisation of Economic Co-operation and Development (“OECD”) adopted theConvention on Combating Bribery of Foreign Public Officials in International BusinessTransactions (“OECD Convention”) on 17 December 1997 in Paris. Signatories to the OECDConvention include all 29 member states of the OECD including the United States–as well asfive non-members. The OECD Convention entered into effect on 15 February 1999. Turkeyratified the OECD Convention on 1 February 2000.The goal of the OECD Convention, stated in the preamble, is to combat the “widespreadphenomenon” of bribery in international business transactions. Article 1 of the OECDConvention requires the signatories to criminalise bribing foreign public officials byproviding: Each Party shall take such measures as may be necessary to establish that it is acriminal offence under its law for any person intentionally to offer, promise or give anypecuniary or other advantage, whether directly or through intermediaries, to a foreignpublic official, for that official or for a third party, in order that the official act or refrainfrom acting in relation to the performance of official duties, in order to obtain or retainbusiness or other improper advantage in the conduct of international business.According to the “Commentaries on the Convention,” which were adopted by thesignatories on 21 November 1997, the OECD Convention sets a “standard” to be met bysignatory states rather than using “precise terms,” and thus leaves the method ofimplementation to the signatory states. However, the OECD Convention states that thesanctions must consist of “effective, proportionate and dissuasive criminal penalties”comparable to those for bribery of local officials. In so doing, the OECD Convention seeks toassure a consistency between the various local legislations with respect to the crime ofbribing foreign officials. The OECD Convention makes it unlawful to offer or pay bribes, butleaves the matter of soliciting or receiving bribes to the domestic laws of the signatorystates. It envisages the criminalization of the bribery of foreign public officials regardless ofwhether the home country of the relevant official is a party to the OECD Convention.10

EMPLOYMENT RELATIONSUnder the Turkish Labour Law (the “Law”) there are provisions regarding job security toprevent unfair dismissals. These provisions apply to workplaces with 30 or more employeesand to indefinite period contracts, and are of particular relevance in relation to thetermination of employment contracts.Fixed Term or IndefiniteOne of the main principles of the Law is that employment is for an indefinite period unlessotherwise stated in the Employment Contract or if the work is temporary in nature. Inaccordance with this principle courts are inclined to interpret the scope of the fixed-termcontracts narrowly. Furthermore, if a fixed term contract is renewed, it would beconsidered as being for an indefinite period, unless there is a justifiable reason (e.g. if theemployment term is tied to the completion of a project).Under the Law employees on fixed-term employment contracts should be entitled to thesame benefits in relation to remuneration as the employees who are working for indefiniteperiod. In principle employees on fixed-term employment contracts are not entitled toseverance payment however this is rather a grey area thus courts may decide to orderseverance payment with relation to fixed-term contracts in some circumstances.Termination of Employment ContractsWorkplaces with 30 or more employees - Job Security ProvisionsFor workplaces with 30 or more employees, there is a job security right in which theemployee who has worked for at least 6 months in the firm, may claim reinstatement if theemployer decides to dismiss him or her without a valid reason such as, the incompetence ofthe employee, the behaviour of the employee, or the requirements of the workplace or thework. An employee will not be able to benefit from job security provisions if there is a“valid reason” set out under the Law, for a termination with immediate effect.In case where the dismissed employee claimed for reinstatement and the judge accepts theclaim and rules that the employee should be reinstated and the employer does not allowthe employee to start work within 1 month of the date of the judgement, the employer willhave to pay compensation in the amount of between 4 and 8 months’ salary. The employerwill also have to pay compensation to the employee covering the time period during whichthe court case was pending and consequently the employee was not allowed to work,which may amount to four months’ salary and other entitlements.11

Workplaces with fewer than 30 employeesUnder Law, indefinite period employment contracts can be terminated simply by givingnotice (notice terms are regulated under the Law). An employee to whom the job securityprovisions are not applicable but whose employment contract is terminated in bad faith(due compensation was not paid), can sue and ask for bad faith compensation in theamount of 3 times the statutory payment in lieu of notice.Work PermitsIn September 2003 the process for foreigners to obtain work permits underwent majorchanges when the “Law Concerning the Work Permits of Foreigners” came into force. Inthis new law the responsibility for administering and granting work permits was put intothe charge of the Ministry of Labour and Social Security (“Ministry”). Previously in factthere had not been any one law specifically governing foreigners’ work permits so inpractice much was new.Foreigners may be exempt from obtaining a work permit under bilateral or multilateralagreements according to which Turkey is a party. In addition, under the relevant regulation,there is no requirement to obtain a work permit in some special circumstances such asvisits for scientific, cultural or artistic activities which is for a period of less than one month,or visits for maintenance and inspection of any machinery and equipment imported toTurkey for a period of less than 3 months or visits for training related to the use of goodsand services imported to Turkey for a period of less than 3 months.Work Permits for Foreign Key PersonnelThe issuance of work permits for key personnel is regulated under the Work PermitRegulation for Foreign Key Personnel. “Key Personnel” refers to the personnel of acompany established in Turkey who fulfils at least one of the following conditions:i) Company shareholder, chairman of the board of directors, members of the board ofdirectors, general manager, deputy general manager, company manager, or othersimilar titles or positions, who are authorised for one of the following responsibilities:to work in the top management or executive positions of the company; orto manage the whole or a division of the company; orto supervise or control the internal auditors, or administrative or technical staffof the company; orto recruit or dismiss personnel for the company, or to make proposals thereon.(ii) Individuals holding fundamental and key information about services, researches,equipment, techniques or management of the company; or12

(iii) For the liaison offices, a person to whom (not more than one individual) a certificate ofauthorisation (Power of Attorney) is issued and granted by the foreign parentcompany.In addition, with regard to the employment in liaison offices, Article 6 of the Work PermitRegulation for Foreign Key Personnel states that a maximum of one person holding acertificate of authorisation (Power of Attorney) in a liaison office operating pursuant to theDirect Foreign Investment Law shall be granted a work permit by the Ministry, providedthat a minimum of 200,000-USD or its equivalent in any other foreign currency has beentransferred from abroad for funding the operations of the liaison office in the previousyear.Work permit applications under the Work Permit Regulation for Foreign Key Personnel canbe filed either from abroad or in Turkey.Applications to be filed in TurkeyOnly foreigners from “A Group” countries as determined by the Ministry of Interior of theRepublic of Turkey, with valid residence permits for at least 6 months, or their employerscan make an application for a work permit directly to the Ministry in Turkey, together withthe relevant documents. The countries categorized as A Group by the Ministry of Interiorshould be checked once again at the time of the work permit application.Applications to be filed AbroadIn order to apply for a work permit from abroad, an application must be filed in writing oronline to the Turkish diplomatic representatives of Turkey in the foreigner's country oforigin or country of permanent residence, together with the foreign personnel applicationform and the other required documents. The Turkish diplomatic representatives shall thensubmit the application to the Ministry via internet. The documents required from theemployer in Turkey must be submitted to the Ministry on the date the foreigner applies tothe relevant Turkish diplomatic representatives or within 10 days from this date. Inaddition, work permit applications submitted by the employer in Turkey to the Ministry 10days before the date of application to the Turkish diplomatic representatives shall also beevaluated.It should also be noted that each application is subject to the evaluation of the Ministryofficials and the decision to grant or not to grant a permit is at their sole discretion. Inpractice we know that it is the experience of many foreign personnel that the procedure forobtaining a work permit takes longer than the periods stated under the legislation.13

ACQUISITION OF PROPERTYAcquisition by Foreign CompaniesIn general the Turkish Land Law prohibits foreign companies incorporated and residentabroad, to directly acquire real property in Turkey. There are only three exceptions to thisgeneral prohibition. Accordingly, foreign companies carrying out their businesses within thescope of the (i) Petroleum Law; (ii) Tourism Law; and (iii) Industrial Zones Law may acquirereal property in Turkey (“Exceptions”).Due to the above-mentioned prohibition, the only way for foreign companies (i.e. those notbenefiting from the said Exceptions) to acquire real property in Turkey is to establish asubsidiary (i.e. Turkish foreign capital company) in Turkey. Following the incorporation, theTurkish foreign capital company must obtain consent from the Governorship ProvincialPlanning and Coordination Directorate (“Directorate”) where the target real property islocated. The Directorate communicates the information and documents about the targetproperty with the Provincial Police Department and the Regional Directorate of MilitaryStaff.Upon positive assessment of each of these governmental authorities, the Directorateinforms the applicant company and the relevant land registry office that the requestedacquisition may be completed.Please note that the target real property will only be investigated by the Provincial PoliceDepartment and the Regional Directorate of Military Staff and the Governorship shall grantthe approval upon their positive assessment. Therefore, usually there is no reason otherreason for refusal other than the target property being situated in a Military Zone orSecurity zones determined by the Provincial Police Department. It should also be noted thatthe company’s Articles of Association should also authorise the company to purchaseproperty.There are no different classes of rights under Turkish Law. Only one type of right existsunder Turkish Law which is similar to the “common hold” concept. However there also exista right called the “intifa hakkı” which is similar to “easements” and is subject limitations(limited title). Those holding such right will have right to use the property for a certain timedetermined either by an agreement, court order or by law. This right will only becomeenforceable once an entry is made in the Title Deed Registry records of the propertyconcerned.14

Acquisition by IndividualsReal persons of foreign nationality can buy property in Turkey. The principle of reciprocityhas been abolished with the new amendments to the law on foreign individuals acquiringproperty in Turkey Information on the names of the countries whose citizens can buyimmovable property (real estate) in Turkey can be obtained either from the Turkishdiplomatic and consular missions abroad or your country`s diplomatic and consularmissions in Turkey.SENGULER & SENGULERLAW OFFICECONTACTS:Selcuk SengulerPartnerTel: +90 212 361 5066Email: selcuk.senguler@senguler.av.trJonathan BlythePartnerTel: +90 212 361 5066Email: jonathan.blythe@eurasia.com.trNazlican KartalAssociateTel: +90 212 361 5066Email: nazlican.kartal@eurasia.com.trThe firm’s consulting arm is •eurasia Consultants Ltd.15

Establishing a business inthe United Kingdomwww.charlesrussell.co.uk1

Establishing a business in the United KingdomContentsPageI Overview 3II Forms of business entities 4III The tax system 10IV Employment, pensions and immigration 16V Property, planning and environmental considerations 23VI Intellectual property 27VII Scotland 302

I OverviewIntroductionThis publication summarises some of themajor points for consideration whenestablishing a business in the United Kingdom.It is not exhaustive and further advice shouldalways be taken in relation to specificcircumstances.The law is stated as at May 2012.For simplicity, this memorandum refers to “theUnited Kingdom” throughout, but it should benoted that there are frequent regionalvariations in the legislation as betweenEngland and Wales, Scotland and NorthernIreland.2. GovernmentParliament, the legislature, is made up of twoHouses. The House of Commons is thedominant legislative authority and its membersare elected by universal adult suffrage. Themembers of the House of Lords currentlyconsist of life peers, some remaininghereditary peers and the senior Archbishopsand Bishops of the Church of England,although there is a proposal to reform this sothat a certain percentage of its members areelected. Draft legislation is introduced intoParliament in the form of Bills, which aredebated in both Houses, and must be passedby both Houses and receive the Royal Assentbefore they can be enacted and become law.The maximum life of any one Parliament is fiveyears.A brief profile of the UnitedKingdom1. English legal systemThe legal system existing in England andWales is a result of the evolution of thecommon law and equity and the enactment ofstatutes over many centuries.Scotland and Northern Ireland are separatejurisdictions each with their own courts andlaws. For an overview of the Scottish systemsee pages 30-31.The United Kingdom (UK) is a member of theEuropean Union (EU) and many laws of theEU form a fundamental and importantadditional source of UK law. Since the UKjoined in 1973, the EU has passed manyEuropean law directives and regulationscovering such matters as financial services,communications, intellectual property,environmental assessment, equality at work,air pollution, waste disposal and access toenvironmental information. Member States areobliged to include directives in their nationallaws, whilst regulations are directly applicablein all Member States.3

