Maquiladora Restructuring Executive Summary
Why Your Company Needs to Consider Restructuring Its Cross-Border Subsidiary

A maquiladora is a legal entity formed for the purpose of manufacturing, assembling, repairing or otherwise processing goods that are destined for the export market.

Many U.S. companies have maquiladora or other subsidiary operations in Mexico. An increasingly alarming willingness by U.S. courts to impose liability on U.S. parent corporations for the operation of their foreign subsidiaries is rapidly causing many U.S. companies with Mexican subsidiaries to reconsider how they structure their corporate relationships and operations. The significance of this issue is enormous: plaintiffs that historically would obtain only minimal damages under the Mexican legal system may now be able to pursue U.S. parent companies in their home jurisdictions for millions of dollars in damages.

Recent Events Raise the Liability Stakes

In August 1999, Salant Corporation, the U.S. parent of a Mexican maquiladora and its insurers agreed to pay $30 million to settle claims resulting from a bus accident that killed 14 maquiladora workers. Although the accident occurred in Mexico and involved Mexican nationals employed by a Mexican corporation, Texas courts ruled that (i) the case would be heard in Eagle Pass, Texas, where the parent company maintained a place of business, and (ii) that U.S. law would apply. Had the case been heard in Mexico under Mexican law, the damages awarded would have likely been less than $50,000.

Effective January 1, 2000, Mexico repealed a long-established law that precluded U.S. parent companies of maquiladoras from being considered as having a permanent establishment in Mexico because of the maquiladora's operations. A permanent establishment would subject U.S. parent companies to Mexican corporate income tax on any profits from the permanent establishment, in addition to the Mexican corporate income tax paid by the maquiladora. On October 27, 1999, the U.S. and Mexican governments reached an agreement, pursuant to the U.S.-Mexico Tax Treaty, that for three years U.S. parent corporations would continue to avoid Mexican income tax provided that the Mexican maquiladora income satisfied certain safe harbor guidelines or provided that the U.S. parent company and its subsidiary entered into a unilateral or bilateral advance pricing agreement with both the Mexican Finance Ministry and the U.S. Internal Revenue Service. As a result, many U.S. companies with maquiladora operations experienced increased Mexican tax costs in 2001. The risk of even greater Mexican tax costs in the future is omnipresent.

Both situations are examples of increased financial and liability exposure for U.S. parent companies that own Mexican maquiladoras or subsidiaries. Furthermore, both types of exposure result from the ownership structure commonly used by U.S. companies that establish these Mexican subsidiaries.

The Time is Now to Revisit Your Corporate Structure

While a maquiladora must be a separately incorporated Mexican entity (and not a branch of a U.S. company), Mexico has allowed a great degree of integration between the U.S. parent company and its Mexican subsidiary. Maquiladoras often have U.S. directors and officers. In fact, maquiladora management is quite often on the payroll of the U.S. parent company, and in many cases these managers live in the U.S. and commute to the Mexican plant. Equipment used by the maquiladora is often owned by the U.S. parent company, shipped to and operated at the Mexican plant and used by the maquiladora company free of charge. The U.S. parent company usually owns the inventory processed by the maquiladora.

Historically, by allowing manufacturing operations to be conducted in Mexico without a complex corporate structure, this integration has been viewed as convenient and beneficial to U.S. parent companies. However, new tax and liability risks have drastically altered this assumption. Failure to recognize and counter this new reality may result in unfettered exposure to liability.

Unfettered Exposure to Liability?

In Rodriguez v. Salant Corporation, the plaintiffs intentionally sued the U.S. parent company in the United States, alleging that the decisions that led to the acquisition of a defective bus involved in an accident were made by the maquiladora management personnel who were on the U.S. parent company's payroll. The suit was settled in 1999 for $30 million. Similarly, in Mendoza v. Contico a wrongful death action was filed against the U.S. parent company when an employee of its Mexican subsidiary was killed while delivering payroll for the maquiladora to another Mexican plant. The plaintiffs alleged that employees of the U.S. parent company made the decisions concerning the payroll procedures applicable to the maquiladora. The suit was settled in 1997 for $1.75 million.

