All too often we hear of companies that do not consider U.S. export controls and trade sanctions in their due diligence checklists when going through an acquisition or merger. When taking over a non-compliant business, the buyer may be responsible for any violations that took place before the acquisition, even if the non-compliant actions were NOT unidentified at the time of the acquisition. In this blog we’ll address export regulations, successor liability, a case study, and practitioner tips on what you should be doing PRIOR to acquiring or merging!
Overview – Export Administration Regulations
In order to protect national security interests and promote foreign policy objectives, the United States imposes export controls and participates in various multilateral export control regimes to prevent the proliferation of weapons of mass destruction and prevent destabilizing accumulations of conventional weapons and related materials. To that end, the U.S. Department of Commerce’s Bureau of Industry and Security (BIS) governs the export and reexport of commodities, software, and technology falling under the jurisdiction of Export Administration Regulations. BIS promotes continued U.S. strategic technology leadership and is responsible for enforcing the regulation of export, reexport, and transfer of items with commercial uses that can also be used in conventional arms, weapons of mass destruction, terrorist activities, or human rights abuses, and less sensitive military items.
The Export Administration Regulations (EAR) regulates the export, reexport, and in-country transfer of some military items, commercial items that could be applied both commercially and militarily or with proliferation applications, and commercial items without any obvious military use. When you are sending anything that may be subject to EAR, you may be required to get a license from BIS before the shipment. License requirements depend on the technical characteristics of an item, its destination, the end user, and the end use. In order to determine if the item, whether it be a commodity, software, or technology, being exported needs a license, the sender must consider the following:
- What is being exported: BIS classifies items under Export Control Classification Numbers (ECCNs), which are all listed on the Commerce Control List (CCL) (15 CFR 774, Supplement 1). If the item falls under U.S. Department of Commerce jurisdiction but is not listed on the CCL, it is designated as EAR99. Even low-technology consumer goods may require a license if the proposed export of an EAR99 item is to an embargoed country, to an end user of concern, or in support of a prohibited end use.
- Where it is being exported: Country-specific license requirements are determined by comparing the ECCN with the Commerce Country Chart. The ECCN and the Commerce Country Chart, taken together, define the items subject to export controls based solely on the technical parameters of the item and the country of ultimate destination.
- Who receives the export also affects the requirement for a license. Certain individuals and entities are prohibited from receiving U.S. exports, and others may only receive goods if they have been licensed, even if those items do not normally require a license on the basis of the ECCN and country of destination. Proscribed parties can be found in the U.S. Government’s Consolidated Screening List.
- End use: Some end uses or applications are prohibited while others are restricted and may require a license (see EAR part 744).
What is Successor Liability?
Successor Liability is the assumption of burdens of an acquired entity by the surviving company in a sale, merger, or acquisition transaction. Regarding export controls, successor liability focuses more on which party of parties in the acquisition are liable, after the acquisition deal is closed, for any violations of export control laws committed by the acquired company before the deal was concluded. Successor liability does allow for the possibility of both the seller and buyer to be determined responsible for export violations incurred by the seller.
Currently, successor liability could be imposed for failure to comply with U.S. export laws and regulations, including the Export Administration Regulations that are implemented by the U.S. Commerce Department, BIS.
Some of the main threats that can negatively affect an organization include export items, operations, customers, and acquisitions, specifically successor liability. In terms of successor liability, one should have a Due Diligence Checklist and consider if it is the same employees, the same company name, and if it is a continuation of the same old company. Successor liability is not imposed on a purchase of assets unless the following exceptions are applied:
- The purchasing corporation expressly or impliedly agrees to assume the liability;
- The transaction amounts to a de facto consolidation or merger;
- The buyer is merely a continuation of the seller; or
- The transaction was fraudulently entered into to escape liability.
To determine whether the buyer is “merely a continuation of the seller” certain factors are examined to determine whether or not successor liability is applied, which is also known as “substantial continuity.” The factors considered are:
- Retention of the same personnel
- Continued operations at the same location under the same business name
- Production of the same products
- Maintenance of the same assets and general business operations
- Holding the company out to the public as a continuation of the previous corporation
In considering these factors, regulators are ensuring that past illegal practices will not continue and that the violators are held accountable for their actions. If the seller is dissolved and devoid of significant assets, the seller would generally not be pursued as a viable responsible target for violation penalties for legal and policy reasons and the buying company may be considered for liability.
An example of export control violation liability falling on a buyer because of successor liability is the case of Sigma-Aldrich Holdings Inc. This case holds that an acquirer of a company can be liable for the export violations of the target company for violations which occurred prior to the acquisition despite how the acquisition is structured. This case provided an expansion of the principle of successor liability to the international business compliance area and increased corporate risk.
