“MISTAKES WERE MADE”



From PLI’s Course Handbook

Coping with U.S. Export Controls 2007

#11207

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19

“MISTAKES WERE MADE” ASSESSING RISKS & LIABILITIES IN MERGERS & ACQUISITIONS UNDER THE EXPORT CONTROL LAWS

Wendy L. Wysong

Clifford Chance US LLP

The author is grateful for the assistance of Clifford Chance attorneys David Dibari, Jason D’Angelo, Adam Klauder, and Michael P. Holland for their thoughtful review and invaluable suggestions.

“MISTAKES WERE MADE” ASSESSING RISKS & LIABILITIES IN MERGERS & ACQUISITIONS UNDER THE EXPORT CONTROL LAWS

Wendy L. Wysong

Clifford Chance US LLP[i]

Wendy L. Wysong

Partner, Clifford Chance US LLP

2001 K Street NW, Washington, DC 20006-1001

(202) 912-5030, wendy.wysong@

Wendy L. Wysong is a partner at Clifford Chance US LLP in its white collar regulatory and litigation group. Her concentration is compliance and enforcement under the Export Administration Act, Export Administration Regulations, Arms Export Control Act, International Traffic in Arms Regulations, and International Emergency Economic Powers Act. She has significant background in parallel criminal and civil proceedings, and has over 21 years of trial experience.

Ms. Wysong is the former Deputy Assistant Secretary for Export Enforcement and Acting Assistant Secretary at the Bureau of Industry and Security, U.S. Department of Commerce, where she served from December 2004 through August 2007. She has been an instructor for the Department of Justice, FBI, Customs Academy, and the Department of Defense.

Prior to joining BIS, Ms. Wysong was an Assistant United States Attorney for the District of Columbia for 16 years. Working in the Transnational/Major Crimes Section, she was responsible for overseeing the investigation, indictment, and trial of international crimes, including export fraud cases, terrorism and immigration. Before working in the international area, she prosecuted public corruption cases, including former House member Dan Rostenkowksi.

Ms. Wysong received her law degree in 1984 from the University of Virginia School of Law, where she was a member of the University of Virginia Law Review. She clerked for Judge Stanley S. Harris of the U.S. District Court for the District of Columbia and later worked at the law firm of Hogan & Hartson, before joining the U.S. Attorney’s Office in 1989. She is a member of the Virginia and District of Columbia bars.

I. Introduction

The trend toward globalization and cross-border transactions has increased the risk and potential liability arising from export control violations — not just for the company committing the violation, but also for any company considering a merger, acquisition, joint venture, investment, development or licensing deal with a company engaging in foreign business. Companies entering into such a transaction must review thoroughly the contemplated transaction itself to ensure compliance with the myriad export control laws that may be triggered by the transaction. But significantly, pre-acquisition due diligence must also include a determination as to whether the target entity has complied with those laws in the past. The failure to do so may result in the acquiring/merging/investment company unwittingly assuming on-going violative practices, for which it will be held independently liable, or even assuming liability for export violations committed long before the acquisition. “Mistakes were made” is a quasi-confession[ii] that is all-too-common today and yet, particularly apt in this context. The key for companies hoping to avoid potentially devastating liability and penalties is to ensure applicability of the implied clause, “but not by me.”

Accordingly, it is critical that lawyers handling transactional matters include export controls in their due diligence reviews: first, to determine whether the transaction itself is subject to export licensing requirements or restrictions, which could halt the deal if compliance cannot be ensured; and second, to determine the level of export control compliance by each of the parties previously involved in foreign activities. Notably, the discovery that export compliance “mistakes were made” in the past need not be a deal-killer. Carefully negotiated disclosures made to the relevant export licensing agencies can limit collateral consequences and determine penalties. The structure of the transaction can be altered, the contracts rewritten, and the purchase price adjusted, if the mistakes are discovered prior to acquisition. If such mistakes are not discovered until after the deal closes, however, severe consequences could result for the acquiring company, which now stands in the shoes of the non-compliant acquired company. Importantly, while monetary penalties can be steep, there can be even more damaging consequences such as suspension of export privileges, debarment from government contracts, and the imposition of costly auditing and monitoring programs.

II. Applicable U.S. Export Control Laws

Including export control analysis in a routine due diligence review can be daunting even to an informed practitioner considering the profusion and complexity of U.S. export laws. There are some 30 overlapping federal statutes and regulations,[iii] as well as 16 federal agencies,[iv] involved in export controls. However, most companies must contend with only three agencies administering three regulatory regimes:

• Most exports involve “dual-use” items, that is, commodities, software and technology that can be used for civilian and military applications. These are regulated by the Bureau of Industry and Security (BIS), within the Commerce Department, pursuant to the Export Administration Regulations (EAR).[v]

• More restricted are products (and related technical data and services) specifically designed or modified for military applications, which are designated as “defense articles.” These are regulated by the Directorate of Defense Trade Controls (DDTC), within the State Department, pursuant to the Arms Export Control Act (AECA)[vi] and the International Traffic in Arms Regulations (ITAR).[vii]

• Exports to most embargoed countries, entities, and individuals are regulated by the Office of Foreign Assets Control (OFAC), within the Treasury Department, pursuant to the International Emergency Economic Powers Act (IEEPA),[viii] and various other statutes and regulatory sanctions programs.[ix] Countries with current embargoes include Cuba, Iran, Sudan and North Korea. Exports to Syria are also restricted, but those prohibitions arise under the EAR,[x] not OFAC’s Syria sanctions.