II Forms of businessentitiesThe following provides a brief introduction tothe various forms of business entity availablein the United Kingdom.The company is the most widely used form.The law relating to companies changed,significantly in some areas, as a result of theCompanies Act 2006 (‘the 2006 Act’), whichcame into force in stages but has been in forcein its entirety as of 1 October 2009.As you will see, the 2006 Act also impacted onLimited Liability Partnerships.1. Individuals trading in Englandand WalesIf an individual wishes to establish and carry atbusiness in England and Wales, he canestablish a company or carry on business as asole trader, or in partnership (with a personresident or not resident in England and Wales).Under section 7 of the 2006 Act, any type ofcompany (including public and unlimitedcompanies) may be formed as, or may beconverted into, a single member company.There are no registration requirements toestablish a business as a sole trader orpartnership, although there are many of thesame continuing requirements as for acompany (e.g. registration for VAT and PAYE).2. PartnershipA partnership can be said to exist between twoor more persons if three conditions aresatisfied. There must be:• a business;• which is carried on by two or morepersons in common; and• with a view to profit.There is also a view that there should be afourth condition namely an agreement to shareany profits realised. Almost any kind ofbusiness may be carried on in England andWales by a partnership provided it is with aview to profit.A partnership does not of course cease to be apartnership if it makes a loss, it is the intentionto make profit that is key.As mentioned above, partnerships are notregistered in the same way as companies andLLPs (see below) and it is a matter of factwhether a partnership exists.It is also not necessary for there to be a formalagreement between the partners, but inpractice there usually is some form of writtenpartnership agreement. Formal agreement isparticularly important in the case of an unequalcontribution to the assets of the partnership byindividual partners as there is an assumptionthat, unless otherwise agreed, partners willshare equally in the profits, capital and anylosses of the partnership.A partnership is not a separate legal entity so,for example, assets will commonly be held bythe partners on trust for the partnership.However partnerships can now sue or be suedin the name of the partnership. Liability of thepartners is unlimited.Profits and capital gains of the partnership aretaxed in the hands of the individual partners.See the section entitled ‘The Tax System’ onpage 10 for details of personal taxes.A partnership is recognised as a legalrelationship throughout the EU and provided ithas been formed in accordance with the lawsof a Member State and has its registered officeor principal place of business within the EU, itwill be treated for all purposes of EU law in thesame way as a natural person who is anational of the Member State. (EuropeanCommunity Treaty, Article 48).3. Limited liability partnershipsA limited liability partnership (‘LLP’) is analternative corporate structure which wasdeveloped to satisfy the need of certainprofessional groups, such as law andaccountancy firms to obtain limited liability fortheir members while retaining the flexibility of a‘traditional’ partnership. However, despite theirname, they are more akin to a company than apartnership and very little partnership lawapplies to them.4

LLPs were created by the Limited LiabilityPartnerships Act 2000, which has been heavilyamended by various statutory instruments.Certain provisions of the 2006 Act apply toLLPs by virtue of the Limited LiabilityPartnerships (Application of Companies Act2006) Regulations 2009, which came into forceon 1 October 2009.The key features of LLPs are:• They are corporate bodies with legalpersonalities which are separate fromthose of their members.• They have unlimited capacity and, like acompany, can therefore do anything thata natural person can do, for exampleown property or be a party to litigation.• Their members have limited liability (butsee ‘Insolvency of an LLP’ below).• They are taxed in the same way as apartnership i.e. the members of the LLPare taxed individually on their drawings(See the section entitled ‘the TaxSystem’ at pages 10-15).• There is no upper limit on the number ofmembers LLPs can have, however theymust have at least two.• Accounting and filing requirements arebroadly similar to those of a company.1. Incorporating an LLPAn LLP is incorporated by filling the requiredapplication form along with a fee (£40, or £14 ifelectronically filed, at the time of writing) withthe Registrar of Companies at CompaniesHouse. The application must be signed by allof the founding members of the LLP,confirming their consent to act.The application also includes a statementwhich must be signed by a proposed memberor a solicitor who has been involved with theformation of the LLP, stating that the personsnamed in the form are ‘associated for carryingon a lawful business with a view to profit’ as anLLP cannot be formed for non-profit makingactivities.2. Management of an LLPLLPs do not have directors in the same way asa company (see below), and members are freeto order themselves as they wish, which isusually done by way of contractual agreementamongst themselves. LLP Agreements areconfidential to the LLP members, unlike acompany’s Articles of Association, which mustbe filed at Companies House.However, a LLP must have at least two‘designated members’ who are responsible forvarious administrative matters such as filingaccounts and the annual return at CompaniesHouse. The identity of the designatedmembers must be provided on incorporationbut can be changed at any time. If nodesignated member is specified all membersof the LLP are deemed to be designatedmembers.Failure of a designated member to comply withtheir duties is a criminal offence.3. Insolvency of an LLPBroadly speaking, the position on theinsolvency of an LLP is similar to that on theinsolvency of a company. There is however anotable difference, which is that any amountsdrawn by a member in the two years beforethe commencement of a winding up can be‘clawed back’ if the member knew that aftermaking the drawing there was no reasonableprospect of the LLP being able to avoidinsolvent liquidation.4. Companies incorporated inEngland and Wales1. FormationAny one or more persons may incorporate acompany in England and Wales by subscribingto a memorandum of association(“Memorandum of Association”), provided thatthe business is for a lawful purpose andotherwise complies with the requirements ofthe 2006 Act regarding registration and form ofincorporation.The most common type of companyincorporated in England and Wales is acompany limited by shares; with suchcompanies the liability of the shareholders islimited (generally) to the amount of the issuedshare capital. It is also possible to formcompanies “limited by guarantee” (which areinvariably not-for-profit companies) and“unlimited” companies where the liability ofshareholders is unlimited, but which at thesame time do not generally need to submitaccounts which are available for publicinspection. The remainder of this section isconcerned with companies limited by sharesPAGE 5

although many of the principles are applicableto the other two types of company.A company limited by shares can be a “privatelimited company” or a “public limitedcompany”. There are various differencesbetween the two types of company, but afrequent procedure is to start with a privatelimited company and then to convert thecompany into a public limited company if andwhen it is decided that the additional status isdesirable or required and the company cancomply with the relevant applicablerequirements.A company is a separate legal entity distinctfrom its shareholders. As of 1 October 2009companies are not required to have anauthorised share capital. A company limited byshares will however need to have a fixednominal value, for example 1 penny per shareand a statement of capital and initialshareholdings must be submitted to theRegistrar of Companies on application forregistration.Since the coming into force of the 2006 Act,the constitution of a company is governedsolely by its Articles of Association. There isconsiderable flexibility over the content of theArticles. A company must register its Articles ofAssociation unless it has model articles.Companies are also required to have aMemorandum of Association. Since thecoming into force of the 2006 Act theMemorandum of Association is now a purelyhistorical document, showing the status of thecompany at the moment of incorporation. It willbe in a prescribed form containing a statementby the founding members of the company thatthey wish to form a company, be members ofthat company and, in the case of a companywith share capital, take at least one shareeach.For companies incorporated prior to 1 October2009, the Memorandum contained an objectsclause, setting out the purpose of thecompany. Depending on the drafting of theclause, this limited the activities that thecompany could carry out. The object clause ofpre 1 October 2009 Companies Act is nowdeemed to form part of the Articles. For 2006Act companies, the notion of the objectsclause is abolished and the objects of thecompany will automatically be unrestrictedunless there are restrictive provisions in theArticles.There are also provisions requiring the displayof the company name, number and registeredoffice address on all invoices, letterheads,notices, etc including electroniccommunications. Under the 2006 Act, a newpower has been introduced for the Secretary ofState to make regulations specifying letters,symbols etc that may be used in a company’sregistered name. If a company is registered forvalue added tax (“VAT”) its VAT registrationnumber must also appear on any invoices andcredit notes.2. DirectorsThe management of a company is conductedby the board of directors. A company musthave at least one director (or two in the case ofa public limited company). Under provisions inthe 2006 Act private companies are no longerrequired to have a company secretary (therequirement to have a secretary is retained fora public limited company).Directors of a company in England and Walesare required as a matter of law to act in thebest interests of the company. The 2006 Actintroduced a statutory statement of directors’duties which comprises seven general duties.The statement also applies to shadowdirectors to the extent that the statement hasreplaced a common law rule or equitableprinciple that applied to shadow directors.The seven general duties are:• duty to act within powers;• duty to promote the success of thecompany;• duty to exercise independent judgment;• duty to exercise reasonable care, skilland diligence;• duty to avoid conflicts of interest;• duty not to accept benefits from thirdparties; and• duty to declare interest in any proposedtransaction or arrangement with thecompany.In addition, since 1986, legislation has existedthat imposes liability on directors formismanagement. The principal liability isknown as “wrongful trading” and may applywhenever a company has gone into insolventliquidation. The court can order that a directorPAGE 6

should personally contribute to the assets of acompany if at some time before thecommencement of the winding up he knew orought to have concluded that there was noreasonable prospect that the company wouldavoid going into insolvent liquidation, and hefailed to take every step with a view tominimising the potential loss to the company’screditors. This legislation is contained in theInsolvency Act 1986 and the courts appearwilling to exercise their powers to order adirector to make such contributions. Inaddition, the court can order directors to bedisqualified from becoming directors of othercompanies. For further information see“Directors’ Responsibilities”, another CharlesRussell publication.Other important changes made by the 2006Act are:• The 70 year age limit for directors ofpublic companies, or private companieswhich are subsidiaries of publiccompanies, was repealed and there isnow a minimum age limit of 16 years fordirectors of all companies.• Companies must have at least onedirector who is a natural person.• Companies are required to keep aregister of the usual residentialaddresses of directors who areindividuals, although this register will notbe open to public inspection. A serviceaddress, other than a residentialaddress, will have to be included on thecompany's register of directors. Thisrequirement also applies to LLPmembers.• There is no residence requirement fordirectors, nor any need to hold meetingsin England and Wales. A company musthowever have a registered office inEngland and Wales. A Welsh companymay pass a special resolution to changeits registered office from Wales toEngland and Wales.3. MeetingsThe concept of an ‘extraordinary generalmeeting’ was abolished by the 2006 Act whichrefers only to ‘general meetings’ or ‘annualgeneral meetings’ (“AGM”). Under the 2006Act, only public companies must hold an AGM.Private companies may continue to do so ifthey wish, subject to their Articles.5. The choiceLegal, commercial and tax considerations willeach play a part in deciding whether to carryon business as a sole trader, a partnership, anLLP or a company in England and Wales. Asexplained, a company in England and Walesmay give the benefit of limited liability, to somedegree at least, but it is often thought desirableto commence business as a sole trader or inpartnership because this structure is moreflexible. Also, currently it is usually easier andmore advantageous from a tax point of view totransfer a business from a sole trader/partnership to a company than from acompany to a sole trader/partnership.6. Overseas companies inEngland and Wales1. General ConsiderationsA company incorporated outside England andWales may trade in England and Wales eitherthrough a subsidiary in England and Wales orthrough a branch office. The branch in Englandand Wales may sign contracts which arebinding on the overseas company.The decision whether to establish a branch inEngland and Wales or to incorporate asubsidiary in England and Wales must betaken separately in each case, but is normallybased on the following considerations:• Commercial. A subsidiary is oftenpreferable because some UK companieswould prefer to do business only withother companies incorporated in Englandand Wales. Grants, loans and otherfinance may also be easier for acompany in England and Wales toarrange.• Taxation. The relevant considerationsare normally the tax system in which theoverseas company does business, theterms of any double tax agreement withEngland and Wales and the expectedtrading results in England and Wales.Sometimes it is more advantageous tostart with one structure and then totransfer the business in England andWales to the other structure. Forexample, the start up costs and initialtrading losses of a branch may bedeductible from taxable profits of theoverseas company in its home countrybut this advantage will be lost when thebranch in England and Wales becomesPAGE 7