A review of the plaintiffs' claims in these cases highlights the risks created by the typically integrated maquiladora or U.S.-Mexico parent-subsidiary structure. The following were all cited in the plaintiffs' attempts to maintain a suit in the United States against a U.S. parent company:

maquiladora management were employed by the U.S. parent company and on the U.S. payroll;
day-to-day decision-making rested with employees of the U.S. parent company and often took place in the United States; and
U.S. parent company-owned equipment was held by the maquiladora and used in Mexico to conduct its business.

This problem is further exacerbated by the holding in a recent Texas Supreme Court case, Dubai Petroleum Co., et al v. Kazi. The decedent in Dubai was an Indian citizen who was killed while working on an oil rig off the coast of the United Arab Emirates. The defendants were either Texas corporations or corporations with principal places of business in Texas.

In Dubai, the Court held that as long as a country grants to U.S. citizens the same rights to sue in its courts for personal injury or death that it grants to its own citizens, the plaintiffs would be entitled to bring suit in the United States under U.S. law. Such reciprocity grant must be by treaty. The Court went further and noted that so-called "equal treaty rights" does not mean that the substantive legal remedies in Texas and the foreign country have to coincide or even be remotely similar. In essence, "equal treaty rights" means that the foreign country must afford U.S. citizens "national treatment" in its courts. Indeed, the Court instructed the lower courts to only look at the law of the foreign country and not its application.

Along with the previously cited cases, Dubai is likely to dramatically expand and facilitate forum shopping and increase the number of personal injury and wrongful death claims brought by non-resident plaintiffs arising out of events occurring wholly abroad.

Avoiding Permanent Establishment at All Costs

The Mexican government's claim to tax the income of the U.S. parent company is based on the existence of a "permanent establishment." According to the heavily negotiated provisions of the U.S.-Mexico Tax Treaty, a U.S. company may have created a permanent establishment when a Mexican company, other than an independent agent, holds assets of the U.S. company in Mexico and uses those assets to process inventory owned by the U.S. company. Thus, under the typical maquiladora structure currently in existence, U.S. parent companies will be considered to have a permanent establishment in Mexico and be subject to Mexican income tax, separate and apart from the tax already due by its Mexican maquiladora. Through 2002, the U.S. and Mexican governments have agreed to defer such taxation if businesses enter into an advance pricing agreement with both governments' taxing authorities, or if maquiladora income reaches a safe harbor level. To comply with either the pricing agreement or the safe harbor rules, most maquiladoras will be forced to pay an increased amount of Mexican taxes and will be faced with an increased level of administrative complexity. After 2002, unless a new agreement is reached between the U.S. and Mexican governments, U.S. parent companies are likely to be subject to tax in Mexico on the portion of their profits attributable to the permanent establishment.

Restructuring 101: A Necessity Your Company Cannot Afford to Ignore

The vast majority of U.S. parent companies with Mexican subsidiaries are currently confronting potentially devastating risks that were not foreseen a few years ago. Creative U.S. plaintiffs' lawyers will undoubtedly attempt to duplicate the successes of Salant, Contico and Dubai and attempt to hold U.S. parent companies responsible for liabilities previously thought to be limited to Mexico. In addition, U.S. parent companies will continue to feel increased pressure by the Mexican government for the payment of a greater share of income tax related to their Mexican production. Continuing to operate under the proto-typical maquiladora structure is becoming increasingly risky. A properly restructured operation can substantially eliminate the threat of permanent establishment characterization and preserve the competitive benefits of operating in a foreign jurisdiction such as Mexico.

Generally, restructured ownership seeks to separate rather than integrate the U.S. parent company and its Mexican subsidiary's management and operations. However, the restructuring must be specifically tailored to each operation, and take into account a number of factors to minimize exposure to U.S. and Mexican tax liability. Additionally, if management-level employees of the U.S. parent company have been delegated decision-making authority in Mexico, employee benefit, employment tax and social security considerations must be reviewed. Maquiladora decision-making authority policies and procedures that are in place to protect the investment of the U.S. parent company must also be revised to ensure that the appearance of integration is eliminated.

Strasburger's attorneys are skilled practitioners that deal with complex international matters on a day-to-day basis. We can assist your company in (i) reviewing its exposure to liability arising out of your operations in Mexico, and (ii) implementing structural and operational changes that can significantly reduce liability exposure and tax risks, while at the same time maintaining the continuity of the day-to-day operations already in place.