Legal Aspects of Reshoring Site Selection

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This article has been kindly provided by Don Cannada of Butler Snow LLP. You can download a PDF version below:
Legal Aspects of Reshoring Site Selection.pdf

Introduction

Successful reshoring of a manufacturing facility requires extensive analysis, expert planning and careful execution. Legal issues abound. Non-compliance with a foreign country’s exit rules might prevent a company from conducting future operations there, while missteps in performing legal due diligence and in understanding and correctly applying U.S. public records, business formation, tax, real estate and regulatory laws can threaten, delay and even scuttle reshoring initiatives.

Although many companies may be tempted to hire a lawyer only when the company’s reshoring efforts run into legal problems, it is generally far safer, more efficient and more cost-effective to hire an experienced lawyer and other professionals with expertise in reshoring legal issues to protect the reshoring company’s interest throughout the reshoring process.

Below is a quick look at some of the legal issues that a company contemplating the reshoring of its manufacturing operations should consider.

Freedom of Information/Public Record Laws

Freedom of Information (“FOI”) is the general term for the laws (sometimes also called “sunshine laws” or “public record laws”) and principles that govern the public’s right to access government records. FOI laws are designed to help the public keep track of its government’s actions and the management of its tax revenues.

All 50 states and the District of Columbia have FOI laws providing public access to government records, most of which are based at least in part on the federal Freedom of Information Act (“FOIA”). State public record laws not only vary widely among each other and are not identical to the FOIA, but they also may be interpreted by state courts differently, even when they have similar language. These distinctions and differences can be critical and should be reviewed and understood before proceeding to supply any written or electronic information to a government body or economic development agency.

Application of FOI requirements to economic development agencies and industrial recruitment can be confusing. First, the manufacturing company seeking economic incentives must recognize that economic development agencies and similar organizations that receive some level of public funding or in-kind support are considered public bodies for purposes of the application of public record laws. Second, this designation applies even if the public support is a one-time payment comprising only a small percentage of a public body’s overall budget and even if the entity is organized as a private, nonprofit that is not controlled by the political subdivision or another public entity.

“Public Information” is generally construed to mean public information collected, assembled or maintained by a government body, or collected, assembled or maintained for a government body if it owns or has rights of access to that information. This covers a wide range of information. The intent is that taxpayers should be able to see any information that is used by people acting on the public’s behalf, unless such information is specifically exempt from disclosure.

Every state FOI has some exemptions. For example, states typically exempt business information that falls into two categories: trade secrets and privileged or confidential information. With respect to economic development records, exemption for information deemed “proprietary financials” or “trade secrets” are intended to protect a company from the release of information that would harm the company if it fell into the hands of a competitor. While economic development exemptions do not create an affirmative duty on the part of the public body to maintain confidentiality, they do provide a justification for nondisclosure when applicable.

The ability to see information about economic development deals may also depend on when the FOI request is made. In many states, information about incentives is not available until after the development agreement has been signed or a fixed time period elapses. Typically, regardless of the time period in question, disclosure is required when the deal is done and the project is publicly announced and/or incentive agreements are finalized.

Bottom line: In order to protect the confidentiality of its project and sensitive information with respect to the project and to the company, a company seeking economic incentives should first contact the economic development agency to ascertain how, how long and if such information can be maintained as confidential by the agency.

Nondisclosure/Confidentiality Agreements

Some companies will not even identify themselves until the parties involved in the industry recruitment process have signed a nondisclosure/confidentiality agreement (“NDA”). The requirement of an NDA usually also applies to third-party servicers and vendors involved in the early stage processes, such as key suppliers, consultants, utilities, engineers, contractors, architects, etc. While NDAs provide a contractual basis to withhold a company’s name and its proposed project plans, NDAs cannot operate to circumvent disclosure requirements under federal and state public record laws (absent an applicable exemption).