profitable in its own right. Tax legislationin England and Wales treats the branchas having the amount of equity and othercapital that it would need if it was aseparate company operating in Englandand Wales. This will effectively limit theamount of debt a branch might have fortax purposes and therefore restrict thededuction for interest that can be claimedfor tax purposes.• Legal. A subsidiary in England andWales may afford some protection to itsparent from trading and other losses orliabilities of operation in England andWales, since the parent will benefit fromits limited liability. However, the parentmay be liable for the obligations of itssubsidiary where, for example, it hasguaranteed the liabilities of thesubsidiary.• Audit. A company incorporated inEngland and Wales has (except forcertain very small companies) to have astatutory audit of its accounts, whereasan overseas company may be based in acountry where this is not necessary.• Publicity of accounts. Subject to certainexceptions, a company in England andWales has to file annual accounts whichare available for public inspection. Abranch has to file the accounts of theoverseas company. If the accounts are ina language other than English, atranslation certified in the prescribedmanner must be annexed. One way ofaddressing the disadvantage of revealingthe overseas company’s accounts wouldbe by interposing a non-England andWales company between the overseascompany and the branch, so that thebranch becomes a branch of thesubsidiary of the overseas company.A branch or subsidiary that has a namecontaining certain words (e.g. “international”and “royal”) can be required by the Secretaryof State to change its name or give reasonsjustifying its use of the name. (Care shouldalso be taken not to infringe a registeredtrademark.) It should be noted that under the2006 Act, existing restrictions on the use ofbusiness names have been extended to coverall overseas companies carrying on businessin England and Wales and not just thosehaving a place of business in England andWales.2. Procedural requirementsThe Overseas Companies Regulations 2009(the “Overseas Company Regulations”) cameinto force on 1 October 2009 and apply inrespect of an overseas company with any kindof establishment in England and Wales,including a branch in England and Wales.Matters addressed by the Overseas CompanyRegulations include the following:(a) particulars of the overseas company(name, legal form, directors etc.) must beregistered with the Registrar of Companieswithin one month of opening anestablishment in England and Wales;(b) alterations to registered particulars must beregistered within 21 days after thealteration is made by delivering a return tothe Registrar of Companies;(c) accounts and reports must be delivered tothe registrar of companies by an overseascompany with an establishment in Englandand Wales unless the overseas company isincorporated in an EEA state and is notrequired by its parent law to deliveraccounting documents. If a company isincorporated outside the EEA and is notrequired to make disclosure under itsparent law, it may prepare its annualaccounts in accordance with either itsparent law, international accountingstandards or Part 15, chapter 4 of the 2006Act. Companies incorporated in an EEAstate who are required to disclose accountsunder their parent law just need to deliverthese to the registrar of companies;(d) trading disclosures are required including arequirement to display the name andcountry of incorporation of the overseascompany at its location in England andWales, in its business letters/correspondence and on its website.(Additional information must be included ifthe overseas company is not incorporatedin an EEA state);(e) specified charges over property in Englandand Wales (as set out in s860(7) of the2006 Act) must be registered by anoverseas company with an establishment inEngland and Wales;(f) a director’s usual residential addressconstitutes protected information and issubject to restrictions on its use orPAGE 8

disclosure by both the overseas companyand the Registrar of Companies.In contrast to overseas companies, overseasLLPs with branches in England and Wales aresubject to very little regulatory requirements.The overseas LLP must include details of itsname and country of incorporation at its placeof business in England and Wales and in all itscommunications, including business lettersand its website.7. Anti-trust/competition lawFollowing the entry into force of theCompetition Act 1998 on 1 March 2000, theUK has competition rules which are similar tothose which apply to cross-border business inthe European Economic Area and theEuropean Union. The Competition Actintroduces two prohibitions which are closelybased on the corresponding Europeanprohibitions under Articles 101 and 102 of theTreaty on the Functioning of the EU.Chapter I of the Competition Act prohibitsagreements or arrangements which may affecttrade within the UK and have as their object oreffect the prevention, restriction or distortion ofcompetition within the UK:- e.g. cartels such asprice fixing and market sharing agreements.Chapter II of the Competition Act prohibitsbehaviour or conduct which amounts to anabuse of a dominant market position which hasor is capable of having an effect on tradewithin the UK:- e.g. selling at unfair prices,stifling innovation, discrimination or tyingdistinct goods.The Office of Fair Trading has wide-rangingpowers of enforcement under the CompetitionAct, including the right to carry out on-the-spotinvestigations or “dawn raids” at companypremises. Fines of up to 10% of anundertaking’s worldwide turnover may beimposed, and businesses can be liable to thirdparties who are affected by a breach of therules. Company Directors who breach the rulesmay face disqualification and persons involvedin cartels may be criminally liable toimprisonment or fines. The non-legalconsequences of infringement, in particular theresultant adverse publicity, may be of equalconcern.Charles Russell provides specialist advice onboth EU and UK competition rules.PAGE 9

III The tax systemThe following is intended to provide asummary of some of the features of the UK taxsystem that are relevant to an overseasbusiness wishing to establish a UK presenceor an overseas individual wishing to work inthe UK. However, the UK tax system is acomplex one and further advice should beobtained.1. Personal taxes1. Income TaxIncome tax rates currently start at 10% (butonly for those on low incomes). Subject to thatthere is a basic rate band of 20% and a higherrate of 40% (currently 32.5% for dividendincome reduced to an effective rate of 25% ifthe non-repayable tax credit is taken intoaccount). From 6th April 2010 there has beena top rate of 50% for those with taxableincome over £150,000 per year (42.5% fordividend income, reduced by the nonrepayabletax credit to an effective rate of36.1%).From 6 April 2013 the top rate of income tax isdue to go down to 45% (37.5% for dividendincome, reduced by the non-repayable taxcredit to an effective rate of 30.6%). Whereindividuals receive income through theiremployment, their employer will be obliged tooperate PAYE (see page 11). They will also besubject to National Insurance Contributions(NICs). The rate of employees’ NICs willnormally be 12% for salaries between £7,605and £40,040 per year and 2% on any excessover £40,040.A tax-free personal allowance is deducted froman individual’s total taxable income. Thatallowance is currently £8,105 for the tax year2012-2013. There is a tapering of the personalallowance for those earning over £100,000 peryear. From 6 April 2013 the basic personalallowance for those aged under 65 will beincreased from £8,105 to £9,205 .A shareholder who is an individual resident fortax purposes in the UK and who receives adividend will be entitled to a (non-repayable)tax credit equal (at current rates) to one ninthof the dividend (hence reducing the effectiverate of income tax to 25% - for higher ratetaxpayers – or 36.1% for top rate taxpayers).Overseas shareholders in a UK company donot usually have any further tax to pay on UKdividends.2. Capital Gains Tax (CGT)CGT is a tax chargeable on the disposal ofassets. All gains (including held over gains) onthe value of assets realised upon disposal aresubject to CGT at 18% or 28%. For companiesgains are added to total income and aresubject to Corporation Tax. In the tax year2012-13, the first £10,600 of gain realised byan individual is exempt from CGT. Companiesalso pay tax on their capital gains, but the taxin question will be corporation tax (see furtherbelow). Companies are not entitled to theannual allowance of £10,600.Entrepreneurs’ relief reduces the rate of CGTto 10% for the first £10 million worth of gainsupon the disposal of certain qualifying assets.The £10m limit applies to gains realised duringthe lifetime of an individual and once expendedduring a lifetime, cannot be used again (thislimit increased from £1m to £2m for disposalsafter 5th April 2010,from £2m to £5m for post22 June 2010 disposals and from £5m to £10mfor post-6 April 2011 gains). Various conditionsmust be met to secure entrepreneurs’ relief.For example, in relation to the shares of atrading company, throughout the 12 monthsprior to the disposal the vendor must havebeen holding at least 5% of the share capital ofthe company whose stock are being sold andhave been an officer or employee of thecompany.2. Taxation of companies1. Corporation TaxWho is chargeable?UK companies are liable to corporation tax ontheir worldwide profits, i.e. broadly income andchargeable gains (less expenses). Non-UKresident companies carrying on a trade in theUK through a “permanent establishment” in theUK are liable to corporation tax on profitsattributable to the UK permanentestablishment. The profits of the UKpermanent establishment may also be taxed inthe country in which the overseas “parent” isresident. In such a case, credit is normallygiven in the overseas country for the tax leviedin the UK (please see the section marked“Double Taxation Treaties”).PAGE 10

Basic charging provisionsThe UK has competitive corporation tax ratesof 20% for profits up to £300,000 and 24% forprofits in excess of £1,500,000 with a slidingscale for profits between £300,000 and£1,500,000 (the top rate is to reduce to 23%from 1 April 2013 and to 22% from 1 April2014), though the thresholds are yet to beconfirmed). These thresholds are reducedwhere there are a number of "associatedcompanies", including overseas companies butnot dormant companies and pure holdingcompanies. Dividends paid by a UK companyare not deductible in computing taxable profits,but dividends paid by a UK company aregenerally not subject to UK withholding taxes.The profits attributable to a UK permanentestablishment are liable to corporation tax atthe full rate of 24%, although if the overseas"parent" is resident in a country with which theUK has a relevant double tax agreement with anon-discrimination article, a lower rate may beavailable.2. Groups of companies –calculation of taxable profitsIt is not possible to artificially reduce profits ofa UK subsidiary by paying the overseas parentcompany more than the market rate for goods,management services or loans. UK tax lawcontains transfer pricing provisions whichenable the UK HM Revenue and Customs(“HMRC”) to adjust prices for tax purposes to amarket rate. These provisions can also applyto transactions between UK companies andother UK companies.The UK rules relating to group relief permitlosses made by a UK company to be set offagainst the profits arising in the sameaccounting period of another UK companywithin the same group, thereby reducing theoverall tax liability of the group. A group forthese purposes comprises a parent companyand its 75% subsidiaries (direct and indirect).The group relationship can be establishedthrough a non-UK resident parent company. AUK branch of a non-resident company mayalso take advantage of the rules relating togroup relief in certain circumstances. Recentcase law has permitted the use of group lossesfrom non-UK companies to UK companies inlimited circumstances, further advice should betaken where required.3. PAYE and NICsInsurance contributions from employees’salaries and remit this to HMRC. This systemis known as Pay As You Earn (PAYE). Suchdeductions are required in respect of salariespaid to UK employees whether or not thesalaries are paid in the UK.In addition to deducting PAYE and employeesNICs, as explained at paragraph 1.1, theCompany will also have to pay employers’NICs at 13.8% above a prescribed threshold(currently £5,564).4. Groups of companies - fundingA number of factors will determine whether theUK subsidiary should be funded with equity ora mixture of debt and equity. From a taxperspective, interest paid on debt is normallydeductible when computing taxable profits.However, where the interest payable exceedsa normal commercial rate or is paid in respectof a level of debt which would not have beenavailable from a third party lender, a deductionmay be disallowed in respect of the excessinterest or the interest payable in respect of theelement of the debt that would not have beenavailable from a third party lender. Where thedebt is provided by a non-UK Lender theremay be withholding tax implications in relationto the interest payments (see further below).Whilst HMRC generally consider the debtshould be matched by equity they havebecome more flexible on this, and although aratio of 1:1 remains their common startingpoint, they do recognise that particularcircumstances and industries can merit adifferent result.5. Capital allowancesThe UK tax system does not allow a deductionfor the depreciation of assets but there is asystem of "capital allowances" which aredeductible when calculating taxable profits.Writing down allowances are granted to tradingcompanies for capital expenditure on“qualifying items”. In particular capitalallowances are available in respect ofexpenditure upon “plant and machinery”,industrial buildings (though this is beingphased out over the next four years ) andbusiness premises renovation. The amount ofthe allowance will be dependant on the type ofasset, when the allowance is claimed and thecompany.Employers are obliged to deduct income tax atthe appropriate rate and employees’ NationalPAGE 11

