Past compliance with the full range of international trade, export controls, and economic sanctions laws and regulations should be a critical element of due diligence in mergers and acquisitions. Unfortunately, trade compliance is often overlooked. As in other areas of law, successor liability has been applied repeatedly to hold acquiring companies liable for export and import violations that occurred before the acquisition. Penalties for violations of these laws can exceed $1,000,000 per violation. In addition, remedying past violations can be time consuming and could potentially restrict the company's future ability to export and contract with the government. As such, any company contemplating a merger or acquisition should ensure they have a framework in place to screen a target company's export and import activities.
Relevant Government Agencies and Successor Liability
Government agencies responsible for export and import laws include the State Department's Directorate of Defense Trade Controls ("DDTC"), the Commerce Department's Bureau of Industry and Security ("BIS"), the Treasury Department's Office of Foreign Assets Control ("OFAC"), and U.S. Customs and Border Protection ("CBP"). DDTC is responsible for administering the International Traffic in Arms Regulations ("ITAR"), which regulate exports of defense articles, defense services, and technical data. BIS administers the Export Administration Regulations ("EAR"), which control items classified under the Commerce Control List ("CCL"), primarily including dual-use goods (i.e., items that have both civil and military applications). OFAC is responsible for implementing the various U.S. economic sanctions programs. Finally, CBP regulates and facilitates imports by collecting import duties and enforcing U.S. import regulations.
All of these agencies have acknowledged and applied the principle of successor liability, holding acquiring companies liable for the misconduct of acquisition targets, even where the violative activity occurred before the closing of the merger or acquisition. While successor liability is not necessarily created merely by the sale of a company's assets or stock, there are many situations where the sale of a company's assets or stock creates successor liability. These include when: i) there is an agreement, either explicit or implicit, to assume liability; ii) the transaction is considered a de facto merger; iii) the transaction is a mere continuation of the predecessor's business; and iv) the transaction was fraudulent and used to escape liability. A de facto merger occurs when a company sells all of its assets and then dissolves. A mere continuation applies when there is a retention of the same employees, supervisory personnel, production facilities, and location; the same products are produced; the same business name is retained; the same assets and business operations exist; and/or the new company holds itself out to the public as a continuation of the previous corporation.
The Evolution of Successor Liability
Successor liability has long been applied to both import and export violations. With regard to import law, for example, the Court of International Trade ("CIT") has found an acquiring company liable for the wrongdoings of the target company it had acquired under the "mere continuation" principle. Specifically, in United States v. Adaptive Microsystems, the court decided this question without even considering whether successor liability applies to import cases. Here, Adaptive Microsystems, LLC went bankrupt and was acquired by another company. The acquiring company continued to use the Adaptive Microsystems name, and also kept most of Adaptive Microsystems' employees. The CIT determined that the post-acquisition company was similar enough to the pre-acquisition company and ordered the acquiring company to pay the unpaid duties of the former company.
More recently, in the 2015 case United States v. CTS Holding, LLC, TJ Ceramic Tile and Sales Import, Inc. ("TJ") began importing several different types of granite and stone polishing machines between August 6, 2004 and September 14, 2006. In 2006, CBP initiated an investigation against TJ and determined that they had misclassified the imports. TJ was ordered to pay duties arising from the misclassifications. Before paying the duties, TJ was sold to CTS Holding, Inc. ("CTS") in 2011. In 2012, CBP moved against CTS to recover TJ's unpaid fees. The CIT held CTS liable pursuant to 19 C.F.R. § 1592 by noting "the word 'person' in § 1592 properly includes corporations and their successors and assigns."
Successor liability is even more commonly found with respect to export violations. In a leading 2002 case, Sigma-Aldrich Corporation ("Sigma") purchased the assets of Research Biochemicals Limited Partnership ("RBLP"). Sigma completed its purchase of RBLP after BIS had alleged that RBLP exported tetrodotoxin citrate without obtaining required export licenses. After the acquisition of RBLP was concluded, BIS alleged that Sigma was now liable for these violations. Sigma appealed to an administrative law judge ("ALJ"), who held that Sigma was liable under the principle of successor liability. Sigma ultimately settled the charges for $1.76 million.
In 2010, BIS imposed the maximum (at the time) civil penalty of $250,000 per violation against Sirchie Acquisition Corporation ("Sirchie"). Here, Sirchie acquired a company that had violated a denial order against its CEO. Sirchie was fined $25 million for the 10 violations that arose out of violation of the denial order.
Similarly, DDTC has found successor liability in ITAR violations. In 2009, Qioptiq S.a.r.L. ("Qioptiq") agreed to pay $25 million to resolve violations by a company it acquired. In this case, the company acquired by Qioptiq had exported night vision equipment without an ITAR license. DDTC suspended $10 million of the penalty in light of compliance costs already incurred by Qioptiq, as well as the cost of future government mandated compliance.
Elements of Trade Compliance Due Diligence Review
Because courts and government agencies will not hesitate to
apply the principle of successor liability to an acquiring company,
it is important to do appropriate due diligence before consummating
a transaction. While not an exhaustive list, the following items
ought to be included on any due diligence questionnaire or
- Review the target company's current export compliance procedures. These include current product classifications, how products are classified under the CCL and USML, risks based on the end-use and the end-users, and risks arising from export destinations.
- Review the target company's current import compliance procedures. Make sure the products have proper markings and classifications.
- For both imports and exports, ensure the target company maintains records.
- Determine whether foreign nationals are employed by the target company and identify their nationalities. If these foreign nationals have access to information controlled under the CCL or USML, that transfer would be a deemed export and a license would be required. Make sure the company has deemed export licenses in place if necessary.
- Ensure the target company has policies in place to ensure compliance with applicable OFAC sanctions. These sanctions are generally applied on a country by country basis, so acquiring companies should review product types, countries of destinations, and end-uses and end-users to determine which sanctions programs are applicable.
- Determine whether the target company has any past violations with DDTC, BIS, or OFAC.
- Determine whether the target company requires its employees to be trained on import and export law. This includes online or in-person training sessions, manuals, and management support of the overall compliance program.
- Review the target company's Foreign Corrupt Practices Act ("FCPA") compliance program. The FCPA makes it unlawful to bribe foreign government officials to obtain or retain business. The Department of Justice ("DOJ") is responsible for FCPA enforcement. As such, this program should cover all the entities' business partners including agents, consultants, representatives, etc. Determine if employees have received FCPA compliance training and whether there have been previous FCPA related investigations.
- When a transaction could result in the control of a U.S. business by a foreign person, parties should consider whether to file a voluntary notice of the transaction with the Committee on Foreign Investment in the United States ("CFIUS"). While these filings are voluntary, CFIUS has the authority to review covered transactions and may block or unwind these transactions.
- Review the target company's policies related to cloud computing. The transfer of files controlled by the CCL or USML may require a license. Make sure the target company has acquired licenses where necessary and has procedures in place to determine whether a license is necessary.
This type of due diligence will help the acquiring company determine the likelihood of whether or not the target company has any outstanding export or import violations. Additionally, this information can be used by the acquiring company to determine what needs to be done to strengthen the target's export and import compliance programs after the merger or acquisition. The issues identified above are an important part of any export or import compliance program even after a merger or acquisition.
In sum, any company considering a merger or acquisition should ensure they do their thorough due diligence, as any violations committed by the target company can prove costly for the acquiring company.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.