Generally, a U.S. company contemplating a transaction with a foreign customer, performing a service overseas, or even working with a foreign national in the United States must consider

• the nature of the item or activity,

• the country involved in the transaction,

• the identity of the person using the item or service, and

• its ultimate end-use

in deciding whether a license must be obtained from Commerce, State, or Treasury before the transaction proceeds or whether the transaction can proceed at all. The export controls apply to the specific transaction being contemplated, such that a U.S. company could not enter into certain joint ventures where, for example, the foreign company had preexisting trade relationships with embargoed countries.

Additionally, those engaged in transactions involving defense articles must register with the State Department.[xi] This would include manufacturers, brokers, and exporters. Notification of changes in ownership and registration amendments also may be required after some transactions have closed.[xii]

Each of the government agencies maintains published lists of individuals and entities for whom transactions with U.S. persons are restricted.[xiii] Companies are expected to review the lists and to prevent such transactions. Entering into almost any type of business relationship with a listed entity would be prohibited, and acquiring a company with such a relationship would require immediate attention.

Further, conditions such as recordkeeping, post-shipment verifications, and resale restrictions may be imposed on a license held by a target company. Those conditions will apply equally to a successor company that continues to export under that license. The license may also need to be transferred officially to the new company, and licenses that are not amended properly, where necessary, become invalid.

U.S. export control laws are considered extraterritorial, generally following a U.S.-origin item to its ultimate destination. Thus, even non-U.S. persons overseas can be charged if they deal with U.S.-origin goods. But even further, a U.S. person dealing with non-U.S.-origin goods overseas may be charged depending on the other entities involved. Thus, the activities and management structure of foreign subsidiaries must be scrutinized to determine the level of U.S. parent company involvement.

Notably, releases of controlled technological information to foreign nationals in the United States, such as international students or foreign delegations, may be “deemed exports”[xiv] and subject to licensing requirements, even though no tangible item is passed, either domestically or internationally. Therefore, while disclosing controlled technical information in e-mails or conference calls overseas is considered to be an export, so, too, is a mere viewing of information by a foreign national that would be controlled for export to that individual’s country of nationality. As a result, joint research and development projects must be carefully scrutinized for compliance.

III. Potential Risks

As noted above, besides the risk of independent liability arising from a new strategic relationship or M & A transaction involving a company with foreign operations, there is also the risk of successor liability. Both the Department of Commerce and the Department of State have aggressively pursued companies under this doctrine to hold acquiring companies liable for the predecessor company’s pre-acquisition export violations.

Generally, a business entity acquiring only the assets of another business entity is not liable for the selling entity’s liabilities unless one of these four exceptions applies:

• there is an agreement to assume liability, explicit or implicit;

• it is a de facto consolidation or merger;

• the transaction is a mere continuation or there is substantial continuation of the predecessor business; or

• the transaction was fraudulent to escape liability.

Substantial continuity can be found when any of the following is present:

• retention of the same employees, supervisory personnel, same production facilities and same location;

• production of same products;

• retention of the same business name;

• same assets and business operations; and/or

• the new company holds itself out to the public as a continuation of the previous corporation.

The doctrine of successor liability applies even if no charges are lodged against the predecessor. The question is whether the predecessor is a shell or an entity with assets answerable to judgment. Either both parties or one of the predecessor or the successor can be charged. As the below example illustrates, the successor’s knowledge or notice of potential liability is one factor but can be inferred from facts, taken in the totality of the circumstances.

In 2002, an administrative law judge (“ALJ”) upheld BIS’s charges, under IEEPA and the EAR, against Sigma-Aldrich and various other related entities which had purchased the partnership interests of a company that had illegally exported biological toxins on more than 500 occasions prior to the acquisition in 1997.[xv] The elaborate corporate structure, with subsidiaries and holding companies created following the acquisition, had received all rights, title and interest of the assets of the predecessor company. The ALJ pierced the corporate veil and determined that the subsidiary created to operate the predecessor’s business exhibited all the “hallmark signs” of the substantial continuity exception. The subsidiary agreed to perform preexisting contracts, it had received the acquired company’s assets, and it continued export practices (including illegal exports for one year) without interruption. Not only could the new subsidiary be held liable, but so also could Sigma-Aldrich, the parent company, as well as a partner company, the ALJ ruled. Direct knowledge of potential liability was not required but could be inferred based on the totality of circumstances, including the way the assets and liabilities had been transferred to the subsidiary (payment of $1) as well as the inclusion of an indemnification clause in the purchase documents if the predecessor company was not in compliance with government regulations.