6. Value Added TaxBusinesses (whether a company, a branch, apartnership or a sole trader) making suppliesof certain goods and services in the UK mustregister for value added tax (“VAT”) if suchsupplies have exceeded £73,000 in the pastyear or there are reasonable grounds forbelieving that such supplies will exceed£73,000 in the next 30 days. Such businessesmust then charge VAT at the appropriate onthe supply of such goods and services. Thestandard rate of VAT is currently 20%, thoughtcertain items attract zero rating, reducingrating (5%) or can be exempt from VAT.Where businesses incur charges to VAT onsupplies of goods or services they havereceived, they may be able to recover thisVAT. Various conditions will determine therecoverability of this and advice should besought. Advice should also be sought wherecross border supplies are made in the courseof the company’s business.7. Limited Liability PartnershipsProvided they are trading LLPs are generallytransparent for tax purposes, having noincome or gains in their own right. Althoughthey have an obligation to submit a tax return,the members of the LLP are responsible forincluding their share of the profits on their ownpersonal tax returns and paying taxaccordingly as if they were members of ageneral partnership.8. Other mattersDouble Tax TreatiesThe UK has one of the world's largest networkof double tax agreements. These are designedto ensure that a company's UK profits are nottaxed in two jurisdictions. There are over 100double tax agreements between the UK andcountries such as member countries of the EU,USA, Canada, Japan and Australia.Withholding TaxesA withholding tax is a deduction of tax atsource. The UK imposes a withholding tax onthe payment of interest, royalties and rent to anon UK person. There are a number ofexemptions from the charge, including certainpayments by banks, payments to UKcompanies and to companies resident in theUK (subject to HMRC confirmation). In thecase of interest paid by a non-UK Lender,there may be a withholding required under thelaws of the states in which the Lender isresident. In most cases, the rate of withholdingtax is substantially reduced or eliminated underthe provisions of an applicable double taxagreement but this will of course depend onthe relevant countries involved.Substantial Shareholdings ExemptionAn exemption from corporation tax on gainsmade on the sale by a UK company of ashareholding of 10% or more in a tradingcompany or holding company of a tradinggroup may be available provided certainconditions are satisfied. This exemption will beof particular interest to overseas companieswishing to establish a UK subsidiary that is tobe an intermediate holding company of atrading sub group.Investment IncentivesThere are various schemes and initiatives thathave been established to encourageinvestment in small companies. For example,the Enterprise Investment Scheme enablesinvestors in qualifying companies to benefitfrom credits against their tax returns inaccordance with the level of their investment.There are various conditions relating to theinvestors and the company which must be metto enable the investment to qualify. Adviceshould be sought if investors are to takeadvantage of such schemes.3. Stamp taxes1. Stamp duty and Stamp DutyReserve TaxA transfer of shares or certain types ofsecurities in a UK company will generallyattract stamp duty at the rate of 0.5% of thepurchase price where the purchase priceexceeds £1,000.Stamp duty reserve tax (“SDRT”) is generallypayable on an unconditional agreement totransfer shares or certain types of securities ina UK company at the rate of 0.5% of thepurchase price, but is repayable if, within sixyears of the date of the agreement, aninstrument transferring the shares or securitiesis executed and properly stamped or, if theSDRT has not been paid, the liability to pay thetax (but not necessarily interest and penalties)would be cancelled.A transfer of an interest in a partnershipholding shares or certain types of securitiesPAGE 12

will also generally attract stamp duty at the rateof 0.5% of the purchase price.There are many exceptions to the requirementto pay stamp duty and SDRT and specificadvice should therefore be taken in all cases.2. Stamp Duty Land TaxStamp duty land tax (“SDLT”) is chargeable inrespect of most land and property transactionsinvolving any estate, interest, right or powerover land in the UK. In particular, it applies totransfers of freehold property and transfersand grants of leases. The rate of SDLT is asfollows:Non Residential or Mixed UsePurchase Price£150,000 or less 0%£150,000 to £250,000(this rate is reduced to 0%for first time users)Rate of SDLT1%£250,000 to £500,000 3%£500,000 or more 4%ResidentialPurchase Price£125,000 or less 0%£125,001 to £250,000 1%£250,001 to £500,000 3%£500,001 - £1m 4%£1m - £2m 5%Over £2m 7%Over £2m and purchase by“non-natural person”Rate of SDLT15%From 21 March 2012 SDLT is at 7% ontransactions in residential property whereconsideration exceeds £1m and from 22 March2012 SDLT is at 15% on purchase ofresidential property for over £2m by a nonnaturalperson. In this context non-naturalperson means that the purchaser is acompany, the acquisition is made by or onbehalf of the members of a partnership one ormore of whose members is a company, or theacquisition is made for the purposes of acollective investment scheme. There areexceptions in certain circumstances for acompany acting as a trustee of a settlementand for property developers.In addition to the above the Government is toconsult on the introduction of an annual chargeon UK residential property and shares orinterests in such property owned by nonnaturalpersons, with the charge likely to beeffective from 6 April 2013.Note as well that capital gains tax is likely to beextended to gains on the disposal of UKresidential property by a non-UK resident, nonnaturalperson, and shares or interests in the“non-natural” person from 6 April 2013.There is a different structure for chargingSDLT on the grant of a lease. The abovetables will remain applicable where a premiumis paid on a lease or a lease is assigned forconsideration. However where a new lease isgranted and a substantial rent is paid, inaddition to the above charges, SDLT ischargeable at 1% on the amount of the netpresent value (“NPV”) of the lease whichexceeds the threshold of £150,000 forcommercial leases and £125,000 forresidential leases. NPV is a tax concept whichis based on the rent payable on the lease witha slight percentage uplift to take into accountthe time value of money. If the NPV does notexceed the threshold, no SDLT is charged onthe rental element. There are many exceptionsto the requirement to pay SDLT and specificadvice should therefore be taken in all cases.4. Taxation of overseasindividualsThe tax position of overseas individualsworking in the UK is complicated and willdepend upon the particular circumstances ofthe relevant individual. The followingparagraphs contain only a brief summary ofthe rules:ResidenceThe current residence test applicable until 6April 2013 is based on case-law and HMRevenue and Customs practice and guidance.Under the current test to be regarded asresident in the UK for tax purposes you mustnormally be physically present in the country atsome time in the tax year. You will always beresident if you are here for 183 days or more inthe tax year (April 6th to April 5th). There arePAGE 13

no exceptions to this. You will also be treatedas resident for a tax year if you visit the UKregularly and after four tax years your visitsduring those years average 91 days or more atax year. Depending on the circumstancesrelating to the pattern of your life, you may betreated as a UK resident even if you spendshorter periods in the UK. From 6 April 2008,when counting days spent in the UK you arerequired to include days of arrival (previouslythey were left out of account) but you do nothave to include days of departure from the UK.In effect you now count the number ofmidnights spent in the UK.However, overnight stays when transitingthrough the UK can also be ignored, providedthe individual in question does not engage (toa substantial extent) in activities unrelated tohis transit through the UK.A new, statutory residence test is due to takeeffect from 6 April 2013. The new test will bebased on a combination of (a) the number ofdays which an individual spends in the UKand (b) certain connecting factors. It will beeasier to maintain non-residence as an“arriver” in the UK than to establish non-UKresidence as a “leaver”. The new test shouldbe much clearer than the current system fordetermining UK tax residence and at the sametime should allow some non-UK residents adegree of additional flexibility in managing theirvisits to the UK. Draft legislation on the newstatutory residence test is still awaited at thetime of writing.Ordinary residenceFrom 6 April 2012 the test of ordinaryresidence is due to be simplified and will berelevant only to the so-called “workday” relief(see further below). Draft legislation is awaitedon this.The current position (ie until 6 April 2013) isthat if you are resident in the UK year afteryear, you are treated as ordinarily residenthere. You may be resident but not ordinarilyresident in the UK for a tax year if, forexample, you normally live outside the UK butare in this country for 183 days or more in theyear.Or you may be ordinarily resident but notresident for a tax year if, for example, youusually live in the UK but have gone abroad fora long holiday and do not set foot in the UKduring that year. In practice, however,residence and ordinary residence normally gotogether.DomicileBroadly speaking, you are domiciled in thecountry where you have your permanenthome. Domicile is distinct from nationality orresidence. Under English law you can onlyhave one domicile at any given time.A person resident and ordinarily resident butnot domiciled in the UK is subject to incometax on the remittance basis (see below) onoverseas earnings if certain conditions aresatisfied. To enjoy the remittance basis onoverseas earnings the individual must be aremittance basis user, (which means that,where appropriate he/she has paid the socalledremittance basis charge of £30,000 or£50,000 for the tax year in question), his/heremployer must be resident outside the UK andthe duties of employment must be performedwholly outside the UK. For this purpose“incidental duties” can be ignored, althoughincidental duties are narrowly construed andgreat care is required if this is to be reliedupon.A person who is UK resident but not ordinarilyresident and who is a remittance basis user(which means that, where appropriate he/shehas paid the so-called remittance basis chargeof £30,000 or £50,000 for the tax year inquestion) is subject to income tax on thearising basis on remuneration for duties whollyor partly performed in the UK, but is liable toincome tax on remuneration for dutiesperformed wholly outside the UK only wheresuch remuneration is brought into (or remittedto) the UK.A person who is neither resident, nor ordinarilyresident in the UK (e.g. someone who is sentto work in the UK for a short period of time)may be subject to income tax on remunerationfor duties performed wholly or partly in the UK.A UK resident, non-domiciliary’s investmentincome from sources in the UK is taxed in full.Such an individual’s income from non-UKsources is taxed (provided such individual haselected for the remittance basis and, whereappropriate, has paid the remittance basischarge) to the extent that it is remitted to theUK.An individual who is UK resident and/orordinarily resident in the UK but not domiciledand who is a remittance basis user is liable tocapital gains tax on disposals of non-UK situsassets on the remittance basis and is liable tocapital gains tax on disposals of UK assets onthe arising basis. Special rules apply if a UKPAGE 14

esident goes non-resident for five or fewer taxyears and, whilst non-UK resident, realisesgains or (if a remittance user) remits theproceeds of certain offshore disposals. Capitalgains tax is payable at 18% or 28%. However,if the conditions for the so-calledentrepreneurs’ relief are satisfied, on disposalson and after 6 April 2011 the first £10m of anindividual’s lifetime gains within the relief issubject to capital gains tax at only 10%. (Until6th April 2010 the relief could only be availablefor the first £1m of relievable gain, from 6thApril 2010 until 22 June 2010 the first £2m ofgains were relievable and from 23 June 2010until 5 April 2011 £5m of gains wererelievable). In calculating the £10m reliefprevious relievable disposals must be takeninto account.Non-residents are not subject to UK capitalgains tax, except to the extent that they carryon a trade in the UK through a branch oragency and realise a gain from disposing of aUK asset used in or for the purposes of thattrade or used or held for the purposes of thebranch or agency.In order to be taxed on the remittance basis,taxpayers must normally have elected to betaxed on this basis and in some cases theymust have paid the so-called remittance basischarge for the tax year in question. Theremittance basis charge is £30,000 fortaxpayers who have been UK resident for sixout of the previous nine tax years. From 6 April2013 an increased remittance basis charge of£50,000 is due to be introduced for taxpayerswho have been UK resident for twelve out ofthe previous fourteen tax years.Cash need not be brought into the UK in orderto constitute a remittance: for example, payinga UK credit card bill from an offshore bankaccount constitutes a remittance to the UK andthis amount will be subject to UK income tax.UK-domiciled or deemed domiciled individualsare subject to UK inheritance tax (a form ofdeath duty payable on a deceased's estateand also on certain lifetime gifts) on theirworldwide estate. A person is deemeddomiciled in the UK if they have been residenthere for 17 out of the previous 20 tax years.Individuals who are neither domiciled nordeemed domiciled are subject to UKinheritance tax only on UK situated assets.PAGE 15