The manufacturing company should make sure that local government entities understand the company’s expectations regarding confidentiality in timing the public approval of various incentives by the city or county governing bodies.

NDAs are often heavily negotiated. A well-drafted NDA will include carefully negotiated restrictions on disclosing confidential information, and it should also prohibit the use of confidential information for any reason other than to further the purpose of the specific business relationship. Although some companies routinely ask a single party, typically the state, to sign an NDA to include and bind all public entities involved in the recruiting process, one state agency cannot bind another agency and the state cannot bind local governmental entities.

Accordingly, the company should obtain separate NDAs signed by each entity that will be involved in the sharing of project information.

Taxes/Business Structure

Taxes play a significant role in reshoring. State and local tax rates and structures vary greatly across the U.S., and the high U.S. corporate income tax rate presents significant challenges for competing globally. As part of any reshoring considerations, a company should carefully assess the potential impact of corporate income tax rates and state sales, use and property taxes on the purchase and ownership of machinery, equipment, real estate and inventory. In addition, stock options, employment agreements, non-compete agreements, deferred compensation agreements, accounting methods, medical and insurance plans and retirement plans all present unique U.S. tax implications that must be considered.

The exit process from a foreign country is also fraught with tax peril. Some countries require the exiting company to settle outstanding taxes and all debts and to deregister the Company before withdrawing from conducting business in that country. Some countries even require payment of closure taxes. In some foreign countries, a departing business should plan for the long haul - - gaining permission to leave and settlement of all taxes and fees could take some time.

Local corporate and tax structures can significantly affect the performance of reshored operations. Reshoring companies should seek advice on the relative tax and other business advantages and disadvantages of using a specific type of business entity and should seek expert legal and tax advice on the choice of the most appropriate business entity. Finally, it is critical to consider accounting structures and strategies to achieve the optimum arrangement for a specific manufacturing operation. A company currently contemplating reshoring should make these decisions well in advance of initiating a move, so that the tax, accounting and entity formation implications can be integrated into the overall business plan.

Proper tax planning will achieve the most advantageous business structure and minimize the overall tax expenditures of the business, thus enabling the business to deploy its financial resources in the most efficient manner.

Real Estate

Letters of Intent

Whether buying or leasing U.S. real estate for an office location or manufacturing facilities, it is customary for the parties to enter into a non-binding “letter of intent” (“LOI”) as a way to memorialize the basic business terms of the transaction in advance of drafting and signing the actual purchase agreement or lease. For example, if leasing real estate, the LOI should include the rental rate, an allocation of the costs for real estate taxes, property insurance, and maintenance obligations, the length of the term, any initial construction or improvements to be made to the premises prior to occupancy, and any options to extend the lease, terminate the lease early, or expand the leased premises, among other key business aspects that may be a part of the deal. If purchasing real estate, the LOI will include such topics as the purchase price, the length of any due diligence period for investigating the condition of the property, and the expected closing date of the transaction. An LOI allows the parties to settle on key deal terms before incurring extensive legal fees involved in drafting the purchase agreement or the lease. Though typically an LOI is non-binding in most respects, it should be entered into in good faith by the parties and as an accurate description of key points to the deal. An attorney specializing in real estate transactions should be involved in the LOI negotiation process from the beginning so that a party can be careful to not unknowingly jeopardize its legal position in anticipation of drafting and further negotiating the final agreement.

