Be Cautious of the American Legal System
How can European companies avoid costly pitfalls when navigating the unique aspects of the American legal system?
Guestblog by: Manny P. Schoenhuber – Lawyer
Please Note: This article does not provide legal advice and is not a legal document.
It is not uncommon for European companies exporting to the U.S. or establishing a presence there to become entangled in legal issues. Whether it’s a jury trial, arbitration, or punitive damages, companies must be mindful of these critical differences in the American legal system.
When we, as Europeans, think of a jury trial in America, our minds may conjure up images of sensational criminal cases or perhaps former President Donald Trump, who recently faced a lay jury’s verdict in New York. However, foreign companies facing legal conflicts in the U.S. can also find themselves before a jury of American citizens.
This is just one of the many significant differences between European legal frameworks and the American legal system. Small and medium-sized enterprises, in particular, often lack dedicated legal departments with international experience, making them unaware of these crucial nuances. The assumption that a codified system, like the European Civil Code, would offer protection in the U.S. is a critical misconception. The American legal framework is based on British Common Law, a system that relies less on statutes and more on significant past judicial rulings. This is especially important for European managers to understand, as the U.S. represents a major market. According to Germany Trade and Invest, the United States is the largest export market and the third largest import market in foreign trade. The numbers speak for themselves: in 2023, the estimated value of exports from the Netherlands to the U.S. was approximately $32.8 billion. Achieving this without the support of European medium-sized businesses would have been impossible.
The U.S. is indeed the land of unlimited opportunities, and regrettably, this includes legal pitfalls. The legal and judicial systems are fundamentally distinct. While European law is based on the French Code Civil, the Americans follow British Common Law (with the sole exception being the state of Louisiana). In the U.S., decision-making primarily hinges on specific past judicial decisions (Case Law).
The American judicial system is fragmented; it encompasses two vertical systems, one at the federal level (Federal Courts) and another at the state level (State Courts), each with three tiers. Furthermore, the jurisdictions of federal and state courts sometimes overlap.
Jury Trials
Not every lawsuit in the U.S. entails a jury trial, but defendants have the right to one under the U.S. Constitution. In a jury trial, the jury acts as the ‘factfinder,’ determining the relevant facts, while the judge resolves the legal issues. In a civil case, both the plaintiff and the defendant can mutually agree to waive the right to a jury trial (Bench Trial) or explicitly exclude it (Waiver of Jury Trial). For instance, a subsidiary of a European company in the U.S. successfully excluded a jury trial in a case against a former employee, even though the employee was entitled to one. The employee had accepted the ‘Waiver of Jury Trial’ when signing her employment contract.
Arbitration
In the U.S., parties can decide to have an arbitration panel, rather than a traditional court, resolve their dispute. The arbitration award is binding and can be submitted to a regular court for enforcement, akin to a ‘traditional judgment.’ For example, a subsidiary of a European company in the U.S. was able to enforce an arbitration agreement against an American client in rural Texas to avoid local prejudice and maintain greater control over the proceedings.
Arbitration is a form of dispute resolution conducted outside regular court systems, where parties present their disputes to a neutral third party, the arbitrator, who makes a binding decision. Additionally, the U.S. features parallel legal systems: at the federal level and at the level of individual states. European companies and their subsidiaries in the U.S. generally prefer federal courts; however, these courts handle legal disputes valued at more than $75,000, and the parties must be based in different states. As such, arbitration, as a mandatory form of dispute resolution, can be a more practical option.
A European company engaged in energy and data transmission systems successfully enforced arbitration in its contracts. An employment dispute was decided in favor of the company. This outcome might have been less certain in a jury trial, where the choice of fact-finders is not directly controlled, and juries commonly prefer to rule in favor of employees.
Discovery
The Discovery Process is a procedure in the U.S., unique and unlike any found in Europe, where evidence is gathered for the main trial. Beyond the mandatory disclosure of documents and answering written questions, “Depositions” involve lengthy oral examinations of witnesses under oath. Should a party fail to present evidence, the court may impose sanctions. For instance, the U.S. subsidiary of a European company was able to impose fines as sanctions against another party in the lawsuit, who repeatedly and inexplicably missed a deposition.