IV Employment,pensions andimmigration1. Employment1. OverviewIn the UK the relationship between anemployer and an employee is governed by:• the express terms of the contract;• implied terms under common law;• statutory rights.2. DiscriminationUnder the Equality Act 2010, it is unlawful foran employer to discriminate on grounds ofrace, sex, disability, religion or belief, marriageor civil partnership, sexual orientation, genderreassignment, pregnancy and maternity orage. There is no service requirement forbringing a claim under the discriminationlegislation and no limit on the amount ofcompensation which an Employment Tribunalcan award.3. Minimum wageEmployers must pay their workers (whichincludes part-time, casual, freelance andtemporary workers) a minimum of £6.08 perhour (to increase to £6.19 on 1 October 2012).A separate rate of £4.98 per hour applies to18-20 year olds and those aged 21 or over andon accredited training. A further rate of £3.68per hour applies to 16 and 17 year olds.4. Working timeFollowing the implementation of the EUWorking Time Directive in the UK, employersmust ensure that their workers do not workmore than an average of 48 hours each week.It is possible to opt out of the 48 hour workingweek through individual agreements with theworker. All workers are entitled to 5.6 weeks’paid holiday each calendar year but employerscan stipulate that bank or public holidays areincluded (there is no general ‘right’ to be paidfor bank or public holidays or to receive higherwages for working on those days). Workersare also entitled to daily and weekly restbreaks and subject to night work limits.5. BenefitsThere is no statutory requirement for anemployer to provide benefits such aspermanent health insurance, private medicalhealth insurance, life assurance, etc. Mostemployers must, however, provide a pensionscheme for their workforce, in respect of whichsee below.6. Data protectionThe Data Protection Act 1998 applieswhenever personal data is processed by anydata controller. Most, if not all, employers aredata controllers and must comply with the eightData Protection Principles under the Act.Amongst other rights, employees have a rightof access to their personal information, andthis includes data held on manual files. Failureto comply with the Act can result in criminaland civil liabilities.7. Terms of employmentEvery employee is entitled to a writtenstatement of terms of their employment withintwo months of starting work (providing the termof employment is for more than one month).The written statement of terms must containdetails of the names of the parties, hours ofwork, place of work, date of commencement,date when continuous employment began,pay, job title or job description, holidayentitlement, length of notice, entitlement to sickpay, pension arrangements (if any), whether acontracting-out certificate is in force in respectof state pension, a note specifying anydisciplinary rules and grievance procedure anddetails of any collective agreements in place.An employer cannot prevent an employeebelonging to and taking an active part in anindependent trade union.8. Redundancies and businesstransfersIf an employer intends to make collectiveredundancies and/or sell part or all of itsbusiness, the employer must inform andconsult with representatives elected by theemployees or representatives of anindependent trade union recognised by theemployer. The employer must also notify theDepartment for Business Innovation and Skills(BIS) of redundancies in certaincircumstances.PAGE 16

9. Information and consultationBy legislation made under the EuropeanWorks Council Directive and Information andConsultation of Employees Regulations 2004,large transnational companies (defined asthose with more than 1000 employees in theEEA and at least 150 in two or more memberstates) must give their employees theopportunity to be consulted by management incertain given situations, most notably inrelation to the financial and economic positionof the company, and the company’s futureplans.10. Posted workersWorkers posted temporarily to work in anotherEU Member State will benefit from certainminimum terms and conditions of employmentavailable in that state if they are morefavourable than those available under UK law.11. Family friendly rightsPregnant employees are entitled to up to 52weeks’ maternity leave, regardless of theirlength of service.Fathers with 26 weeks’ service by 15 weeksbefore their baby is due are entitled to twoweeks paternity leave and then may take overtheir partners’ maternity leave after 20 weeks.Those adopting a child are entitled to up to 52weeks adoption leave if he or she has beenemployed for 26 weeks before the adoption.There is no obligation on employers tocontinue paying employees’ full salaries whilstthey are on maternity, paternity or adoptionleave, unless contractual payments areprovided for in their contracts of employment.However, there are statutory pay schemeswhich operate in these circumstances.Employers are under a duty to considerapplications for flexible working fromemployees who are parents of children under17 (or 18 if disabled) and employees withcaring responsibilities for adults.12. TerminationThere are statutory minimum periods of noticeon the termination of employment, namely oneweek after four weeks’ service and oneadditional week for each completed year ofservice up to a maximum of 12 weeks’ noticeafter 12 years’ service.Employees must have two years’ service tobring a claim for unfair dismissal. There aresome situations where an employee does notneed one year’s service to bring a claim forunfair dismissal, for example if the dismissal ispregnancy related or related to health andsafety issues. Employees with more than twoyears’ employment are entitled to receive astatutory redundancy payment if theiremployment is terminated for reason ofredundancy.2. Pensions1. IntroductionThere are three tiers of pension provision inthe United Kingdom: the basic state pension,the state second pension, and employers’ andemployees’ own private arrangements.Basic State PensionAll employees with sufficient earnings historywill receive a flat rate Basic State Pension(2012-13, £107.45 per week for a singleperson) from the Government at their statepension age. This is financed by employees’compulsory social security contributions,National Insurance Contributions (NICs), whichemployers are required to deduct fromemployees’ pay and then pass directly to theGovernment.From December 2018 the State Pension agefor both men and women will start to increaseto reach 66 in October 2020. However, thegovernment announced on 29 November 2011that State Pension age will now increase to 67between 2026 and 2028. This change is notyet law and will require the approval ofParliament.State Second PensionEmployees may also become entitled to theState Second Pension (known as S2P,formerly SERPS) from the Government. Againthis is financed by compulsory NIC paymentsand is payable from state pension age,although the amount of this pension dependsupon the amount earned during theemployee’s working lifetime.Private provisionThe third tier of pension provision is providedby employers and their employees. Thisprivate provision can be either by means of anoccupational pension scheme, which anemployer establishes and operates for its staff;PAGE 17

or by employees (and their employers) makingcontributions towards employees’ ownpersonal pensions, which are individualinvestment contracts marketed and sold byinsurance companies.2. CompulsionState PensionsThe Basic State Pension and S2P arecompulsory in that employees must pay NICs(and therefore build up rights to a statepension).Stakeholder PensionsLimited private pension provision has alsobeen compulsory since 2001 as a result ofthen Government’s introduction of stakeholderpension requirements. A stakeholder pensionis simply a personal pension that meets certainrequirements relating to the maximum level ofcharges it may make.Employers’ limited obligations are:• to designate a stakeholder pension fortheir staff (having first consulted withemployees about the introduction of thestakeholder); and• to allow employees to have theircontributions to the stakeholder deductedfrom their salaries and passed directly tothe insurance company operating thestakeholder.There is no obligation upon employers toactually contribute anything towardsemployees’ stakeholder pensions.Although introduced with the intention ofencouraging pension saving by employeeswho do not have access to an occupationalscheme, the stakeholder regime failed todeliver a marked increase in pension saving sothe “auto-enrolment” regime was introduced.3. National employment savingstrust Automatic enrolments &employer contributions (phasedin from 2012)When?With effect from 2012 UK employers willbecome obliged to automatically enrol all‘eligible jobholders’ in a pension scheme. Thelarger employers will start to automaticallyenrol their jobholders from 2012 but businesswith fewer than 250 employees will, dependingon their size, commence auto-enrolment from1 April 2014 to 1 April 2017.Who?All employers must enrol their ‘eligiblejobholders’:-• aged between 22 and state pension age;• earn at least £8,105 pa (2012/13);• includes all workers other than those whoare genuinely self-employed.Jobholders must be enrolled but they do havethe option of opting-out (subject to time limits).The employer must re-enrol them every threeyears.How much?The employer and jobholder must paycontributions on earnings between £5,564 and£42,275. Employers will pay a minimum of 3%and jobholders will need to contribute 5%(although they will get tax relief on this). Formoney purchase schemes, these contributionlevels are phased in over the first three years.What scheme?The employer can choose to establish its ownscheme or use NEST, the National EmployeeSavings Trust. NEST is subject to somerestrictions which may make it unattractive tosome employers.Where can more guidance be found?The Pensions Regulator is charged withhelping employers prepare for automaticenrolment. Its website contains detailedguidance, which will be updated as the newregime ‘goes live’.www.thepensionsregulator.gov.uk4. Regulating non-state pensionprovisionPension provision in the UK is highly regulatedby both the Government and variousregulatory bodies.Most pension schemes benefit from special taxtreatment by HMRC. In return for complyingwith certain requirements laid down by the taxauthorities, these schemes – and thecontributions made to them by employers andemployees – enjoy generous tax reliefs.PAGE 18

Prior to 6 April 2006, UK tax restrictions placedlimits on the maximum benefits thatoccupational pension schemes could provide,and the maximum (or ‘capped’) salary thatcould be taken into account when calculatingthese benefits.Pensions tax simplificationAs from 6 April 2006, the previous tax regimeunderwent fundamental simplification in avariety of respects. It is no longer compulsoryfor pension schemes to limit benefits andcontributions in the manner outlined above.Instead, HMRC now lays down limits on thecapital amount of any savings that may be builtup in a tax-favoured pension arrangement,both in any one year and over the course of anindividual’s life.These are known as the Annual Allowance andthe Lifetime Allowance. From 6 April 2011 theAnnual Allowance will be £50,000 and from 6April 2012 the Lifetime Allowance will fall to£1.5m. Any sums in excess are subject topunitive tax charges. Compliance is primarilythe responsibility of the individual, rather than– as was previously the case – the pensionscheme in question. There are also limits onthe tax relieved amounts that can becontributed each year.Matters are however complicated by the factthat the old regime of complex benefit limits,whilst no longer compulsory, continues toapply to many occupational pension schemes5. Occupational and personalpension schemes - what arethey?Traditionally most occupational pensionschemes were established on a defined benefit(DB) basis, meaning that the level of pensionpayable at retirement was calculated byreference to a formula in the scheme’s rules(these scheme are often known as final salaryschemes as the calculation provided a portionof the individual salary at retirement). Afteremployees have made their contributions , itbecomes the employer’s obligation to inject asmuch additional funding as necessary toprovide the promised level of benefits. Anactuary, who applies probability theory to anumber of financial and demographicassumptions in order to predict the future, willdetermine how much the employer has to payto provide these benefits.A number of changes to the regulatory regimesince the late 1990s, increased longevity andpoor (and volatile) stock market performancein recent years, have led to this type ofscheme falling out of favour with employers.Most have now replaced them with definedcontribution (DC) schemes, which transfer theinvestment risk to the scheme’s members. Insuch a scheme, the assets are simply investedin individual retirement accounts for each ofthe scheme’s members, who invariably havesome element of choice as to how these areinvested. The resulting fund is then used tobuy an annuity from an insurance companywhen the employee retires. Most importantly,the level of pension is not fixed and willdepend on three things: the amount ofcontributions made, the level of investmentreturn obtained on the scheme’s assets, andthe annuity rates in force at the time of theemployee’s retirement.Occupational pension schemes are generallyestablished ‘under trust’. This means that thescheme’s assets are held separately fromthose of the employer that sponsors thescheme, in the hands of individuals known astrustees.These may be senior company staff, orpersons chosen by the scheme’s members(the company’s employees), or both; but theirduties are primarily owed to the members ofthe scheme, rather than to the company thatsponsors the scheme. The trustees’involvement ensures that the security of theassets, from which pensions will be eventuallypaid, is not dependent upon the company’scontinued existence.Personal pension schemes do not havetrustees: instead, insurance companies, whichoperate (and look after the assets of) theseschemes, must meet strict solvencyrequirements laid down by the Government.When an employee leaves a company thatoperates any kind of occupational pensionscheme his benefits will normally remain inthat scheme until he retires, when they willbecome payable to him. Alternatively, at anytime until the employee retires, he may insteadchoose to transfer these benefits to a pensionscheme operated by his new employer or tohis own personal pension scheme.The most common type of pensionarrangement, for new employers in the UK, ishowever a group personal pension plan or astakeholder scheme, which can effectively bepurchased very quickly and easily from aninsurance company. These arrangements, bydefinition, provide pension benefits on aPAGE 19