Sigma-Aldrich, its subsidiary and the partner company, settled the charges by paying a fine of $1.76 million. The fine was attributed not only to the violations that occurred prior to the acquisition, but also the violations that continued thereafter when the subsidiary failed to cease the illegal practices. At the time, it was one of the largest penalties ever paid to the Department of Commerce for export violations — equaling eight times the value of the actual shipments involved. Since then, BIS has continued to charge successor companies,[xvi] stating that “successor liability can attach to a successor company for any disclosed or undiscovered acts of a prior company if that successor business substantially carries on the predecessor’s business without interruption.”[xvii]

The State Department has also held successor companies liable for the transgressions of a predecessor company. As an example of the breadth of successor liability, DDTC held both Hughes Electronics Corporation and Boeing responsible for export violations by Hughes Space and Communication, a Hughes subsidiary that Boeing acquired in 2000. In the mid-1990s, Hughes Space had provided technical assistance to various Chinese entities following the failed launches of Chinese rockets carrying Hughes communication satellites. Thereafter, when Boeing acquired the assets of the subsidiary Hughes Space, its former parent Hughes Electronics agreed to be responsible for any pre-acquisition export control violations, an indication of knowledge. DDTC charged both Boeing and Hughes even though the violations ended by 1996 and even though it was an asset sale only.

In 2003, Boeing and Hughes agreed to jointly pay a $32 million fine. Each company also agreed to remedial compliance measures, the costs of which were partially offset by a portion of the fine. In addition, the companies were required to appoint special compliance officials to oversee their operations in China and other countries.[xviii]

IV. Potential Liability

Violations of the export control laws can give rise to substantial civil and criminal penalties. Those penalties can include monetary fines, imprisonment, and collateral consequences that can destroy a company.

Presently, violations of the Export Administration Regulations can result in civil monetary penalties of up to $50,000 per charge, as well as denial of export privileges.[xix] If the violations were willful (i.e., done with specific intent), criminal charges can be brought, which currently could result in a maximum penalty of twenty years imprisonment and/or up to $250,000 (or twice the gross gain) for individuals and $500,000 (or twice the gross gain) for corporations.[xx]

The Arms Export Control Act carries a maximum civil penalty of $500,000 per violation, in addition to possible administrative debarment from exporting.[xxi] Criminal violations of AECA can carry ten-year sentences and monetary penalties as high as $1 million for each violation.[xxii] In those cases, automatic debarment is usually mandated by statute.[xxiii]

Violations of the various economic sanctions programs presently in place against countries such as Burma, Iran, or Sudan are charged under the International Emergency Economic Powers Act, which currently carries civil penalties as high as $50,000. Criminal penalties can include imprisonment of up to twenty years and fines as high as $250,000 (or twice the gross gain) for individuals and $500,000 (or twice the gross gain) for corporations.[xxiv]

Under any of these regimes, parallel civil and criminal charges may be pursued, subjecting a company to the possibility of two different and potentially conflicting proceedings. For example, providing cooperation in a civil proceeding can have obvious negative consequences in a parallel criminal action. Moreover, there may be parallel civil proceedings conducted by two separate agencies as conduct forming the basis for one agency may also be independently chargeable under another agency’s authority. Therefore, it is not unusual for companies to face civil charges by BIS and OFAC, while simultaneously addressing criminal charges brought by the Department of Justice.

Potential results before one agency may have collateral consequences for resolution by the other agencies. This arises frequently when future export privileges are in question. Both Commerce and State can limit future exports, either by imposing a presumption of denial of future license applications, which can be overcome but are delaying, or by suspending export privileges for as long as 20 years. Often, the threat of such a “denial order” can be more significant to a company than a monetary penalty. Indeed, for a company contemplating or conducting international business, it can be a death blow or at least draw into question the company’s ability to fulfill preexisting contracts.

For the Commerce Department, these denial orders can be either permanent[xxv] or temporary,[xxvi] the latter being issued ex parte during the pendency of an investigation to prevent future exports. Again, the effect of temporary denial orders may be permanently destructive of a company’s on-going business even if it is thereafter lifted. Moreover, both the State Department and Commerce Department may cross-debar or deny export privileges based on denials of export privileges under the other agency’s regulations.[xxvii] Thus, a carefully constructed plea or settlement agreement with one agency, perhaps limiting the scope of an export denial to certain countries, may still result in a broad denial by an agency left out of the negotiation. Convictions under other non-export statutes may also form the basis for a denial order, so that companies with foreign operations negotiating a plea to a charge under the Foreign Corrupt Practices Act,[xxviii] for example, must consider whether the conviction would trigger a State Department debarment[xxix] or Commerce Department denial order.[xxx]

Other unanticipated collateral consequences could include debarment from government contracts following conviction or settlement. The U.S. Department of Defense and other U.S. government agencies, as well as foreign governments, can debar companies charged with export violations on contracts involving defense articles or services. The attendant delay that can occur while a company seeks to convince the government that it can obtain the license so that it should be awarded the contract can be equally as damaging as actual debarment.

Beyond possible statutory and regulatory penalties, a company must consider the economic impact of the potential damage to its reputation and business relationships. Customers wary of a company’s ability to obtain licenses necessary to perform supply contracts may find other suppliers. Vendors may be unwilling to risk their products getting into the wrong hands or may simply be concerned about their customer’s economic viability and may no longer be committed to serving that client. A company’s reputation and business relationships are a key factor in its enterprise value, and the damage to either must be factored into the decision to move forward with a transaction.

Accordingly, in contemplating the risks of moving forward, it is well worth the effort to consider all potential liabilities. The potential liability a company may assume by acquiring a company with foreign business or that has committed export violations, even well before the acquisition, is not limited to a few fines, and should not be thought of as the “cost of doing business.” The reaction of each relevant agency must be considered, and all collateral consequences must be taken into account. Carefully negotiated pleas can unravel when an inexperienced attorney, unfamiliar with the substantive area of export controls, fails to address the possible civil consequences of conviction. It is also not unusual, unfortunately, for one agency to offer assumptions as to the possible outcome before another agency; in truth, all that agency can do is guess. Separate resolutions must be worked out with each relevant agency. Global resolutions are possible only if all relevant agencies are involved.