Purchase and Sale Agreements

When property is being purchased, the buyer and seller will enter into a purchase and sale agreement (“PSA”), setting forth the binding terms and conditions for the pending sale. The PSA will address many aspects of the transaction and the responsibilities of the purchaser and seller, including specification of the exact property being purchased, the purchase price and the escrow of an earnest money deposit, due diligence and property investigation matters (including environmental testing and investigations, such as a “Phase I” report), title insurance and survey matters, indemnification obligations in the event a party is subjected to a claim or loss arising from the fault of the other party, obligations of the parties while the sale is pending, representations and warranties of the parties as to the condition of the property and the parties themselves, events of default and remedies, and the closing date and particular documents to be delivered as part of the closing, such as the deed to be filed with the local court system making a public record of the property conveyance. Title insurance matters, for example, are particularly important to address in the PSA because investigating the title matters allows the buyer to ensure that the property being purchased is actually owned by the seller, it can alert the buyer to any recorded covenants, conditions and restrictions that may impose various types of obligations upon the property owner (such as construction restrictions and ongoing maintenance and operational requirements), and it also discloses whether there are any liens or encumbrances associated with the property that will need to be released or paid off prior to or at the time of the sale (such as a mortgage or liens for delinquent taxes). Additionally, local governmental authorities often impose zoning restrictions for particular property areas that regulate the types of activities that can be conducted on the property; therefore, local zoning regulations should be investigated to ensure that the particular type of use of the property that the purchaser desires to engage in is permitted.

Leases

When real property is being leased, the landlord and tenant will enter into a lease agreement, setting forth the binding terms and conditions for the lease arrangement. The lease will address in detail many responsibilities of the landlord and tenant, which, in addition to those often addressed in the LOI, as mentioned above, includes the following: representations and warranties of the parties as to the condition of the leased premises and the parties themselves; specification of events of default and remedies; indemnification obligations in the event a party is subjected to a claim or loss arising from the fault of the other party; the tenant’s rights to make alterations to the premises; the ability of the tenant to assign or sublet the premises to a third-party; and the tenant’s responsibilities for returning the premises to the landlord at the end of the term, particularly regarding either the removal or surrender to the landlord of any alterations or improvements made to the premises during the term.

Construction

In the event that a reshoring operation involves the construction of a manufacturing facility, owners must navigate a unique legal landscape as construction laws vary widely from state to state. Construction issues include: state and federal law construction contract requirements, permits and licenses, insurance and bonding requirements, indemnity requirements and restrictions, construction lien laws, labor union and other labor issues, building codes and standards, and environmental and safety standards. All parties to the construction process, including the owner, architect, contractor, engineer, legal counsel and other construction consultants, must understand the legal requirements and limitations related to construction of the project and agree upon a detailed project timeline well in advance of the time that construction is scheduled to begin.

Additional construction requirements and limitations are often present when economic incentives are involved. For example, economic incentive agreements may: require approvals of the plans and specifications for the project by the public authority; set specific construction or environmental standards; require construction contracts for the project to use prevailing wage labor rates and meet affirmative action requirements; specify that future tax assessments cannot be contested; and provide the government authority with the right to inspect and approve certain aspects of construction.

Intellectual Property

Trademarks

A key advantage of reshoring is the reduced risk of intellectual property theft in the U.S. as a result of its intellectual property laws and strict enforcement of such laws. A trademark is a word, name, or symbol that is used with goods or services to indicate their source and to distinguish them from the goods and services of others. U.S. trademark rights are granted to the person who files an application for registration of the trademark and first uses the trademark in the U.S. in a commercial manner. Generally, a trademark is eligible for protection if it is not confusingly similar to any other existing trademarks and if the mark is not generic or merely descriptive. Trademark rights may be used to prevent others from using a confusingly similar mark, but not to prevent others from making or providing the same type of goods or services or from selling the same goods or services under a clearly different mark (such is the realm of patents, which are further discussed below). Trademark registration with nation-wide protection in the United States can be sought at the federal level by filing an application with the United States Patent and Trademark Office (USPTO). Any person who is using a trademark or has a genuine intention to use a trademark in commerce may apply for registration with the USPTO. For additional state-specific protection, which will be limited to within the borders of a particular U.S. state, a state-based registration can be sought by filing with the applicable state trademark regulatory agency so long as the applicant is actually using the mark in commerce at the time of filing the state application. Through what is known as the Madrid System, international registration of trademarks can be obtained in a cost-effective and efficient way for trademark holders to ensure protection for their marks in multiple countries through the filing of one application with a single office. The World Intellectual Property Organization administers the Madrid System and coordinates the transmittal of applications and renewals and other relevant documentation with all member countries. In addition to the Madrid System, applicants with an existing foreign trademark registration may also apply to obtain a U.S. trademark registration directly with the USPTO by submitting a filing based on the existing foreign registration. Once a trademark registration is granted in the U.S., it can continue perpetually, so long as the mark is continuously used and the registration is properly maintained and renewed with the USPTO or the applicable regulatory agency (typically, renewal is required every 5 to 10 years). Filing a trademark application in the U.S. starts a legal proceeding that may be complex and will require you to comply with all requirements of the trademark statute and rules. An attorney may save you from future costly legal problems by helping you navigate the application process to provide optimal protection of your trademark rights. Further, an attorney can help you understand the scope of your trademarks rights and advise you on the best way to police and enforce those rights.