‘defined contribution’ basis. They are alsooften linked to a life assurance schemeproviding a tax-free lump sum defined as amultiple of salary in respect of employees whodie whilst in the company’s service.Each employee in such a scheme has theirown personal pension, under the umbrella ofan agreement between their employer and theinsurance company. If the employee leavesthe company’s employment his pension willautomatically follow him to his new employerand he may continue contributing to it until hisretirement, if his new employer does notoperate its own scheme.3. ImmigrationNationals of European Economic Area (EEA)countries, Swiss nationals, and certainCommonwealth citizens with UK parents orgrandparents have the right to live and work inthe UK, as do certain dependants of British orEEA nationals (subject to appropriate visas).The following paragraphs apply to nationals ofother countries.Since 2008 the UK has had a 5-tier pointsbased system to cover most economic,working and studying visas for entry to the UK.Tiers 1 and 2 will be the most relevant aspectsof the 5-tier system for those seeking toestablish a business in the UK but otheraspects of the system may be relevant in somecases. We also only highlight aspects of Tiers1 and 2 and do not cover themcomprehensively.1. Applications under Tier 1An individual who wishes to establish abusiness in the UK can make an application toenter the UK under Tier 1 (Entrepreneur) of thePoints-Based System (“PBS”). The applicationshould be made to the British diplomatic postin the country where the individual is legallyresident. The Tier 1 (Investor) category mayalso be relevant.In all Tier 1 categories applicants will need toprovide original documentary evidence tosupport their claim for points, and the evidencewill be rigorously checked.Tier 1 (Entrepreneur)Tier 1 (Entrepreneur) is for individualsinvesting in the UK by either setting up ortaking over a business. Entrepreneurs must beactively involved in the running of this businessin the UK, and cannot take up any otheremployment in the UK. A total of 95 points isrequired for a successful application.Individuals must score 75 points bydemonstrating that at the date of theirapplication they have access to £200,000 (orin certain circumstances £50,000) which isheld in a regulated financial institution, andfreely transferable to and disposable in the UKfor the purposes of investment in the intendedbusiness.Entrepreneur applicants must also score afurther 20 points by demonstrating that theycan speak English to the required standardand that they have enough money to supportthemselves whilst in the UK,To obtain a further 2 year extension of theinitial 3 year 4 months Tier 1 (Entrepreneur)visa, applicants must demonstrate thefollowing:• that they have made the £200,000investment in one or more businesses inthe UK (the investment should notinclude the value of any residentialaccommodation, property development,or property management);• within 6 months of initial entry into the UKthey registered as a director of anexisting or newly established company orregistered as self-employed with HMRevenue and Customs and continue tobe so registered;• that they were actively engaged in thebusiness at the time of their application;• that their investment created theequivalent of two new full time paid jobsfor at least two persons settled in the UK,and that these jobs have existed for atleast 12 months each; and• that they satisfy the language andmaintenance requirements.Tier 1 (Investor)This category is for high net worth individualswho are willing to make a substantialinvestment in the UK. Investors must score 75points by demonstrating that they either haveat least £1,000,000 of their own money whichis held in a regulated financial institution anddisposable in the UK, or by demonstrating thatthey own personal assets which (taking intoaccount any liabilities to which they aresubject) have a value exceeding £2,000,000PAGE 20

and that they have money under their controlheld in a regulated financial institution anddisposable in the UK of no less than£1,000,000 (which is permitted to includemoney loaned to the individual by a regulatedfinancial institution).Unlike the Tier 1 (Entrepreneur) visa, anapplicant does not have to meet the Englishlanguage requirement and is not required toshow that they can support themselvesfinancially whilst in the UK.An investor will have 3 months from the date ofentry to the UK to invest at least £750,000 oftheir capital in the UK by way of UKGovernment Bonds or share or loan capital inactive and trading UK registered companies(excluding companies principally engaged inproperty investment, and excludinginvestments by way of deposits with banks orbuilding societies), and the balance must beotherwise invested in the UK.Investors will be issued with a visa for 3 yearsand 4 months, which maybe extended for afurther period of 2 years provided that theinvestor meets the conditions of the pointsbased extension test in force at the time(summarised above). Investors are free toundertake any employment or pursue selfemploymentand other business opportunitiesin the UK.2. Applying under Tier 2Employers wishing to employ individuals underTier 2 of the PBS must first have registeredwith the UK Border Agency as a “LicensedSponsor” and the individual must then besponsored by that employer.To be eligible to apply to come to the UK underTier 2, an individual must have a job offer inthe UK from an employer registered with theUK Border Agency as a Licensed Sponsor.The job must be graduate level or above, andthe salary must meet or exceed the minimumacceptable hourly or annual salary for the typeof job, as set down from time to time by the UKBorder Agency. The individual must also score50 points for “attributes”, which are scoredacross two criteria: the type of job offer (e.g. ifit is on the UK Border Agency’s ShortageOccupation List, for an intra company transfer,if the salary is over £150,000, if the migrant isswitching from a student visa category or if thejob has passed the “resident labour markettest”), and the prospective salary to be paid inthe UK. Individuals must also score a further10 points for each of financial “maintenance”and English language ability (intra-companytransfereesare exempt from the Englishlanguage requirement).3. Sole representativesThe first representative in the UK of anoverseas company which does not alreadyhave a representative branch office orsubsidiary in the UK can seek permission toenter the UK as a Sole Representative of thatoverseas company to establish a wholly ownedsubsidiary or register a branch in the UnitedKingdom.Applications to enter the UK as a SoleRepresentative are made to the Britishdiplomatic post in the country where theoverseas company is situated. Applications asSole Representatives are normally granted foran initial period of 24 months.4. Family members, settlement andcitizenshipFamily members of individuals grantedpermission to enter the UK may also begranted permission to enter the UK asdependents. This normally covers spouses,civil partners (and unmarried partners wherethe parties have been living together for twoyears or more), and children under the age of18. Applications are dealt with by the Britishdiplomatic post in the country where the familyresides.Under current rules, where an individual hasremained in the UK continuously for five yearsin one of the categories set out above, theycan apply for settlement in the UK and after sixyears residence in the UK (which must includeat least 12 months in the UK with settledstatus) it is presently possible to apply forBritish citizenship, although it is important tonote that during the qualifying period forcitizenship there are restrictions on the amountof time a person can spend outside the UK.However, the UK Border Agency keeps theposition on settlement and citizenship underregular review, so the requirements couldincrease or decrease over time.5. Business visitorsWhere a non-EEA/Swiss national needs toenter the UK for the purposes of takingpreparatory steps to set up a business or foremployment/self-employment in the UK, theymay enter as a business visitor. However, thisvisa does not allow individuals to actually setup in business or be employed in the UK.PAGE 21

Nationals of some countries (which include theUSA, Australia, Canada, Japan and SouthAfrica) are not required to apply for prior entryclearance before travelling to the UK as abusiness visitor. However, the majority of non-EEA/Swiss nationals will be required to applyfor prior entry to the UK from the Britishdiplomatic post in the country in which they arelegally resident.PAGE 22

V Property, planningand environmentalconsiderations1. Property1. The mechanics of propertytransactionsThere are no controls on foreigners buying UKproperty. Generally the terms of a propertyacquisition are agreed on a subject to contractbasis and thereafter searches and enquiriesare raised and title is investigated. When thisprocess has been satisfactorily concluded,contracts will be exchanged for the sale andpurchase, or the grant of the lease, of theproperty (as appropriate). At this point bothseller and buyer are contractually bound toproceed to complete the transaction.Completion normally follows some weeks afterexchange, when the transfer or grant of theinterest is completed, any capital monies dueare paid and possession is granted.The whole of England and Wales is subject toa system of compulsory registration of varioustypes of disposition, most notably transfers orlettings or 7 or more years of land.This will eventually result in all freehold andlong leasehold property titles being registeredat the Land Registry and most title rights andinterests may be checked simply by referenceto the register. Where land is stillunregistered, title rights and interests must bechecked in the Land Charges register and byreference to the documents of the title held byexisting landowners.The above system does not apply in Scotlandwhere, although registration is alsocompulsory, an entirely different procedure isused (see pages 30-31).2. TenureProperty interests in England and Wales fallinto two classes of tenure: freehold andleasehold.Freehold amounts effectively to absoluteownership of the land and buildings on it andthe airspace above it. There is no time limit onfreehold ownership. Freeholders maynevertheless be subject to restrictivecovenants in favour of adjoining owners (whichlimit the absolute rights of the freehold owner)or to rights in favour of adjoining owners (egrights of way, services or light and air) whichmay be noted on the title.Leasehold interests are lesser interests in landin that they exist for a defined period (which forexample may be as little as a week or as muchas 999 years) and are often of only a buildingor part of a building on the land. At the end ofthe defined term the lease comes to an endand the land reverts to the landlord. Althoughsome commercial organisations in the UK ownthe freehold interest in their premises or, lesscommonly, a “long” lease, many businessorganisations occupy their commercialpremises on a rack rent lease for termscommonly between 5 and 10 years. The usualcharacteristics of such a lease are as follows:A rack rent is the best rent obtainable for theproperty in the open market subject to thelease terms.The initial rent is determined throughnegotiation and it will be subject to review tocurrent market rent at periodic intervalsthroughout the term of the lease.Generally such reviews are on an upward onlybasis and do not, therefore, result in areduction of rent at a review taking place at atime when the market is in decline.Note, however, that the code for commercialleases, which sets out various industry bodies’views on best practice, strongly recommendsthat landlords should offer alternatives toupwards only rent reviews priced on a riskadjustedbasis. To date, the existence of thiscode has dissuaded the UK Government fromlegislating to outlaw upwards only rent reviews.Additionally a modern commercial lease willpass on to the tenant the cost of insurance andmaintenance of the property (including itsstructure and plant). The latter will be achievedeither by imposing a direct obligation on thetenant to repair and maintain the property or byrequiring the tenant to contribute towards thecosts of repair and maintenance (particularly ina multi-let building) via a service chargecalculated and administered by the landlord.Calculation of service charges andmanagement of service charge accounts issubject to the guidance issued by the RICSand which came into effect on 1 April 2007.The lease will usually require the tenant tohand back the property at the end of the leasein good repair or pay compensation instead.PAGE 23