Uniform Foreign-Country Money Judgements Recognition Act
A foreign judgment can be enforced in the U.S. only after it has been recognized by an American court. Under the Uniform Foreign-Country Money Judgments Recognition Act, a final and enforceable judgment for a definite sum of money serves as the initial step for recognition by a U.S. court. Once this recognition occurs, and the judgment is no longer subject to review, the winning party can proceed with its enforcement. A German bank followed this process after securing an enforceable judgment against American debtors in a German court. By referencing the Uniform Foreign-Country Money Judgments Recognition Act, a Texas court also recognized and fully enforced the German judgment.
“Alter Ego” and “Piercing the Corporate Veil”
In the U.S., foreign companies face the risk of full liability if they offer products or services through their European parent company. The liability of the European parent company is possible if the American subsidiary is merely a “shell” or “puppet,” and the European parent can be considered the actual operator. This assessment is based on an overall view, taking into account all circumstances of the individual case. Factors include the parent’s control over the American subsidiary, overlapping personnel, and consolidated accounting. Ignoring these factors could lead to significant liability claims.
Blocker Entity
A European company made this oversight. It established a U.S. Corporation wholly owned by its European subsidiary. However, the European parent appointed all the “Directors” and “Officers” for the U.S. subsidiary, and accounting was not separate but centrally managed in Europe. An American court deemed the U.S. subsidiary as the “Alter Ego” of the European company and ruled that it could be fully liable.
This risk can be mitigated by establishing a U.S. subsidiary through a so-called “Blocker Entity.” This approach effectively “blocks” potential liability in the U.S. for the European parent company or its assets. Practically, this typically involves setting up a U.S. corporation (Inc.) as a wholly-owned subsidiary of a European company, handling U.S. operations solely through the American Inc.
Jurisdiction clause
A jurisdiction clause specifying a particular state must have a substantial relationship to the contract in question. For instance, the chosen state law should pertain to the location where the contract’s performance occurs or where the parties are established. However, parties must always ensure that the agreed-upon state law is favorable for the content of any potential legal dispute. In one instance, the jurisdiction clause in a contract between the American subsidiaries of two European companies referred to the law of Nevada. However, both subsidiaries were incorporated under Delaware law and were based in Texas. Consequently, the Texas court ruled that Texas law should apply in this case.
Punitive Damages
Under U.S. law, the primary focus for a breach of contract is typically on compensation through damages. In addition to monetary damages from the breach (General Damages) and damages that were foreseeable at the time the contract was made (Consequential Damages), punitive damages may also be sought when actions extend beyond mere contract violation, reaching the level of egregious conduct. These damages aim to penalize the behavior and deter its recurrence. For instance, a company sought punitive damages against the owner of an adjacent property. The neighboring company’s artificial lake had caused significant damage to the company campus over several years due to unusual water flow. The company was entitled to punitive damages as the neighbors had deliberately ignored and failed to rectify the situation.
American Rule
According to the American rule, each party in a U.S. legal dispute must bear its own legal expenses. However, plaintiffs may also arrange a contingency fee (typically between 30% and 40% of the awarded amount). Additionally, the American Rule can be contractually bypassed with a “Prevailing Party Attorneys’ Fees Provision,” requiring the losing party to cover all legal dispute costs. Court fees are independent of the dispute’s value and are charged as a fixed amount per complaint. By incorporating a “Prevailing Party Attorneys’ Fees Provision” in its contract with a client, the U.S. subsidiary of a European company was able to secure 100% of legal costs as part of a settlement. Conducting business across countries and legal systems is invariably challenging. However, with the right legal support and awareness of critical factors like those mentioned above, you can successfully execute your international business plans.
This guest blog was written by Manny P. Schoenhuber, an attorney at Jackson Walker LLP in Houston.
Feel free to contact him at mschoenhuber@jw.com or visit www.jw.com
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