Patents

U.S. patent rights are granted to inventors of new and useful inventions. Patent owners have the right to exclude others from making, using, offering for sale, or selling the invention in the U.S. or importing the invention into the U.S. There are two principal types of patents: (1) utility patents, which cover the functional aspects of the invention or process, and (2) design patents, which cover the design or appearance of the invention. Generally, the life-span of a utility patent is 20 years, and is 14 years for a design patent. An invention is not eligible for patent protection if the invention was in use or available to the public in the U.S. more than one year prior the patent application. To obtain patent rights and protection within the United States, an application must be filed with the United States Patent and Trademark Office (USPTO), or an “international application” can be filed through the Patent Cooperation Treaty (PCT) process. The PCT streamlines the initial filing process, making it easier and initially cheaper to file a patent application for protection in multiple countries through one centralized application processing agency. Therefore, a company new to the United States can file a PCT application designating the US and any other country that is a member country to the PCT. The PCT procedure consist of two main phases: (1) filing the initial international application, and (2) the international application then being evaluated under the patent laws in force in each particular country where protection is sought. The patent application process is a considerably difficult undertaking unless the applicant has specialized knowledge of patent law. Careful preparation of the application is required in order to ensure that the invention is properly and thoroughly protected. Therefore, it is highly recommended to engage a patent attorney early on in order to best navigate this process.

American Labor and Employment Laws

General Overview

This overview is intended to provide a basic understanding of the U.S. labor and employment laws that govern the rights, duties, and responsibilities between employers and workers. The federal employment laws apply equally to all states; however, the employment laws of one state do not necessarily apply to another state. Therefore, some states are more favorable to employers than others. One important consideration to keep in mind is that state law can broaden or enhance the protections or entitlements provided under federal law, but they cannot limit or degrade them. An employer who does not comply with state and federal employment requirements is at risk of civil and/or criminal liability. Because the laws vary widely from one state to another relating to employer-employee relationships (i.e., hiring, discharging, compensating, etc.), it is always recommended to contact a labor and employment attorney with any state-specific questions.

The Department of Labor (“DOL”) is the federal agency responsible for regulating, investigating, and enforcing most of the federal labor and employment laws in America. Within the DOL are sub-agencies that enforce individual areas of the law. The Equal Employment Opportunity Commission is responsible for investigating and enforcing claims brought under federal laws that prohibit unlawful discrimination, harassment, and retaliation in the workplace. These agencies have promulgated regulations that require employers to post signs that provide notice of certain rights under federal law. Many states have similar agencies that require compliance and posting of various state-specific labor and employment laws.