V. Due Diligence Compliance Review

Given the risks and liabilities for violations of the U.S. export control laws, careful due diligence review of a significant transaction involving an entity with international business is critical. Again, discovery of a violation need not scuttle the deal, but it is important to identify such a violation and affirmatively take corrective and ameliorative action that may not be possible post-acquisition.

The benefit of adequate due diligence review in minimizing liability, ensuring appropriate valuation given the risks involved, lessening delay and disruption of the transaction, and identifying and avoiding future compliance issues justifies the effort. In order to maximize the effectiveness of the review, it is wise to include export and import professionals, as well as financing, contractual, and distribution specialists.

Two overarching questions should be kept in mind during the analysis: first, is this transaction itself compliant with the export control laws and second, is/was the target company compliant with those laws. While both questions can be answered through the same process, their resolution may be very different.

Required Analysis

The full scope of the target company’s international activities (including all partners, affiliates, and foreign subsidiaries wherever located) must be identified. This includes all products and services, as well as all suppliers and vendors, markets and customers, agents, and distribution networks. The acquiring company must completely understand the full range of operation to determine whether the target company:

1 manufactures, distributes or exports controlled items, services or technology,

2 is involved with individuals or entities whose names appear on BIS’s Entity List of weapons proliferators, OFAC’s list of Specially Designated Nationals, or the denied parties lists of BIS and DDTC, and

3 is doing business in restricted countries.[xxxi] Dealings with China, Russia, India, and Pakistan, though not restricted are sensitive and have a high risk of potential liability. The UAE, Hong Kong, Singapore, Malaysia, and other countries identified as transshipment hubs also bear a close look.

The inquiry should focus on (1) the nature of the items or service involved: are they OTS or specially designed in some manner for a particular application; (2) if made overseas, whether they incorporate U.S.-origin components or technology; (3) whether the items or services are listed on the Commerce Control List[xxxii] or U.S. Munitions List;[xxxiii] (4) what the country of ultimate destination is, through which countries the items will pass, what their intended/actual end use is; and (5) who the intended/actual end user will be.

Questions should also focus on the extent of foreign involvement. For example: are foreign persons employed domestically and what is their involvement in any controlled projects; are outside contractors, consultants or outsourcing companies involved and what is being transferred to them in order for them to perform their function; what is the nature of the ownership, control or influence of foreign owners. Practitioners should keep in mind that transfers of technology overseas or domestically to foreign nationals through electronic transmissions, speeches, demonstrations, or website postings are considered exports. Therefore, if it is determined that an item is controlled, all transfers of related technologies to foreign entities should be explored. The company’s website, internet and intranet computer systems, as well as e-mails or faxes should be reviewed as there can be “deemed export” violations even if the item itself never leaves the country.

If a company has dealings in the Middle East with a country that has recognized the Arab League boycott of Israel, its export documents and that of its financing institutions and freight forwarders must be scrutinized for violations of the U.S. anti-boycott laws.[xxxiv] These laws prohibit U.S. companies from entering into agreements to support the boycott and from responding to inquiries about their dealings with Israel or Israeli companies. Requests for such information must be reported to the Department of Commerce. Importantly, all entities in the chain of a prohibited response may be held liable for the response and/or the failure to report the request. The practitioner should be aware that such requests often appear in letters of credit and boilerplate contracts from entities even in countries where the Arab League boycott has officially ended.

The target company’s operations should be examined to understand its corporate structure, governance, process ownership, compliance policies, practices and competencies, corporate culture, economic stability, and financing. The focus should be on the company’s relationships with foreign subsidiaries, the day-to-day involvement of upper management in operations, the financial pressures particular divisions may have faced, and whether there is a culture of “yes” at all costs.

The company’s export compliance practices, program, and licensing history must be thoroughly investigated.

1 Practices: Questions should be raised as to whether the company is aware of the export control laws, whether the laws apply to the company’s activities, and whether the company is in compliance. If licensing requirements apply, inquire as to whether the appropriate licenses were obtained and whether license conditions are satisfied. Review the company’s documents relating to licensing, but also its shipping records for items shipped, appropriately or inappropriately, without a license. With regard to defense articles and services being manufactured or exported, it must be determined whether the company is appropriately registered with the State Department.

2 Program: Because companies that regularly export are expected to maintain an export compliance program, a lack thereof could be a red-flag, and will certainly increase the complexity and intensity of the due diligence review. A company that regularly exports, yet has managed to avoid putting a compliance program into place, will have to convince the government that its export violations were something less than deliberate ignorance or willful blindness.

If the company has an export compliance program, it should be evaluated to ensure that it contains elements that would make it effective, depending on the size and scope of the export business. Guidance is provided on agency websites,[xxxv] but an export compliance program should encompass the following criteria, both in design and implementation.

1) Performance of a risk analysis to determine the need for compliance. It should include a record of classification or other means by which the level of controls for an item was determined.

2) A formal written compliance program. Both the design and a record of its implementation should be included. Any export manuals distributed to employees or available for their review should be examined.