The lease will normally also contain provisionsregulating the purposes for which the propertymay be used and the manner in which thetenant may dispose of its lease.An outright sale of part of the leased propertyis generally prohibited but a transfer of thewhole (commonly called an assignment) ispermitted subject to obtaining the landlord’sprior consent which (generally) may not beunreasonably withheld. The liability of theoriginal tenant of a building following anassignment is dependent upon the date thatthe lease was granted. If the lease (or theagreement leading thereto) pre-dates 1January 1996, then, as a rule, the originaltenant (and, in all probability, its successors intitle) will each remain liable for its obligationsunder the lease throughout the term of thelease even after a further transfer. In practice,post 1995 leases generally limit tenants’liability to the period of their own ownershipand that of their immediate successor.Modern commercial leases generally allow thetenant to sub-let all or part of the property,subject to the prior approval of the landlord,but the precise nature and extent of the rightswill be the subject of negotiation in each caseat the time the lease is drawn up.Leases will almost certainly require thelandlord’s consent to the carrying out of anyalterations to the property (particularly wherethose alterations affect the structure). Theextent to which a landlord must be reasonablein giving consent is a matter of negotiation atthe time the lease is drawn up. In most cases,the tenant will not be entitled to any paymenteven if these alterations improve the property.Finally, it should be noted that businesstenants enjoy a measure of statutory protectionin that, unless certain circumstancesprescribed by statute apply (eg persistentdefault by the tenant, redevelopment or arequirement by the landlord to occupy theproperty itself), a commercial tenant will beentitled to renew its lease on market terms.This valuable right can, however, be excludedby the landlord giving a prescribed form of“warning notice” followed by a tenant’sdeclaration that it agrees to the exclusion of itsrights.3. Tax considerationsAnother section of this guide has commentedon capital allowances. In addition to this aspectit should be noted that occupiers (as opposedto owners) of commercial property are liablefor business rates (ie a local property tax)usually based on the size of the premiseswhich is being used. Additionally, VAT may bepayable on any capital payment made toacquire a property interest, upon rentalpayments under a lease or on developmentcosts. SDLT is payable currently on all capitalpayments at the rates set out on page 13.2. Town & country planningA system of town and country planning controloperates in the UK. Planning powers reside,principally, in local authorities (eg districtcouncils, London boroughs). Subject to certainlimited exceptions (such as below), newbuildings may not be erected, existingbuildings may not be altered, nor the use ofland or existing buildings changed, without firstobtaining the requisite planning consent.There is a limited ability to change use withinthe same use class without the need forconsent, such as changing from one lightindustrial use to another light industrial use,and to change the use between differentclasses in particular cases, where the new useis generally seen as less onerous than the old.Applications are made to the relevant planningauthority and will be determined in accordancewith the current development plan for the area.There is normally no right of compensation ifplanning permission is refused, although thereis a right of appeal.Additional controls apply to the proposeddevelopment of a building which is listed asbeing of particular architectural or historicinterest or is in a conservation area. The list ismaintained by English Heritage whilst localauthorities determine their own conservationareas and set up appropriate policies for them.Enterprise Zones and Simplified PlanningZones have been set up by the Government incertain parts of the country in order tostimulate industrial and commercial activity bythe removal of certain tax burdens and byrelaxing or speeding up the application ofplanning control.The planning system in England and Wales isundergoing much reform at almost all levels atthe moment. A new (lowest) tier of planninghas been introduced at the neighbourhoodlevel. Parish Councils or other groups formedfor the purpose are now drawing upneighbourhood plans relating to developmentin their areas. At the local level, Local Plansare being replaced by Local DevelopmentFrameworks, which govern developmentthroughout the local authority. In March thePAGE 24

National Planning Policy Framework wasintroduced which sets out new guidance at thenational level for development. Local plansare expected to adhere to the guidance unlessthere is good reason why not.The Government is in the process of removingthe former regional tier of planning as part ofthe process of returning certain planningpowers to the local level.The Infrastructure Planning Commission wasset up in 2009, to deal with nationallysignificant infrastructure projects. NationalPolicy Statements relate to the differentinfrastructure categories. In April 2012, theCoalition Government moved the functions ofthe Commission to the Planning Inspectorateand they are now delivered by the NationalInfrastructure Directorate. A Secretary of Stateis now the final decision maker in largeinfrastructure decisions.With reducing carbon dioxide becoming ofincreasing importance, the planning system isalso embracing the move. Local authoritiesare trying to reduce carbon dioxide at locallevel, through their local planning controls.Building regulation controls, imposed at anational level, are also driving this initiative.Improvements to the energy performance ofplant and equipment must therefore beconsidered in any new building or majorrefurbishment. The Government wants all newhomes to be “zero carbon” by 2016 and allnon-domestic buildings to be zero carbon by2019. The Welsh Assembly however alreadywishes all new buildings in Wales to be zerocarbon - it has been striving for this since2011. Various measures are being brought into achieve such targets.3. Environmental controlsBusinesses operating in this country should beaware not only of major environmentallegislation but also of the large and rapidlygrowing body of statutory instruments,regulations and guidance notes on ”green”issues, much of which is specific to certainindustrial sectors.The Environmental Protection Act 1990 andthe Environment Act 1995 contain much of themost important legislation. The 1990 Actcreates a system of integrated pollution controlby making it necessary for businesses toobtain a specific authorisation for the mostpotentially polluting industrial processes.These are designed to achieve the use of “thebest available techniques not entailingexcessive cost” in order to prevent or reducethe release of potentially harmful substances.Waste management also forms an importantcomponent of environmental law. Under theEnvironmental Permitting Regulations, in forcesince April 2008, operators of installations,mobile plant and other waste operationssubject to the regime, must hold anEnvironmental Permit. This regime combinesthe permitting systems for activities under thepollution prevention and control regime and thewaste management regime.Increasing attention is being directed to wasteminimisation, recycling and re-use. TheGovernment is seeking to introduce industryleaseschemes, including a workable voluntaryprogramme for the packaging industry.The Water Resources Act 1991 regulates thedischarge of substances into controlled water.The discharge of poisonous, noxious orpolluting matter, solid waste, trade effluent andsewage effluent constitutes a criminal offenceunless carried out under and in accordancewith an authorisation. Coastal waters areincluded within the 1991 Act and dischargesinto the sea from the prescribed processes aregoverned by the Environmental Protection Act1990. The Environment Agency has publishedguidance to help prevent the pollution ofwatercourses, by those carrying outdevelopment works nearby.A large number of statutory instrumentsimpose stringent controls on matters such asthe location and storage of hazardoussubstances, radioactive substances, pesticidesand genetically modified organisms.Of particular concern to those intending to setup business in the UK may be the powersgiven to local authorities and the EnvironmentAgency by the Environment Act 1995 inrelation to contaminated land. Britain was thebirthplace of the industrial revolution and inmany parts of the country there is a significantrisk of land contamination arising fromprevious industrial processes, some of whichmay have gone on decades ago. Although theprinciple is that the original polluter will beprimarily liable, current owners and occupiersof contaminated land can be compelled to bearthe clean-up costs if the original pollutercannot be found or if subsequent owners buywith sufficient information about the pollution/contamination. Liability for contaminated landPAGE 25

is strict, so the enforcing authority does notneed to show that the polluter intended tocause the contamination or was otherwise atfault. Updated statutory guidance in relation toEPA was issued in April 2012.Those doing business in the UK must alsoconsider the European and internationalbackground in assessing environmentalresponsibilities and the potentially very costlyconsequences of breaching environmentalcontrols.Increasingly, EU and UK legislation is directedtowards energy efficiency, the reduction ofCO2 emissions and improving air quality. Allentities which are electricity suppliers licensedunder the Electricity Act 1989 are required toprovide evidence that they have suppliedcustomers with a certain amount of electricitygenerated from renewable sources. On 1 April2010 the UK brought in a mandatory UK-wide“cap and trade” emissions trading scheme forlarge businesses and public sectororganisations, called the CRC EnergyEfficiency Scheme. This sits alongside theexisting EU Emissions trading scheme andClimate Change Agreements, which catchEnergy-Intensive Industries. The CRC EnergyEfficiency Scheme requires organisations withsignificant annual electricity bills to buy andtrade Allowances and to provide data to theGovernment about their energy use and CO2emissions. The aim is to provide an incentivefor private and public sectors to become moreenergy efficient and help the UK reduce itsoverall greenhouse gas emissions.Legislation for energy efficiency, reduction ofCO2 emissions and improving air quality islikely to be changed in the foreseeable future.It will become more onerous for businesses.PAGE 26

VI Intellectual propertyAll businesses own and use intellectualproperty. It protects the results of innovation,creative effort and goodwill. For example, trademark law protects the name under which abusiness trades, there is copyright in thedocuments and artwork it creates, and patentsare available to protect its technology.Some of the intellectual property that abusiness uses will be developed by its ownemployees and some will be bought or takenunder licence.Intellectual property rights are valuable assets,and companies attribute large sums in theirbalance sheets to copyright works, patents andbrands.The principal intellectual property rights are:• patents;• copyright;• registered and unregistered trade marks;• registered and unregistered designs;• database right.It is also possible to use the law to protectconfidential information, know-how and tradesecrets, even though these are notconventionally regarded as property as such.The principal attributes of these intellectualproperty rights are set out below.A business proposing to trade in the UK willneed to consider the intellectual property rightsavailable both under English and EU law(which applies in the UK). For example, inaddition to the rights granted by English law, itis possible to own a Community trade markand Community designs. Businessesproposing to trade in the UK or establishthemselves in the UK therefore need tounderstand how intellectual property rights arecreated and protected in the UK and Europe.For the purpose of this note, we will treat EUrights as if they were local rights.Foreign intellectual property rights are notcapable of being enforced as such in the UK.They may entitle businesses to equivalentrights under English law, but not necessarilyand not on the same terms. Businessesentering the UK need to establish what theirrights are and what action they need to take toperfect them.Intellectual property rights are rights inproperty and they can be dealt in, assigned orlicensed to others. The owner of intellectualproperty generally has the exclusive right toperform certain acts with respect to the worksprotected by it; for example, the right to copy acopyright work, to use a patented process or tomake an item to a design. Third parties are notusually allowed to perform any of these actsunless the owner grants them a licence to doso, usually in return for a fee.If a company finds that someone else is usingits intellectual property without a licence, quickaction is needed to enforce the intellectualproperty and to protect the business.1. PatentsA patent protects an inventive product orprocess. In order to qualify for patentprotection, the invention has to satisfy anumber of conditions, namely, it must be new(in other words not previously disclosed to thepublic), demonstrate an inventive step (i.e. itmust not be obvious to someone who is skilledin the relevant field) and must be capable ofindustrial application.Patents are territorial rights and are applied forin specific countries or groups of countries. Inthe UK, a patent application is filed containinga description of the invention, claims and anydrawings, a search for inventions in the area isconducted and the application is thenexamined in the light of the search results. Inprinciple, once granted the patent will normallylast for twenty years from the date of theapplication subject to payment of renewal fees.During this time, the owner of the patentgenerally has a complete monopoly over theuse and exploitation of the invention coveredby it. Once the patent has expired, theinvention may be used or exploited by anyoneelse.2. CopyrightCopyright arises automatically and protects theway in which an idea is presented, in contrastto the idea itself. In the UK, copyright cannotbe registered (unlike trade marks andregistered designs). Copyright will only subsistif, amongst other things, the work is original -that is, the work is not copied. Examples of thevery different types of work that attractcopyright protection include text or drawings inPAGE 27