Initial Employment Considerations

Federal law prohibits employers from making hiring decisions based on protected characteristics (i.e., race, gender, religion, disability, etc.), but also requires employers to follow certain rules regarding employment eligibility and reporting. According to the EEOC, employers must be careful not to make pre-employment inquiries into an applicant’s race, religion, disability, or other protected characteristic unless done in good faith and for a nondiscriminatory purpose. Failure to hire someone for an unlawful reason can lead to civil liability. One law that all employers should be aware of is the National Labor Relations Act (“NLRA”), which offers employee protections and governs relationships between labor unions and company management. Depending on the laws of your state, labor unions may be a more prominent part of your workforce. However, keep in mind that the NLRA applies to virtually all employers - even those without labor unions in place.

Employers should inquire if the employee is subject to a non-competition, non-solicitation, or other restrictive agreement from a past employer. Some states prohibit an employer from poaching employees of another employer. Breach of such restrictive covenants can lead to significant civil damages against both the employee and his/her new employer.

Other considerations may also include background and credit checks, drug testing, and other pre-employment inquiries, but they must be done in accordance with state and federal law.

Considerations During Employment

All employees should receive a copy of your employee handbook, which should at least contain a copy of the company’s equal employment, sexual harassment, and complaint reporting policies. Employees should be trained on those policies and reporting procedures. Similarly, management and human resources should be trained on recognizing, investigating, and remedying unlawful discrimination, harassment, etc. It is important to remember that employers, in many instances, employers can be held liable for the actions of their employees. This can include claims such as retaliation, harassment, negligent hiring/supervision, and many other types of civil claims.

Federal and state laws regulate when, where, and under what conditions a person can work, and how an employer must compensate its employees. The Fair Labor Standards Act (“FLSA”) established rules regarding minimum wages, overtime pay, record keeping requirements, and child labor standards. This affects both full-time and part-time workers. The FLSA also governs many other aspects of the employment relationship, and contains exemptions and nuances to the FLSA. Therefore, you should secure the advice of a labor and employment attorney if you have questions.

Generally, federal law prohibits employers from taking action against an employee based on protected characteristics (i.e., race, gender, religion, disability, etc.) or protected conduct (i.e., First Amendment speech, reports of unlawful discrimination, etc.). Employers may also be required to accommodate mental and physical disabilities under the American’s with Disabilities Act (“ADA”), and provide protected medical leave for qualified employees under the Family and Medical Leave Act (“FMLA”). Employers may have a duty not to disclose an employee’s protected health information to third parties. Similar duties of privacy can exist throughout the employment relationship, and should be addressed on a state-by-state basis. These areas of the law often bring danger of civil liability to employers who are unaware of the laws.

Virtually all employers are required to carry (1) workers’ compensation insurance, which provides an employee who is injured on the job an exclusive compensation remedy, and (2) unemployment insurance, which compensates an employee who is out of work through no fault of his own. Some states prohibit retaliation against employees for filing claims for those types of benefits. Denying an employee’s claim for benefits in bad faith can lead to high civil damages awards. Other forms of insurance, such as Employment Practices Liability Insurance (“EPLI”), are available to help protect employers from liability for acts of their employees or third parties. Although not all employers are required to provide employees with health insurance, the Patient Protection and Affordable Care Act (“PPACA”) can penalize employers with over 50 employees who do not provide health insurance.

The Occupational Safety and Health Administration (“OSHA”) is part of the DOL that ensures safe and healthy working conditions for Americans by enforcing standards and providing workplace safety training. Under OSHA regulations, employers are required to provide a reasonably safe workplace. Although workers’ compensation insurance generally protects an employer from employees who are injured on the job, OSHA can still issue fines for violations of OSHA standards. OSHA regularly inspects workplaces to ensure compliance with its standards. Always remember that a labor and employment attorney can be an invaluable asset to any type of government investigation in your workplace.

Employment Separation Considerations

Although many states provide for “at-will” employment, meaning that an employer can take action against an employee for a good reason, bad reason, or no reason at all, federal law might still prohibit an employer from taking action against the employee. This typically comes up in situations where an employee claims that his/her race, religion, or other protected characteristic was a reason for his discharge, which is unlawful. It can also be difficult to navigate when an employee has requested an accommodation for his/her disability, has requested or taken protected leave of absence, or has complained of unlawful conduct. Retaliating against an employee for those reasons is prohibited by federal law.