3) Oversight by appropriate senior organizational officials with access to all levels, including corporate executives and counsel.

4) Adequate and regular training on export controls for all employees who may become involved in international operations, such as sales personnel, shipping staff, and financial analysts. An attendance record should be kept of this training as well as some measure of its effectiveness.

5) Adequate screening of customers and transactions against lists maintained by U.S. export control agencies.[xxxvi]

6) Recordkeeping practices that meet requirements of all relevant laws.

7) Existence of an internal system for reporting export violations.

8) Regular internal or external reviews or audits, and a record of the results of reviews and audits.

9) Procedures for remedial actions, such as voluntary disclosures and licensing.

Of course, it is not sufficient to develop such a program, without adequate implementation. When a problem is discovered and a decision is made to disclose the violation to the government, the government is willing to give mitigation credit for an effective compliance program, but only if there is proof of its actual implementation.[xxxvii] Moreover, it will make a difference whether the program was in place before the violation was discovered or whether it was implemented as a result of discovering the violation; credit is given for both, but the former receives a higher level of mitigation, i.e., “great weight.”

3 Licensing history: The licensing paper trail can be extensive and can be found in surprising places within the company. A non-hypothetical example: A vice president of marketing takes it upon himself to obtain a commodity classification (CCAT) that the international sales manager says may provide a negative result. Instead of forwarding the negative CCAT to the international sales department or even the shipping department, the Vice President buries it in his files and allows the illegal shipments to continue. His company is held criminally liable on a theory of corporate knowledge for the Vice President’s secret knowledge of the illegality of the sales.

The entire licensing trail must be obtained, including records of phone calls to agency advice lines, commodity classifications obtained prior to license applications, and licensing decisions. The acquiring company should review records of past enforcement actions, prior disclosures made to agencies and the results thereof, and legal advice obtained as well as the results of internal investigations or audits. The violations giving rise to any investigations, external or internal, should be examined to determine the possibility of recurrence and remediation effectiveness. If there are pending investigations, all records should be obtained — even records of innocuous agency inquiries and outreach as well as records of attendance at export seminars are relevant as they will indicate a level of knowledge of export controls.

Sources of information include all relevant documents going back to original requests for quotes from the customer and to any suppliers or vendors, all shipping documents and correspondence, correspondence with relevant agencies, and any documents pertaining to licensing or permits to export. Export compliance staff, shipping personnel, and sales staff (both domestic and international), agents and distributors, vendors and suppliers are also good sources of information.

The review should also consider the company’s compliance with the laws of its host nation.

VI. Recommended Compliance, Remediation, and Resolution Measures

After the due diligence review is complete, measures may be necessary to bring the transaction into compliance, corrections of past practices may need to be implemented, and questions of liability for violations may need to be resolved.

1. Compliance measures to consider

If the transaction is a takeover or merger with a foreign entity in which assets or ownership will be held in foreign hands, special export licensing and approval may be required from the Department of Commerce, particularly if sensitive technology is involved or the investors or buyers are from high-risk countries. If the company is registered with the State Department, approval for some parts of the transaction will need to be obtained from DDTC.

Approval for the transfer of export licenses may also be necessary. BIS, for example, will require approval of the transfer of export licenses following the sale of the license-holder’s assets, but not for a mere stock sale where the entity remains intact. DDTC has specific procedures for transferring export licenses, beginning with notification within 60 days of the time the decision is made to enter into the transaction if it involves a foreign person and 5 days if only U.S. persons are involved.[xxxviii] Both parties must provide notification. A second notification is required within 5 days of closing, with specific information and certification. A filing must be made to amend licenses and all Technical Assistance Agreements must be amended and a copy of the amendment sent to DDTC within 60 days of closing.

U.S. persons are barred from entering into transactions with certain countries and entities set forth on the various lists maintained by BIS, OFAC, and DDTC. The due diligence review set forth above would expose such transactions and perhaps prevent the deal from proceeding. Alternatively, if the deal proceeds, the safest course would be to cease any such dealings or divest that operation, understanding that if those dealings or operations were illegally conducted by the predecessor company, the successor company could be liable. However, if an acquired company legally conducted those activities through a foreign subsidiary or if the foreign company with such dealings is being acquired and structured as an independent subsidiary, it is possible that the deal could proceed without issue, although it would depend on the acquiring company’s comfort with any potential liability and tolerance for negative press reports surrounding its dealings with prohibited parties and pariah countries. If the foreign subsidiary is completely outside the supervision of the U.S. parent company and involves no U.S. persons, and if it was not created solely to deal with the prohibited parties or sanctioned countries, it may be possible to avoid export control issues. There is no specific guidance, however, as to what level of contact is permitted —certainly integration of IT services, finances, procurement or other global services would raise concerns with BIS, OFAC, DDTC, and the Department of Justice. Whether sufficient isolation is even possible to immunize the acquiring company is an open question.

Finally, an export compliance program should be put into place or a pre-existing program should be reviewed and integrated into that of the parent company.

2. Remediation options

The measures described above can be taken if the due diligence review uncovers no export violations and are simply good business practices to avoid export compliance problems that could arise from international transactions, particularly mergers and acquisitions.