a document (or on a website), software code,literary works and sound recordings.Most forms of copyright last for the life of theauthor plus seventy years, although in somecases the term is significantly shorter: forinstance, it only lasts for fifty years in the caseof computer software and sound recordings.The owner of copyright in a work can preventsomeone else from copying it but, in contrastwith patents, cannot stop someone else fromusing an identical work that they haveindependently created or from exploiting theidea behind the work.3. Trade marksA trade mark in its widest sense is any sign(such as a word or logo) that designates theorigin of a business’s goods or services, so asto distinguish them from the goods or servicesof other businesses.Unregistered trade marks are protected underthe law of "passing off", although to assertthem can be expensive and time-consuming. Itis usually preferable for businesses to seek toregister their trade marks for the specific goodsand services for which they are used. Trademark registrations are generally obtainedcountry by country, although it also possible toobtain an EU-wide trade mark registration(known as a “Community Trade Mark”) as wellas an international registration in whichspecific countries are nominated.In the United Kingdom, trade markregistrations initially last for ten years but canbe renewed thereafter for further ten yearperiods, in theory indefinitely. Trade marks thathave been registered are often displayed withthe ® symbol.The ability to secure trade mark registrationsgoes to the heart of protecting a brand, andregistrations can be obtained not just forwords, but also for symbols, colour, sounds,shapes and even smells (although shapes andsmells can be very difficult to register inpractice).Note that trade marks may be referred to as“trademarks” outside the UK.4. Registered designsIn the UK, it is possible to protect designs byregistering them. In order to qualify forregistration the design must be new, and itmust have individual character: it must createan overall impression that is different from thatof any previous design. Industrial designs, aswell as aesthetic or artistic designs, can beregistered. Although design registration mustbe applied for with reference to a product, theregistration actually protects the design itself,as applied to any product. Some designscannot be registered, for example designs thatare solely dictated by the technical function ofthe product in question, or where the shape ofthe product is dictated by the requirement to fitor connect with other specific features ofanother product. A design right registrationlasts for up to twenty-five years (subject torenewal), during which time the owner canprevent anyone else from using the design orany design which does not create a differentoverall impression.In addition, it is also possible to obtain an EUregistration for a design, which covers allstates of the European Union. The basicprinciples of this are the same as those for UKregistered designs. EU registrations also lastfor up to twenty-five years.5. Unregistered design rightIn the UK, unregistered design right (UDR)(also referred to as “Design Right”) arisesautomatically when an original design isrecorded or a product is made to the design. Itessentially covers purely industrial orfunctional designs rather than aestheticdesigns. Protection lasts for either fifteen yearsfrom the date the design was first recorded in adocument or an article/whichever is earlier, orten years from the date when a productcontaining the design is first marketed for saleor hire. The scope of protection afforded byUDR is more limited than in the case ofregistered designs. In particular, UDR onlyprevents copying and so does not protectagainst similar but independently createddesigns. Any third party is entitled to a licencefrom the owner during the last five years of theright to do any act which would otherwise bean infringement of the right.There is also a limited EU unregistered designright, which lasts for three years from the datethe design is first disclosed or made availableto the public.6. Database rightDatabase right is aimed at protecting theinvestment put into creating databases, andspecifically in obtaining, verifying andpresenting the database contents. The firstPAGE 28

owner of a database right is normally theperson who has made this investment.The owner can prevent anyone else fromextracting or re-utilising a part of the contentsof the database. Database right lasts for fifteenyears from the date when the database wascompleted. Databases may also be protectedby copyright.7. Confidential informationThe confidential information of a business,such as know-how, has been described as itslifeblood. Many businesses rely on theirconfidential information as much as on anyintellectual property rights in order to give thema competitive advantage. Under English law, aduty of confidence arises if confidentialinformation is disclosed in circumstanceswhere the recipient has a duty (including aduty inferred from the circumstances) to keepthe information confidential.In view of the potential for disputes as to whathas been disclosed and the extent of therecipient’s duties, it is essential thatbusinesses that disclose confidentialinformation, such as customer lists or technicaldata, do so under the terms of a confidentialityagreement - also known as a non-disclosureagreement. It is important to note thatinformation that is not truly confidential (e.g.because it is trivial) cannot be protected. Inparticular, information that enters the publicdomain ceases to be protectable, although it isstill possible to claim damages for priorunauthorised disclosure if this happens.Information may cease to be protectable underthe law of confidence if too many disclosuresare made.PAGE 29

VII ScotlandWe are grateful to Anderson Strathern,solicitors in Edinburgh, who prepared thisSection.1. ParliamentScotland has a separate legal system fromEngland and Wales. Since July 1999, Scotlandhas had its own Parliament, based inEdinburgh, although the Parliament and itscommittees have held sittings in other parts ofScotland. The Parliament’s powers are set outin the Scotland Act 1998. It only hascompetence to legislate on what are called‘devolved matters’ and cannot legislate onmatters that are ‘reserved’ to the UKParliament. The reserved matters are listed inSchedule 5 to the Scotland Act.Reserved matters include certain aspects ofthe UK Constitution, many aspects of defenceand foreign affairs, fiscal, economic andmonetary policy, immigration and nationality,data protection, firearms and misuse of drugslegislation, national security, interception ofcommunications and official secrets, mostaspects of insolvency, intellectual property,consumer protection (except food safety),certain aspects of energy and transport, socialsecurity, many aspects of employment law,equal opportunities and professionalregulation, time, outerspace and a number ofother miscellaneous matters.Anything not listed in Schedule 5 is, thereby,devolved and within the Scottish Parliament’slegislative competence.The Scottish Parliament was given limitedpowers in relation to taxation under theScotland Act 1998, enabling it to vary the rateof income tax. However, recent legislationpassed by the UK Parliament in the form of theScotland Act 2012 has devolved new powersin relation to income tax and borrowing. Inaddition, the new Act devolves stamp duty landtax and landfill tax.A referendum is likely to be held in Scotland inthe autumn of 2014 on the question ofindependence for Scotland. Even if the resultis in favour of independence the details ofimplementation would take time to benegotiated and legislated.2. PropertyScottish property law is different from Englishproperty law and it is in relation to property thatcompanies and businesses frequentlyencounter the Scottish legal system. Scottishlaw being a civilian legal system in commonwith most of continental Europe has developedon a different basis from that applicable inEngland and Wales.There is no principle of equity in Scots law withthe result being that contracts will generally beinterpreted literally and strictly according totheir terms. The approach of the Scottishcourts to enforcement of contracts is thatparties will have negotiated terms and each isexpected to honour their obligations. If theresult is inequitable to one party then that isnot material. The result is simply the intent ofthe parties when they negotiated the contract.Scottish legal advice is therefore necessary forcontracts or land transactions of any typeundertaken in Scotland.For most commercial and business propertiesScotland has two types of land holding:• Heritable, where the interest is held inperpetuity but is frequently subject torestrictions or conditions (usually referredto as burdens) enforceable by certainthird parties. This approximates tofreehold in England with restrictivecovenants; and• Leasehold.1. Contracting for propertyScottish property law is designed to ensurethat parties enter into a binding contract at oras near to the outset of the transaction. Thecontract itself will provide the necessarycomfort which the purchaser requires toensure that he obtains good title. It isimperative that any purchaser stipulates whathe requires the seller to produce and the sellermust match that with what he can deliver.Scotland has always been proud of its landtransfer system as being both fast and efficientand therefore bringing certainty to propertydeals at an early stage. The complexity ofmodern land law and the associated issueswhich are now commonly incorporated intoproperty contracts mean that, to some extent,negotiating a property contract is now more aprolonged exercise than in the past. However,where the parties wish, the Scottish legalPAGE 30

system will produce a fairly fast transfer of theproperty.There have been recent changes in the systemof contract in Scotland whereby the previousformality rules which were required to enterinto binding contracts have been relaxed. It istherefore now possible for parties to becomecontractually bound on the basis ofcorrespondence between two parties. In somecircumstances, contracts do not even requireto be in writing. The basic principle of theagreement and intention of the parties(consensus in idem) is still required, butadditional care is required throughout thenegotiation process.For these reasons it is more important thatlawyers are consulted at the outset of anytransaction and that advice is taken as to theconduct of negotiations to ensure that nocontractual obligation is undertaken before theparties so intend.2. Leasing business/commercialpremisesThe style of lease commonly used forcommercial properties is broadly similar to thatused in England and Wales although theapplication of Scots law to the terms producesmaterially different results in certain respects.It follows that the rights and responsibilities ofthe parties will be different from elsewhere inthe UK. Scotland has virtually no legislationregarding leasehold interest for commercialproperties.for a year in the case of shop facilities uponapplication to the sheriff. A tenant musttherefore seek advice well in advance of theexpiry date of the lease to ensure that theirnegotiating power is not compromised in anyway.3. AdviceLand Law in Scotland recently underwentmajor reform. The Title Conditions (Scotland)Act 2003, the Tenement (Scotland) Act 2004(which applies to commercial premises as wellas to residential premises) and the Abolition ofFeudal Tenure (Scotland) Act 2000 werephased in from 1 November 2003, abolishingmany differing conditions that existed overproperties in Scotland.The new legislation was designed to simplifyand codify Land Law in Scotland although ithas introduced a replacement system ofinterpretation and registration of title conditionswhich requires careful consideration andspecialist advice. A knowledge of both the newand previous law is essential to fully advise ontitles to properties.The Anti-Social Behaviour (Scotland) Act 2004has introduced a system of compulsorylandlord registration in Scotland which is amust for any client buying residentialinvestment property. Where corporate andbusiness transactions involve a "Scottishdimension", Charles Russell can arrangeScottish legal advice or recommend to youlawyers in Scotland.The courts tend to apply the terms of leasesvery strictly. This is illustrated by some recentcases where disputes in both Scotland andEngland have arisen over similarly wordedclauses and the courts in the respectivecountries have adopted a different approachwhich in turn produces different results.In Scotland a tenant’s right to assign itsinterest in the lease is regulated by the termsof the lease. Most commercial leases willpermit a tenant to assign its interest subject tolandlord’s consent which cannot beunreasonably withheld or delayed. In thatevent, on completion of the assignment, theoutgoing tenant is unconditionally releasedfrom all obligations to the landlord since thereis no privity of contract.A tenant of commercial property in Scotlandhas no right to require a renewal or extensionat the end of the contractual period of thelease other than a very limited right to extendPAGE 31

London5 Fleet PlaceLondon EC4M 7RDUnited KingdomTel: +44 (0)20 7203 5000CheltenhamCompass House, Lypiatt RoadCheltenhamGloucestershire GL50 2QJUnited KingdomTel: +44 (0)1242 221122BahrainFloor 31, Bahrain World TradeCentre, West Tower, Isa AlKabeer AvenuePO Box 31249, ManamaKingdom of BahrainTel: +973 17 133200GuildfordBuryfields HouseBury FieldsGuildfordSurrey GU2 4AZUnited KingdomTel: +44 (0)1483 252525Geneva9-11, rue du Prince1204 GenevaSwitzerlandTel: +41 (0)22 591 1888Charles Russell LLP is a limited liability partnership registered in England and Wales, registered number OC311850,and is authorised and regulated by the Solicitors Regulation Authority. Any reference to a partner in relation to CharlesRussell LLP is to a member of Charles Russell LLP or an employee with equivalent standing and qualifications. A list ofmembers and of non-members who are described as partners is available for inspection at the registered office, 5 FleetPlace, London, EC4M 7RD.PAGE 32