Discharging employees can also run afoul of state laws, union contracts, or even implied employment contracts arising from promises made in a handbook or other communication with the employee. This can be true eve in states that provide for “at-will” employment. Some states also have “public policy” exceptions to “at-will” employment that can bring civil liability.

When an employment relationship ends, employers may have continuing obligations to the former employee. Under the Consolidated Omnibus Budget Reconciliation Act (“COBRA”) the employer has a duty to notify a former employee of his/her rights under COBRA when an employee loses health insurance coverage. An employer may also have a duty not to disparage the former employee to third parties, including other employers. Keep in mind that a negative reference to a prospective employer can potentially bring legal claims of defamation, malicious interference, and the like.

Immigration

U.S. immigration laws dealing with non-U.S. employees can be both complex and uncertain. A company’s inability to transfer skilled technical employees to the U.S., combined with the inability to hire U.S. employees with those skills, may undermine the prospects of a successful reshoring initiative. A company’s failure to engage qualified legal counsel in the immigration process can be disastrous and the company’s remedies in the event its efforts are unsuccessful are often extremely limited.

Employers must also inquire about all applicants’ citizenship because, with only a few exceptions, the Immigration Reform and Control Act (“IRCA”) makes it illegal for an employer to hire illegal immigrants. All employers are required to attest to their employees’ immigration status under IRCA using a Form I-9.

Employee Benefits

A U.S. business must understand the local or industry market for stock options and similar equity compensation plans, health benefits, retirement plans, severance expectations, disability and life insurance benefits, etc., and provide a compensation packet that is adequate to attract and retain skilled employees.

Regulations

U.S. and state regulations can present significant risks for reshoring. The heavily regulated and sometimes uncertain regulatory environment of the U.S. and its 50 states is often cited as the key obstacle to reshoring efforts. These regulations include manufacturing standards, safety regulations, consumer protection laws, import and export controls, labor restrictions, licensing and permitting. Reshoring efforts can be thwarted if the costs of doing business in the U.S. are driven up by the U.S. tax and regulatory system. These costs can be substantial, particularly in the most heavily regulated states, and can serve as a disincentive to business investment. Accordingly, it is important for the reshoring company to investigate and quantify the regulatory cost of doing business in U.S. and in specific states.

Companies that reshore should use caution when claiming a product is Made in America. A company cannot legally make that claim without complying with strict Federal Trade Commission (“FTC”) standards. Basically, if a company wants to claim a product is American made, final assembly must take place in the U.S. and the majority of total manufacturing costs must be spent on American parts and processing. A Made in America claim can also be implied. Examples include use of images of an American flag or an outline of a U.S. map or a company ad touting the “true American knowhow” of its products.

Although one would think that bringing production back to the U.S. would minimize the impact of U.S. regulation of international conduct, in many cases the opposite is true. The aggressive enforcement of U.S. laws of the overseas sales and conduct of U.S. companies raises special considerations for companies engaged in reshoring its manufacturing. Although there are no special laws that apply to such companies, U.S. law may nevertheless be applied to companies engaged in this type of activity, particularly if reshoring results in the need to establish new trading patterns that emphasize collaborative relationships with affiliates or other trade partners. The combination of changing patterns of trade and the need to share technical data in a collaborative fashion often changes the risk profile of the organization in a way that implicates U.S. controls on exports and overseas conduct.

Conclusion

In deciding whether and/or where to reshore a manufacturing operation in the U.S., a manufacturing company faces a complex decision involving a multitude of legal and other considerations. These companies can minimize risk and increase rewards by carefully analyzing these factors and engaging qualified legal counsel to assist in the analysis of these many considerations.