On the other hand, if an export violation is uncovered, steps must be undertaken to correct the problem. To avoid the possibility of independent liability, the illegal activity should cease. It is always worse if a company knowingly inherits an illegal export practice and allows it to continue following acquisition. Disciplinary action or reassignment of the responsible parties can be considered, along with improvements to the compliance program, increased compliance resources for training, hiring an export compliance expert or a reputable outside consulting company, and implementing IT improvements with export software. Senior management should be involved so as to demonstrate a renewed culture of compliance.

The next step is an internal investigation of the violation to discern the extent of the activity. At the outset, consideration should be given to whether the investigation should be undertaken by internal employees or by an independent third-party. Investigations conducted by the latter may be viewed by regulatory enforcement authorities as more robust and impartial. If the independent third-party is a law firm, work product that is produced during the investigation will also fall within the attorney-client privilege.

Oftentimes, diligent investigation will uncover related violations, such as exports of different items or to different destinations, illegal transfers of technology or “deemed exports” related to the initial item, and antiboycott violations. The possibility of violations of FCPA, money laundering laws, and disclosure requirements should also be considered in the internal investigation.

Finally, data privacy and bank secrecy laws applicable in many non-U.S. jurisdictions, as well as restrictive employment laws, must be taken into account in designing both the scope and methodology of the investigation. Companies operating internationally should take care to ensure that their good faith efforts to cooperate with authorities in one jurisdiction do not result in violations of law in another. Equally important, international companies need to be careful not to make representations to U.S. authorities regarding cooperation that they may be prohibited from fulfilling under other applicable laws. It is essential that any such conflicts of law be identified early in this process and proactively managed.

Once the full extent of non-compliant conduct is identified, corrective measures should be taken such as obtaining accurate classifications and licenses, if appropriate. False statements made on documents filed with the government, such as shipping documents or licensing applications, may need to be corrected.[xxxix] In doing so, however, one is almost ensuring government discovery of the violation. Accordingly, whether to make a voluntary disclosure to the relevant government agency must be considered, as discussed below.

3. Resolution of liability

Although there is no requirement to disclose past violations of the export control laws, it may be advantageous to do so. Agencies will take disclosure into account in evaluating the violations and whether and at what level to assess penalties.[xl] The full benefits are available only if the agency has not already learned of the violations, an increasing likelihood given the competition’s incentive to level the post-acquisition playing field by tipping the government, increased investigative resources with the addition of the FBI[xli] and the recently heightened focus of DOJ,[xlii] expanded law enforcement tools under the PATRIOT Act, and increasing international law enforcement cooperation.

Moreover, the failure to disclose may call into question a company’s reliability and trustworthiness as an exporter, and may subject that company’s license applications to heightened scrutiny by DDTC (with attendant delays and perceived inability to honor contracts). Failure to provide notice in time for an illegal shipment to be stopped through prompt government action, if the company knows of the on-going shipment, may constitute more serious violations.

Besides the risk of discovery, other considerations include the potential penalties without disclosure, including those for any additional charges relating to a cover up of the original violation. In addition to the civil and criminal penalties specified above, consider the cost of litigation, the disruption to business by the government investigation, and damage to business relationships.

The benefit of voluntary disclosure arises both from containment and minimization of penalties, but also through the certainty derived therefrom. Disclosing the violation and resolving the issue of liability and potential penalties provides a more accurate valuation of the target company and revenue projections moving forward. As a result, the parties can consider whether the purchase price should be renegotiated, whether the transaction should be restructured as a stock sale instead of an asset sale, whether an indemnification clause is necessary, whether an escrow arrangement should be created to handle financial liability, whether the closing should be postponed or whether the transaction should move forward at all.

VI. Conclusion

The implication of export control restrictions must be considered in contemplating significant transactions with foreign companies. Careful review and accurate assessment of the potential risks and liabilities is essential for the companies involved. It is also critical for the other companies involved in such transactions, such as investment banks, accounting firms, and other entities to ensure proper valuation and pricing. Early involvement of knowledgeable export counsel in a transaction to identify and resolve potential risks will prevent further mistakes from being made.

Endnotes

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[i] The author is grateful for the assistance of Clifford Chance attorneys David Dibari, Jason D’Angelo, Adam Klauder, and Michael P. Holland for their thoughtful review and invaluable suggestions.

[ii] This familiar construct, called the “past exonerative tense,” by New York Times writer William Schneider, is generally used to obfuscate accountability in other contexts. See, e.g., Ronald Reagan, Address before Joint Session of Congress on State of Union (Jan. 27, 1987); Alberto Gonzalez, News Conference (Mar. 13, 2007). As will be explained below, in the context of successor liability, it appropriately places mistakes, but not accountability, elsewhere.

[iii] Besides those specified in the text, other significant laws relating to export controls include the Trading With the Enemy Act (TWEA), 50 U.S.C. app. §§ 1-44; Antiterrorism & Effective Death Penalty Act of 1996, Pub. L. 104-132, 110 Stat. 1214-1319; Toxic Substances Control Act, 15 U.S.C. §§ 2601-2629; Foreign Corrupt Practices Act, 15 U.S.C. § 78dd-1 and 78dd-2; Atomic Energy Act of 1954, 42 U.S.C. § 2011-2297g-4 and 10 C.F.R. parts 110 and 810; Endangered Species Act of 1973, 16 U.S.C. §§ 1531-44.

