The UK Startup's Guide to Managing U.S. Litigation Risk

You took the plunge and established a U.S. subsidiary. Now, how do you protect your UK company from U.S. litigation?

Why Is the U.S. Litigious?

We often speak with UK companies concerned that they’ll be sued the moment they step off the plane in the States. That’s simply not true - usually you’ll be given at least a few hours to make yourself comfortable...

Joking aside, litigation risk is in fact higher in the U.S. than in most other countries, and the threat of litigation often is used as leverage to achieve favorable business outcomes, whether the potential claimant is an unhappy contractual counterparty, a disgruntled employee, or an aggressive U.S. patent or trademark owner. The U.S. generally does not have the “loser pays” rule common in the UK and many other countries; in many non-U.S. countries, the loser in litigation bears a significant part of the winner’s legal fees.

Consequently, even a relatively weak claim in the U.S. has value because the party bringing the claim knows the defendant’s cost to settle the claim likely is less than the cost of defending it. Well-funded companies and individuals represented by contingent-fee lawyers can leverage this dynamic to assert claims they wouldn’t otherwise if they were at risk of paying the defendant’s legal fees.

What Can I Do to Minimize U.S. Litigation Risk?

Below are a few steps you can take to reduce the risk of claims in the U.S. These action items will be familiar to domestic U.S. businesses, but may reflect a very different approach to how your company conducts business in the UK or other European markets.

1. Pro-actively manage risk.

Savvy U.S. companies manage litigation risk proactively, anticipating potential problems and addressing them before they arise. What this means obviously varies in the context, but it generally requires greater care—for example, in making sure that contracts accurately describe services and performance obligations, that HR matters are handled sensitively, that early indications of problems are taken seriously, and that regulatory and tax issues are addressed in advance.

The aggressive U.S. litigation environment is why U.S. companies maintain close relationships with outside counsel, build substantial in-house legal teams, and take legal advice on a proactive “problem-avoidance” basis, rather than a reactive “problem-solving” basis; the lack of a “loser pays” rule means that solving legal problems in the U.S. is substantially more expensive than avoiding them in the first place. To a much greater extent than in virtually any other country in the world, legal advice is the cost of doing business in the States. As noted in a recent article by UK-based Octopus Ventures, companies in the U.S. spend nearly triple the amount on legal services for every dollar of revenue than their counterparts around the globe.

2. Establish compliance procedures.

Some person or persons in your organization need to have clear responsibility for ensuring compliance with U.S. contracts, laws and regulations, and your systems need to permit appropriate tracking of compliance.

3. Maintain appropriate insurance coverage.

It is critical that you obtain appropriate insurance advice from a broker with North American experience in order to understand what kinds of coverage (and with what limits) a company in your business might be expected to procure in the U.S. Some of these are mandatory (such as workers compensation insurance for your employees), some will be required by contractual counterparties (such as evidence of professional liability insurance, which in the U.S. is generally referred to as “errors and omissions” insurance, or certain kinds of automobile coverage), some are highly prudent (such as directors’ and officers’ liability insurance), and some may depend on the nature of your business (such as employment practices liability insurance, IP liability insurance, and cyber insurance). In any case, you can only reach appropriate conclusions as to what makes sense once you have obtained the advice, and you should revisit your conclusions at least annually.

How Do I Keep My UK Parent Company Out of U.S. Litigation?

While a UK parent company can take care to conduct U.S. business through its U.S. subsidiary, the parent company still may find itself initially named as a co-defendant in claims asserted against the U.S. subsidiary because the parent typically has “deeper pockets” that can increase the settlement value of the claim.

All is not lost, however. Here are a few steps that your UK company can take to mitigate the risk of being dragged into U.S. litigation involving your U.S. subsidiary:

1. Allow your U.S. subsidiary to do its own business.

If you have decided to expand to the United States, it makes sense to let your subsidiary handle the vast majority of U.S. business dealings. If the subsidiary (and not your parent) registers to do business in the states where it will conduct business, the parent avoids consenting to jurisdiction in that state. Similarly, if your subsidiary is responsible for entering contracts with U.S. entities, any claims arising out of those contracts should be brought against the subsidiary, and if the contract requires consent to litigation in a particular state, only the subsidiary will be agreeing.

2. Reduce your own U.S. contacts.

U.S. courts will only exercise authority over foreign companies that have a certain level of contacts with the state where the court is located. Having a subsidiary located in the state will not be enough. But if the foreign parent corporation purposefully directs its own activities at the state, it can lawfully be sued in the state based on claims relating to those activities. By minimizing your parent company’s contacts with the U.S., and allowing U.S. operations to be handled by your U.S. subsidiary, you can significantly reduce your risk of having to defend a lawsuit in a U.S. court.

3. Make sure your subsidiary is independent, observes corporate formalities, and can pay a judgement.

To mitigate the risk of being required to defend a U.S. litigation based on your subsidiary’s conduct, take steps to ensure that your subsidiary is a fully functional and separate business. U.S. courts generally take the view that a parent and subsidiary are two separate entities that are not responsible for the others’ conduct. But that’s only when the businesses really are operating separately. You should make sure that your subsidiary complies with corporate formalities, including creating the subsidiary’s own board of directors, having the subsidiary hire and pay for its own employees, keeping finances separate, and documenting intercompany loans. Sufficiently capitalizing—and documenting the reason for the capital structure—the subsidiary will also make a court more inclined to allow the subsidiary to answer for its own conduct, and not look to the parent instead.

4. Butt out!

Of course, there needs to be some oversight over your newly formed subsidiary’s activities. But once up and running, the less direction and control the parent exercises over those activities, and the more you allow your subsidiary to run on its own, the less likely you will be hailed into a U.S. court. If your subsidiary takes an action at your direction and under your control, a U.S. court may hold you responsible.

5. Do not discuss a U.S. dispute concerning your subsidiary directly with the complaining party or their counsel.

If your UK parent or U.S. subsidiary receives a legal letter, engage U.S. counsel as soon as possible and do not directly communicate with the lawyer asserting the claim. This way, the UK parent can avoid its actions in connection with the dispute being used as evidence that the UK entity is controlling the business of the subsidiary.

Post produced by Tonia Klausner, Daniel Glazer and Meher Talib at Wilson Sonsini Goodrich & Rosati. Tonia can be reached at tklausner@wsgr.com, Dan at daniel.glazer@wsgr.com, and Meher at mtalib@wsgr.com.

The foregoing does not constitute legal advice and should not be relied upon for business or legal decisions.