The case entailed an enforcement action initiated by the BIS for violations of the EAR, alleging that the Research Biochemicals Limited Partnership (RBLP) exported tetrodotoxin citrate without obtaining the required export licenses. RBLP had sold its business to Sigma Aldrich Corporation after the alleged illegal action occurred. This transaction was structured as a sale of assets rather than a sale of stock. BIS then initiated an enforcement action against Sigma Aldrich after they concluded the acquisition. This enforcement action alleged violations of EAR for: exporting goods without obtaining required export licenses, making false or misleading statement, and violating export recordkeeping requirements. BIS claimed that Sigma Aldrich was liable for the RBLP’s export control violations as the successor in interest to RBLP in addition to violations which it had committed on their own.
The judge ruled that Sigma Aldrich was indeed liable for illegal actions previously committed by RBLP based on the principle of successor liability because under this principle the acquiring company is responsible for the liabilities of the target due to the “substantial continuity” of the target company’s people, products, and business. This case then shows how successor liability can be applied under export control regulations no matter the structure of the acquisition.
Implications for Companies Conducting Acquisitions
A target company involved in international business activities is subject to a broad range of federal laws that regulate the international business transactions. When an acquirer purchases a company, it is often stepping into the shoes of the target and is then subject to these laws. If this target has violated these laws, it is possible that the acquirer will take on these liabilities even when the structure is as a purchase of assets rather than stock. BIS has announced that they will prosecute companies for the export control violations of companies they acquire regardless of how a transaction is structured.
As a result of the case of Sigma-Aldrich Holdings Inc, buyers need to conduct a highly specialized due diligence review that focuses on past compliance of the selling company. This due diligence should be conducted by a member of the deal team that has specific expertise in export control law. In case the acquirer sees a pattern of sloppy compliance, the acquirer should consider having the seller file a voluntary disclosures PRIOR to the closing. Lastly, it is highly recommended that a buyer consider using strong warranties, representations, and indemnification clauses focused on violations of international business statues in their acquisition agreements.
What Should You Do
If you are either exporting goods or looking to purchase a company that is, it is essential to:
- Ensure an effective export compliance plan is in place
- A key foundation of proactive and effective export compliance requires the development of an export compliance plan. An export compliance plan establishes a set of procedures for your organization to ensure that everyone is on the same page about how standard processes work, who is responsible for what, how to identify violations, what to do when violations occur, etc. An export compliance plan helps build consciousness in your organization that compliance is critical – both to avoid costly penalties and to protect national security. Diaz Trade Law helps exporters create export compliance manuals that help prove you have a process in place to classify your merchandise correctly, vet your customers and ensure you can prove you can take compliance seriously and implement all the important great weight mitigating factors. Diaz Trade Law has significant experience in developing and enhancing export compliance plans for organizations. Additionally, Diaz Trade Law can assist your business in auditing and improving your current plan so that it is in its best shape.
- Engage in regular export compliance training
- A foundation of a strong export compliance program is export compliance training. Training is important because it (1) ensures that all employees understand the export regulations and reinforces internal policies and procedures, (2) demonstrates to federal government agencies that your business is proactive about export compliance, and (3) avoids your business from being subject to costly penalties and even criminal liability. Fortunately, export compliance training can be highly tailored to meet your company’s needs. All your training events include assessments for comprehension, certificates for successful participation, and ample opportunities for Q&A. For your next export compliance training event, trust Diaz Trade Law to provide highly-effective, engaging training.
- Thoroughly vet your proposed export transaction (Due Diligence is key!)
- Unsure whether a proposed export transaction violates the Foreign Trade Regulations or other export control laws? Diaz Trade Law has significant experience vetting your potential transaction against U.S. export control laws and in assisting clients to properly file their EEI. Through research and due diligence, Diaz Trade Law ensures that your transaction won’t get you in trouble later down the road.
- Request authorization when necessary
- BIS or DDTC export authorization is required for many export transactions of controlled goods. Diaz Trade Law has significant experience in vetting proposed transactions to determine whether BIS or DDTC authorization is required. Furthermore, Diaz Trade Law assists clients by filing export license applications on their behalf.
- Engage in mitigation and corrective actions
- If your business has violated U.S. export control laws, there is a lot you can do to mitigate penalties and prevent future violations. Diaz Trade Law has significant experience representing businesses in dealing with the U.S. Commerce Department’s Bureau of Industry & Security and the Census Bureau. Specifically, Diaz Trade Law has successfully assisted clients in (1) submitting voluntary self-disclosures to mitigate penalties, (2) negotiated agreements with BIS and Census, and (3) built corrective action systems to help ensure that your business does not make the same violation again.
Check out our Bloomberg Law article on Submitting a Voluntary Self-Disclosure to the U.S. Census Bureau, Submitting a Voluntary Self-Disclosure to the BIS, and Export Licensing Under the EAR.
Diaz Trade Law has significant experience in a broad range of export compliance matters. To learn more about the services we offer, contact us at firstname.lastname@example.org or call us at 305-456-3830.
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