[iv] Bureau of Industry & Security, Department of Commerce; Directorate of Defense Trade Controls, Department of State; Office of Foreign Assets Control, Department of Treasury; Immigration & Customs Enforcement and Customs & Border Protection, Department of Homeland Security; Federal Bureau of Investigation; Department of Justice; Defense Criminal Investigative Service; Defense Threat Reduction Agency, Department of Defense; Office of International Programs, U.S. Nuclear Regulatory Commission; Office of Fossil Energy, Department of Energy; International Affairs Office, U.S. Fish & Wildlife Service, Department of Interior; Drug Enforcement Administration; Food & Drug Administration; International Affairs, Environmental Protection Agency.

[v] 15 C.F.R. §§ 730-744.

[vi] 22 U.S.C. §§ 2778-2799.

[vii] 22 C.F.R. §§ 120-130.

[viii] 50 U.S.C. §§ 1701-1706.

[ix] See Foreign Assets Control Regulations at 31 C.F.R. part 500.

[x] See the Syria Accountability and Lebanese Sovereignty Act of 2003, 22 U.S.C. § 2151, as expanded 69 FR 26766 (May 14, 2004).

[xi] 22 C.F.R. § 122.1; 22 C.F.R. part 129.

[xii] See 22 C.F.R. § 122.4. Intended ownership or control changes involving foreign persons require 60-day advance notice and notification within five days of closing is also required. Given these tight deadlines during fast-paced negotiations, it is necessary to involve an export compliance expert from the beginning of the transactions. There is also a legal process governing clearance of foreign investment under the Exon-Florio Amendment and the Foreign Investment and National Security Act of 2007, which is administered by the Committee on Foreign Investment in the United States.

[xiii] See, e.g., OFAC Entities List, 31 C.F.R. ch. V, apps. A,B,C; BIS Entity List, 15 C.F.R. part 744 (Supp. No. 4); BIS Denied Persons List, 15 C.F.R. part 764 Sch. No. 2; DDTC Debarred Parties List, 22 C.F.R. § 127.7.

[xiv] 15 C.F.R. § 734.2 contains the regulations dealing with “deemed exports” under the EAR. There are also “deemed export” provisions in the ITAR at 22 C.F.R. §§ 120.17 and 125.2.

[xv] Documents relating to this case, In the Matter of Sigma Aldrich Business Holdings, Inc. et al., Case Nos. 01-BXA-06, 01-BXA-07, and 01-BXA-11, including the ALJ’s decision, can be found at .

[xvi] See, e.g., “BIS Export Enforcement: Major Cases List, August 2007,” at 11, available at (detailing WesternGeco LLC’s $2,890,600 administrative penalty, which was paid by its parent company, Baker-Hughes, for failure to follow conditions placed on export licenses issued for mapping equipment exported to China); “Symmetricom, Inc. Settles Charges of Unlicensed Exports,” BIS Press Release (Oct. 28, 2004) available at (noting that Symmetricom was held liable for predecessor’s unlicensed exports and fined $35,500); “Saint-Gobain Settles Charges of Unlicensed Exports,” BIS Press Release (Jun. 25, 2004) available at (successor held liable for predecessor’s violations and fined $697,500); “Rockwell Automation Settles Charges of Unlicensed Exports,” BIS Press Release (Mar. 14, 2005) available at (noting that Rockwell was held liable for predecessor’s violations and its own and fined $46,700); “GE Ultrasound and Primary Care Diagnostics, LLC Settles Charges of Unlicensed Exports,” BIS Press Release (Oct. 18, 2004) available at (noting that GE Ultrasound and Primary Diagnostics was held liable for predecessor’s violations and its own and fined $32,500); “South African Company Settles Charges of Unlicensed Resale of Cyanides to Unauthorized End Users,” BIS Press Release (Nov. 17, 2005) available at (noting that ProChem (Proprietary), Ltd., as successor corporation to Protea Chemicals (Proprietary), Ltd. agreed to pay civil penalties totaling $1.54 million pertaining to unauthorized sales); see also “Voluntary Self Disclosure Cases FY2006,” available at (noting that Cerac, Inc. was held liable as a successor and fined $297,000 and UGS Corp. was held liable as successor to Structural Dynamics Research Corp and fined $57,750).

[xvii] Presentation by Wendy Wysong, Deputy Assistant Secretary for Export Enforcement BIS, 2005 AAEI Annual Conference (May 23, 2005).

[xviii] DDTC’s focus on remediation and compliance in this context is also illustrated by another successor liability case in which DDTC charged both General Motors and General Dynamics for violations committed by General Motors’ subsidiaries before they were acquired by General Dynamics. General Dynamics had discovered the violations during its due diligence review and made a voluntary disclosure to DDTC. Of the $20 million fine imposed, General Dynamics’ share was only $5 million which it was to spend on improving its internal compliance practices.

[xix] The Export Administration Act (EAA), 50 U.S.C. app. §§ 2401-20, pursuant to the EAR is not permanent legislation and is currently in lapse. During lapse periods, the EAR are kept in effect by Presidential Order under IEEPA. Exec. Order No. 13222, Aug. 17, 2001, 66 FR 44025, Aug. 22, 2001 (3 C.F.R. Comp. 783 (2002)), as extended by the Notice of Aug. 15, 2007, 72 FR 46137, Aug. 16, 2007. During these periods, penalties for violations of the EAR are limited to those set forth in IEEPA as specified above. It should be noted, however, that for violations committed prior to March 9, 2006, when IEEPA was amended, the civil fine is $11,000. H.R. 3199, USA PATRIOT Act Improvement and Reauthorization Act of 2005, Pub. L. 109-177, § 402(1), (2). During the rare periods when the EAA is in effect (the last period ended August 20, 2001), civil penalties can be as high as $120,000 for national security violations. Finally, it should be noted that there is legislation pending that would renew the EAA and raise the penalties still higher. A bill introduced in the Senate on August 3, 2007, S. 2000, would raise civil penalties to $500,000 per violation and criminal penalties for individuals to $1 million and for corporations to $5 million or ten times the value of the export. The Senate also passed legislation on June 26, 2007, to amend IEEPA that would raise the civil penalty to $250,000 or twice the value of the exports and the criminal penalties to $1 million for individuals and corporations. See S. 1612, International Emergency Economic Powers Enhancement Act.

[xx] The penalties set forth above are those available under the alternative fine provision, 18 U.S.C. § 3571. Under IEEPA, the maximum criminal monetary fine is $50,000. Accordingly, prosecutors generally seek the alternative fines. For violations committed before March 9, 2006, imprisonment is limited to ten years. When the EAA is in effect, criminal penalties are $250,000 for individuals and for corporations, the greater of $1 million or five times the value of exports involved.

[xxi] 22 U.S.C. § 2778(e); 22 C.F.R. § 127.7.

[xxii] 22 U.S.C. § 2778(c); 22 C.F.R. § 127.3. The alternative fine provision, 18 U.S.C. § 3571, is also available.

[xxiii] 22 C.F.R. § 126.7(a), 127.7.

[xxiv] See supra endnotes xix and xx.

[xxv] 15 C.F.R. § 764.3(a)(2).

[xxvi] 15 C.F.R. § 766.24(b)(3).

[xxvii] See 15 C.F.R. § 766.25; 22 C.F.R. § 12.7(a)(6).

[xxviii] 15 U.S.C. § 78dd-2.

[xxix] 22 U.S.C. § 2778(g); 22 C.F.R. § 120.27.

[xxx] 15 C.F.R. § 766.25.

[xxxi] Countries for whom certain activities are restricted currently include: the Balkans, Belarus, Burma, Cote d’Ivoire, Cuba, Democratic Republic of Congo, Iran, Iraq, Liberia, North Korea, Sudan, Syria, and Zimbabwe. The countries and the extent to which the restrictions apply frequently change so the OFAC website () should be checked regularly.

[xxxii] 15 C.F.R. § part 774 (Supp. No. 1).

[xxxiii] 22 C.F.R. § part 121.

[xxxiv] 15 C.F.R. § part 760. The antiboycott laws cover U.S. citizens and business entities organized under U.S. law, U.S. branches or subsidiaries of foreign companies, foreign nationals in the United States foreign operations of U.S. concerns “controlled-in-fact” by U.S. concerns but not U.S. citizens residing outside the U.S. employed by non-U.S. persons. Id. at 760.1. For an excellent discussion of the antiboycott laws, see Edward O. Weant III, “An Overview of U.S. Antiboycott Law and Regulations,” PLI Coping with U.S. Export Control Laws at 145 (2006).

[xxxv] See, e.g., ; .

[xxxvi] See supra endnote xi.

[xxxvii] See, e.g., 15 C.F.R. § part 766 (Supp. No. 1 III.B.2) (noting that the BIS Penalty Guidelines provide that BIS will consider whether the party has an effective compliance program and whether its overall export compliance efforts have been of high quality). 15 C.F.R. § part 766 provides that “[i]n determining the presence of this factor, BIS will take account of the extent to which a party complies with the principles set forth in BIS’s Export Management System Guidelines (EMS). Information about the EMS Guidelines can be accessed through the BIS Web site at . In this context, BIS will also consider whether a party’s export compliance program uncovered a problem, thereby preventing further violations, and whether the party has taken steps to address compliance concerns raised by the violation, including steps to prevent reoccurrence of the violation, that are reasonably calculated to be effective.”

[xxxviii] 22 C.F.R. § 122.4.

[xxxix] 15 C.F.R. § 764.2(g)(2)(requiring disclosure to BIS of changes of “any material fact or intention from that previously represented, stated or certified); 50 U.S.C. app. § 2410(b)(2)(requiring disclosure to the Secretary of Defense of actual knowledge that licensed goods are being used by a controlled country for military or intelligence purposes).

[xl] For detailed information concerning BIS Voluntary Self-Disclosures (“VSDs”), see 15 C.F.R. § 764.5 and Wendy Wysong, “Voluntary Self-Disclosure at BIS,” (Oct. 11, 2006) (available at ). For information concerning VSDs to the DDTC, see 22 C.F.R. § 127.12.

[xli] 28 C.F.R. § 0.85(d), 69 FR 65,542 (Nov. 15, 2004) (granting the FBI the authority to investigate any criminal violations of law, including violations of the AECA, EAA, TWEA, and the IEEPA, in certain foreign counterintelligence areas).

[xlii] See Mark A. Kirsch & Jason A. D’Angelo, “Export Control Cases on the Rise,” The National Law Journal (July 23, 2007); Chitra Ragavan, “Justice Department to Focus on Technology Transfer,” U.S. News & World Report (Feb. 20, 2007).

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